We are upgrading our call on plantation sector to OVERWEIGHT with CY2014 CPO prices increased to RM2800/mt (Previously RM2700/mt). The RM100/mt increase is due to lower end-2014 inventory level estimate by 30% to 1.60m mt (from 2.30m mt previously). In the short term, we believe Malaysia stocks level should have peaked in Nov at 1.98m mt and we expect it to decline by 2.8% MoM to 1.92m mt in Dec. More importantly, we expect the downtrend in inventory to be sustained throughout 1Q2014 and this should allow CPO prices to continue appreciating up to RM2900/mt by Mar-2014. In our view, plantation company earning is now at an inflection point as 4Q13 average CPO price is poised to recover YoY for the first time after 8 consecutive quarters of decline YoY. This should lead to the similar trend in plantation company earnings. Beyond 4Q134, we expect the trend of earnings recovery to last throughout 2014 as we believe CPO prices should improve YoY to RM2800/mt from the low base of RM2400/mt in 2013. Among the big caps, we have upgraded our call to OUTPERFORM for both SIME (New TP: RM10.30; Old TP: RM9.75) and KLK (New TP: RM26.10; Old TP: RM24.80). We have also increased our Target Price for PPB (New TP: RM16.60; Old TP: RM16.50; Maintain OP), FGVH (New TP: RM4.75; Old TP: RM4.55; Maintain MP), GENP (New TP: RM10.00; Old TP: RM9.85; Maintain UP), IJMP (New TP: RM3.62; Old TP: RM3.25; Maintain MP), TAANN (New TP: RM5.00; Old TP: RM4.85; Maintain OP), UMCCA (New TP: RM7.50; Old TP: RM7.30; Maintain MP) and CBIP (New TP: RM3.60; Old TP: RM3.18; Maintain OP). For Top Picks, we like IOICORP (OP; TP: RM6.50) for big cap planters and TSH (OP; TP: RM3.38) for mid cap planters.

2014 average CPO price assumptions increased by RM100/mt or 4% to RM2800/mt mainly on lower inventory level estimate in end-2014. Note that we have lowered our end-2014 inventory level estimate by 30% to 1.60m mt (from 2.30m mt previously). Main reason for the significant decline in inventory is due to expected lower palm oil import (POI) in 2014. As it is, POI for 11M13 already declined by 0.78m mt or 60% YoY to only 0.53m mt (as compared to 11M12 level of 1.30m mt). Putting into perspective, the impact of the reduction of 0.78m mt of palm oil import into Malaysia is significant as we think this is the key factor that has removed 30% of the peak inventory of 2.62m mt inventory in Malaysia on Dec-2012. Going forward, we believe that swift Indonesia biodiesel program should cause POI to decline by another 55% to only 0.24m mt in 2014. This will lift CPO prices higher to average of RM2800/mt in 2014.

Malaysia stocks level should have peaked in Nov. Malaysia stocks level grew 7.1% MoM to 1.98m mt and this came in within market estimate range of 1.96m-1.98m mt. However, we think inventory should have peaked as we estimate that Dec-13 inventory will decline by 2.8% MoM to 1.92m mt. The main reason for the decline will be the seasonally observed sharp 10% decline in production in December based on historical 10-year production trend. We believe that the downtrend in inventory can be sustained throughout 1Q2014 and this should allow CPO prices to continue appreciating up to RM2900/mt by Mar-2014.

Earnings is now at an inflection point. For the first time after 2 years, 4Q13 average CPO price is poised to recover YoY. As it is, average CPO prices so far in 4Q13 is RM2521/mt or 3% higher than the 4Q12 level of RM2465/mt. While the 3% increase may be small, the change in direction from successive 8 quarters of earnings decline YoY to earnings growth of at least 10% chould act as a catalyst for the plantation sector. We expect the trend of earnings recovery to last throughout 2014 as we believe CPO prices should improve YoY to RM2800/mt from the low base of RM2400/mt in 2013.

Higher biodiesel mandate in Argentina positive to CPO prices. About one week ago on 2-Dec-2013, Argentina Government has announced its plan to boost the mandatory biodiesel blend to 10% from the current 8%. We expect the news to be supportive to soybean oil (“SBO”) prices as it should raise demand for soybean oil domestically in Argentina from 0.88m mt in 2013 to roughly 1.05m mt in 2014 (based on Oil World estimate). We are positive on the news as CPO prices should benefit indirectly from higher SBO prices as both are usually used as a substitute to each other.

Beware of El Nino threat in 2H14. In its latest forecast published on 5-Dec-2013, US National Climate Prediction Centre (NCPE) has mentioned that “while current forecast probabilities are still greatest for ENSO-neutral by mid-summer, there is an increasing chance for the development of El Nino. In addition, we gather that there is approximately 45% probability that El Nino may emerge in 2H14 (July 2014-Sep 2014). At this juncture, we have not factored in the possibility of El Nino into our forecast. However, we wish to highlight that CPO prices may be boosted to above RM3000/mt if El Nino happens. As El Nino will cause continuous dry season, palm trees FFB production may be affected significantly and in the worstcase scenario, up to 30% decline in production.

Sector upgraded to OVERWEIGHT; Upgrade both SIME and KLK to OUTPERFORM. Among the big caps, we have upgraded our call on both SIME (New TP: RM10.30) and KLK (New TP: RM26.10) to OUTPERFORM as we believe their earnings should improve significantly in line with better CPO prices. Our big cap Top Pick is IOICORP (OP; TP: RM6.50) as we believe its valuation should rerate higher post its demerger exercise with IOI Properties. As for mid cap Top Pick, we like TSH (OP; TP: RM3.38) as it should benefit more from recent CPO prices increase due to its high FFB growth.

Source: Kenanga