Despite growing 7% MoM, the palm oil inventory for Sep-13 which came in at 1.78m mt for Sep-13 was 6% below market expectation of 1.90m mt. Palm oil production growth also came in weaker than expected at 10% MoM (against consensus estimate of 15% growth MoM). In our view, consensus may have underestimated the impact of tree stress after the bumper harvest last year. Meanwhile, exports registered healthy growth of 5% MoM to 1.61m mt due to better demand from India and Pakistan. Overall, we believe the latest numbers are positive to CPO prices as the demand growth MoM has been able to absorb the seasonal supply increase.

We expect Malaysia to benefit from Indonesia’s successful implementation of its biodiesel policy. Note that in Sep-2013, Malaysia import of palm oil remained very low at 19,483 mt or 67% below the 2012 monthly average of 58,900 mt. This should be taken as a sign that Indonesia has successfully implemented its biodiesel plan. As Indonesia is the world’s biggest palm oil producer, more usage locally should lead to lesser quantity available for export. This will also lessen export competition with Malaysia and is positive to CPO prices in the long-term.

Maintain NEUTRAL on the sector with our current CY13-CY14 average CPO price forecasts of RM2,400/mt-RM2,700/mt unchanged. Our top pick is CBIP (OP; TP: RM3.18). We also have OUTPERFORM calls on PPB (TP: RM15.20) and TSH (OP; TP: RM2.56). Maintain MARKET PERFORM on SIME (TP: RM9.80), IOICORP (TP: RM5.40), KLK (TP: RM21.50), FGVH (TP: RM4.55), GENP (TP: RM9.35), IJMP (TP: RM3.00) and UMCCA (TP: RM7.30). Maintain UNDERPERFORM on TAANN (TP: RM3.55) due to its high cost issue.

Inventory level is 6% below market expectation. Malaysia Sep-2013 stocks level was higher by 7% MoM at 1.78m which is below the market estimate of 1.90m mt but close to our expectation of 1.75m mt. Palm oil production growth came in weaker than expected at 10% MoM (against consensus estimate of 15% growth). In our view, the consensus view may have underestimated the impact of tree stress after the bumper harvest last year. This is positive to CPO prices as the additional supply is being absorbed by increasing demand thus avoiding inventory level spike.

Exports registered good growth of 5% MoM to 1.61m mt due to better demand seen in India (+90% MoM to 292k mt) and Pakistan (+29% MoM to 133k mt). We believe demand from India has returned as the Indian rupee has appreciated by ~10% from its lowest point on 28-Aug. As for Pakistan, we think its traders may have resumed buying after two consecutive drops in purchase, to replenish their stocks level. Good demand is also noticed in the first 10 days of Oct-2013 as palm oil exports have grown 17% MoM, according to cargo surveyor data. Overall, increasing demand of palm oil globally should bode well for CPO prices.

Malaysia to benefit from swift Indonesia biodiesel plan implementation. Note that in Sep-2013 Malaysia import of palm oil remained very low at 19,483 mt or 67% below 2012 monthly average level of 58,900 mt. This should be taken as a sign that Indonesia has successfully implemented its biodiesel plan. We reckon that higher local palm oil usage in Indonesia should curb the quantity available for export and hence lessen the competition with Malaysia. In the long run, this is positive to CPO prices and benefits both countries.

Looking ahead, we expect Oct-13 inventory to increase by 4% MoM to 1.85m mt. On the supply side, we have assumed a 2% increase MoM to 1.95m mt in line with seasonal trend. On the demand side, exports should grow 5% MoM as we expect stock-up activity in India ahead of the Deepavali Festival which falls on 3 Nov. We do not think that the 4% increase in inventory is a major concern as CPO prices should be supported by strong crude oil prices and weak Ringgit.

OUTPERFORMs on CBIP (Top Pick), PPB and TSH. We like CBIP (OP; TP: RM3.18) due to its superior dividend yield of 4.2% (higher than all planters under our coverage) and its steady margin improvement historically in its palm oil mill construction division despite the volatile CPO prices. In addition, CBIP balance-sheet is very solid with net cash of RM128m as of end-Jun. We also like PPB (OP; TP: RM15.20) as it stands to benefit from the recent Indonesia’s plan to raise the biodiesel proportion in fuel to 10.0% (from 7.5%) as its earnings contribution from Wilmar should increase. Lastly, we like TSH (OP; TP: RM2.56) for its strong earnings growth despite low CPO prices as it is supported by its structural advantage of high FFB volume growth and its downstream JV with Wilmar in Sabah.

Source: Kenanga