According to Reuters, the United States Food and Drug Administration (USFDA) has proposed banning artificial transfats in processed food ranging from cookies to frozen pizza due to the risk of heart disease. Note that the majority of hydrogenated oils in US are derived from soybean oil (SBO). As palm oil is the most natural, preferable and affordable substitute to hydrogenated SBO, we reckon that CPO prices should be boosted if the USFDA proposal is finalized. Our channel check shows that palm oil demand in US could increase by about 2.0m mt in order to replace the hydrogenated SBO. In the long run, we think that the current CPO-SBO discount of about USD110/mt will diminish and this should theoretically allow CPO prices to trade on par with SBO at RM2850/mt. We maintain our NEUTRAL call on the sector at this juncture with our current CY13-CY14 average CPO price forecasts of RM2,400/mt-RM2,700/mt unchanged. We may upgrade our sector call to OVERWEIGHT depending on the final USFDA ruling outcome. We expect all planters to benefit from better CPO prices if the USFDA proposal is finalized. However, planters with additional fundamental strength of higher FFB growth should benefit more. These include TSH (OP; TP: RM2.56), GENP (MP; TP: RM9.35) and IJMP (MP; TP: RM3.00). While we have MARKET PERFORM calls on GENP and IJMP currently, we may revise our Target Price upwards subject to the outcome of final USFDA ruling.

Transfats to be banned in the United States (US)? According to Reuters, the USFDA has proposed banning artificial transfats in processed food ranging from cookies to frozen pizza due to the risk of heart disease. The news portal also quoted USFDA stating that partially hydrogenated oils (the primary dietary source of trans fats) have been shown to raise "bad" cholesterol. Reuters also mentioned that the USFDA proposal is subject to a 60-day public comment period in which food companies are expected to outline how long they expect it to take them to reformulate products. If the proposal becomes final, partially hydrogenated oils would be considered food additives and would not be allowed in food unless authorized by health regulators. Note that majority of hydrogenated oils in US is derived from SBO.

Palm oil prices should be boosted if the USFDA proposal is approved. Assuming the approval materializes, demand for palm oil is poised to increase in the US as it will be the most natural, preferable and affordable substitute to hydrogenated SBO. Note that palm oil does not need to go through the hydrogenation process as it has the highest melting point of 35°C among all vegetable oils. Hence, palm oil demand in US could increase by about 2.0m mt in order to replace the hydrogenated SBO based on our channel check. In the long run, this will be positive to CPO prices as the current CPO-SBO discount of about USD110/mt diminish.

All planters to benefit but the greatest impact should be on TSH, GENP and IJMP. We believe all planters should benefit from higher CPO prices if the USFDA proposal is finalized. However, our early estimate shows that average CPO prices for 2013 may only increase by another RM50 to RM2750. Hence, potential FY14E earnings impact may be minimal in the range of 2%-6%. Based on our estimate, we think current share price for big cap planters are already reflecting Fwd. PER in the range of 16x-23x and this is close to planters’ peak valuation of 20x-24x. Note that such scenario of high Fwd. PER was caused by stable local planters’ share prices despite a significant decline in consensus Fwd. EPS in line with lower CPO prices estimate.

However, American Soybean Association (ASA) responded strongly by stating that “We have concerns that if the USFDA were to finalize this determination, food processors may be pressured to replace remaining partially hydrogenated oils with those high in saturated fat such as palm or coconut oils, which would not be a good outcome for consumers”. However, our channel check shows that it is still arguable among the experts whether saturated fat from palm oil is bad for health. Excluding the saturated fats issue, palm oil is actually rich in nutrients such as beta-carotene, alpha-carotene, vitamin E tocotrienols and other carotenoids, which act as super-antioxidant that helps reduce cancer risks. 

Source: Kenanga