We recently upgraded our sector call to OVERWEIGHT (11-Dec-2013) as we expect CPO prices to rise in CY2014 to an average of RM2800/mt or 17% higher than the expected CY2013 average of RM2400/mt. Our bullish view on CPO prices are premised on: (i) sustained strong demand from Indonesia biodiesel industry, (ii) stocks level in Malaysia should have already peaked and continue to decline throughout 1Q14, and (iii) QE tapering is actually positive to CPO prices, if materialise, as it will increase its competitiveness against soybean oil due to a weaker Ringgit. As a result of better CPO prices, we think that planters’ earnings are at an inflection point with quarterly results expected to show significant improvement YoY, starting from 4Q13 onwards and last throughout CY2014.

For big cap planters, our top pick is IOICORP (OP; TP: RM4.95). After the recent demerger with its property division, IOICORP has emerged as the biggest non-GLC listed plantation company in Malaysia with pure plantation exposure in both upstream and downstream activities. For mid cap planters, our top pick is TSH (OP; TP: RM3.38) due to its superior FFB growth which will provide leverage exposure to better CPO prices. We also have OUTPERFORM on SIME (TP: RM10.30), KLK (TP: RM26.10), PPB (OP; TP: RM16.60), TAANN (TP: RM5.00) and CBIP (TP: RM3.60). Maintain MARKET PERFORM for FGV (TP: RM4.75), IJMP (TP: RM3.62) and UMCCA (TP: RM7.50). Lastly, we maintain our UNDERPERFORM call on GENP (TP: RM10.00) due to its stretched valuation.

MPOB data showing good demand from Indonesia biodiesel industry so far. We believe that the most efficient and transparent way to ascertain Indonesia biodiesel demand will be from MPOB data of palm oil imports (POI) into Malaysia. This is assuming that almost all of POI into Malaysia is from Indonesia. In the month of August when Indonesia announced plans to raise its biodiesel admixture to 10.0% (from 7.5% currently), POI tumbled 88% YoY to only 7,533 mt (the lowest in almost 7 years). This trend of significantly lower POI YoY into Malaysia persisted up to the latest Nov MPOB data and we think this will continue throughout 2014. As Indonesia is the world largest CPO producer, less supply (due to higher local biodiesel usage there) into Malaysia will limit inventory build-up in Malaysia and hence supportive to CPO prices.

Malaysia stocks level should have peaked in Nov. Although stocks level grew 7% MoM to 1.98m mt in Nov-2013, we believe it should have already peaked, as we expect Dec-2013 inventory to ease 3% MoM to 1.92m mt. The main reason for the expected decline is the seasonally observed sharp 10% production decline in December. More importantly, we believe that the downtrend in stock level can be sustained throughout 1Q14 and this should support CPO prices to continue appreciating up to RM2900/mt by Mar-2014.

QE tapering net impact is positive on CPO prices. Recall that on 18-Dec-2013, US Federal Reserve has started its QE tapering by trimming its monthly bond purchases to USD75b (from USD85b previously). Since then, USD has strengthened further against MYR. In such an economic environment of weakening MYR against USD, we believe CPO prices will be more competitive against soybean oil (which is priced in USD). While we also take note that planters with significant debts in USD may experience higher translation loss, we believe that the impact from better CPO prices is much more significant.

Earnings is now at an inflection point. For the first time in two years, 4Q13 average CPO price is poised to recover YoY. As it is, the average CPO price so far in 4Q13 is RM2506/mt or 2% higher than the 4Q12 level of RM2465/mt. While the 2% increase may be small, the change in direction from eight successive quarters of earnings decline YoY to earnings growth of at least 10% should be enough to serve 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.

Soybean oil prices may have bottomed. Recently, soybean oil (SBO) prices have declined to below 39 US cents per pound (or USD860 per MT) due to the higher supply in the US and expectation of bumper soybean crop from South America. However, we are not overly concerned as the risk of soybean crop damage has increased in Argentina. Additionally, recall that the latest USDA forecast for SBO prices is in the range of 38-42 US cents per pound and we view this as a sign that the downside for SBO now is very limited. Hence, this should be supportive to CPO prices, being a substitute product.

Source: Kenanga