Malaysia’s palm oil stocks level of 1.69m mt in Mar-14 came in 6% higher than consensus estimate of 1.60m mt as palm oil production unexpectedly surged 17% MoM. We believe that palm trees may have started their production uptrend cycle after a 10-month hiatus. However, CPO prices may not come under pressure as we believe that any extra supply will be absorbed by Indonesia’s biodiesel mandate. Note that our Indonesia biodiesel tracker using MPOB import figures had continued to indicate smooth biodiesel implementation in Indonesia as the Mar-2014 import of palm oil remained very low at 15,140 mt or 83% lower YoY.

On the demand side, export is weak as it declined 8% MoM to 1.24m mt in March but we believe that this is temporary as the bumper soybean crops from South America should only last until end-May. Looking ahead, we expect Apr-14 inventory to increase by 4% to 1.75m mt but CPO prices’ downside should be limited. Overall, we maintain our positive view on CPO prices in the mid to long term due to sustainable demand seen from Indonesia biodiesel industry and stable food demand.

Reiterate OVERWEIGHT on the sector with our current CY14 average CPO price forecasts of RM2,800/mt unchanged. Our top picks are TSH (OP; TP: RM4.10) and SIME (TP: RM10.00). We also have OUTPERFORM calls on IOICORP (OP; TP: RM5.15), KLK (TP: RM26.10), PPB (TP: RM17.00), IJMP (TP: RM3.80), TAANN (TP: RM5.00) and CBIP (TP: RM4.80). Maintain MARKET PERFORM on FGVH (TP: RM4.75), GENP (TP: RM10.85) and UMCCA (TP: RM7.50).

March stocks level came in 6% above consensus estimate as production uptrend may have started after 10 months of tree stress. Malaysia stocks level inched up 2% MoM to 1.69m mt which is 6% higher than consensus estimate of 1.60m mt and 4% above our estimate of 1.62m mt. Palm oil production unexpectedly surged 17% MoM as the tree stress impact may have ended. While the production uptrend may have started in both Malaysia and Indonesia, CPO prices may not come under pressure as we believe that any extra supply will be absorbed by Indonesia’s biodiesel mandate. Note that our Indonesia biodiesel tracker using MPOB import figures continue to show strong biodiesel implementation in Indonesia as the Mar-2014 import of palm oil remained very low at 15,140 mt or 83% lower YoY.

Weak palm oil exports in March should be temporary. In Mar-2014, palm oil export declined 8% MoM to 1.24m mt. This could be caused by the bumper soybean harvesting season in South America, which has started in March, which has caused SBO prices to decline 9% from its peak in Mar to 40.63 US cents per pound. As a result of the cheaper SBO, demand may have shifted away from CPO to SBO in March. Nevertheless, we wish to highlight that the harvesting season for South America should end soon in May and this means limited downside for SBO prices and indirectly CPO as well. Both SBO and CPO are commonly used as substitute to each other for food and industry use.

Expect Apr-14 inventory to increase by 4% to 1.75m mt. On the supply side, we have assumed 3.0% increase MoM to 1.54m mt in line with seasonal trend. On the demand side, exports should improve 1% MoM to 1.26m mt as the weather in the northern hemisphere heats up from March onwards. Note that palm oil tends to solidify in cold weather and hence is used more during warm temperature. Local consumption should stay strong at 0.24m mt. Despite the higher inventory expected, the downside in CPO prices should be limited as prices below RM2600/mt should boost discretionary demand from biodiesel producer in Indonesia to fulfil the high biodiesel mandate.

Strong warning on El Nino. The Australian Bureau Of Meteorology (ABM) has mentioned that “it is now likely (estimated at a greater than 70% chance) that El Niño will develop during the southern hemisphere winter (SHW)”. Effectively, this means that El Nino may occur as soon as two months henceforth when SHW begins from 21-Jun to 22-Sep. While near-term dry weather concern is no longer in the picture after rains started in 2nd half of March, we believe that the market will take the warning from ABM seriously and this should be supportive to CPO prices.

We like TSH and SIME. Our overall top pick for the sector is TSH (OP; TP: RM4.10) as it stands to benefit more from the recent CPO prices increase due to its high FFB growth. Recall that its FY13 FFB output growth of 28% YoY to 542,951 is the strongest among planters under our coverage. For big caps, we have shifted our preference from IOICORP (OP; TP: RM5.15) to SIME (OP; TP: RM10.00) due to the latter’s more attractive valuations among the big caps. Note that SIME’s Fwd. PE at 16.1x currently is lower against other big caps planters such as FGV’s 17.9x, KLK’s 19.5x and IOICORP’s 23.0x.

Source: Kenanga