Malaysia’s palm oil stocks level of 2.05m MT in Aug-14 is above expectation as it is 5% higher than consensus estimate of 1.95m MT. The higher-than-expected inventory is likely due to surprisingly strong production, which surged 22% MoM to 2.03m MT (effectively making it the highest ever monthly production in Malaysia). We believe that the peak production period may have arrived earlier than expected in Aug-Sep this year instead of the usual Oct-Nov period. On demand side, export is still flattish MoM due to weak demand from China. Looking ahead, we expect Sep-14 inventory to increase 8% to 2.21m MT assuming 5% production growth MoM and 22% exports growth after Malaysia removed the CPO tax. While this news is bearish on CPO prices, the latest export data from Intertek (showing export growth of 40% MoM in the first 10 days of September) should be an indicator that CPO prices has bottomed at RM2,000/MT. We reiterate our NEUTRAL call on the sector with our CY14-CY15 average CPO price forecasts at RM2,500/MT unchanged. Our only top pick is SIME (OP; TP: RM10.10) due to potential spin off exercise within SIME’s business divisions. Maintain MARKET PERFORM on IOICORP (TP: RM5.30), KLK (TP: RM23.80), FGV (TP: RM4.00), PPB (TP: RM15.00), TSH (RM3.40), TAANN (TP: RM4.50), UMCCA (TP: RM7.50) and CBIP (RM4.85). Maintain UNDERPERFORM on GENP (TP: RM9.55) and IJMPLNT (TP: RM3.50).

Aug stocks level of 2.05m MT is higher than expected as it is 5% above consensus estimate of 1.95m MT and 16% above our estimate of 1.77m MT. The higher-than-expected inventory was due to strong production, which unexpectedly surged 22% MoM to 2.03m MT. Effectively, Aug-14 production is now the highest ever monthly production in Malaysia. We believe that the peak production period may have arrived earlier than expected in Aug-Sep this year instead of the usual Oct-Nov period. Hence, CPO prices should have bottomed out as production should decline from October onwards.

China demand is still weak as exports to China tumbled 19% MoM and 53% YoY to 156k MT; making this the strongest decline among major palm oil consumer countries. We believe that this could be caused by the recent crackdown on the commodity financing trade in China. Export to EU was also down 13% MoM to 176k MT in which we think may be caused by more rapeseed oil usage there in view of their high rapeseed production. Overall, slow demand coming from China should limit the upside of CPO prices.

Sep-2014 inventory may increase 8% to 2.21m MT as total supply of 2.15m MT should outpace total demand of 2.00m MT. We have assumed 5% production growth MoM in line with seasonal pattern. On the demand side, we expect strong export growth of 22% as the recent CPO tax removal in Malaysia should help to increase demand from overseas. The expected higher inventory in September is likely to cap CPO prices upside.

But exports surge of 40% MoM in the first 10 days of September could signal the end of bearish CPO prices. Intertek data shows that Malaysia’s exports of palm oil jumped 40% MoM in the first 10 days of Sep-14 (against the same period last month). We believe this is caused by the swift action by Malaysian government to exempt Crude Palm Oil (CPO) from export taxes for September and October. We expect the news to have positive impact on CPO prices as it should encourage demand from countries, which may prefer CPO (against refined palm oil) such as India and China. Such a strong export surge is unusual and we believe that the news is likely to prevent further fall of CPO prices to below RM2000/MT.

Maintain NEUTRAL with SIME (OP; TP: RM10.10) as our only top pick. We like SIME as we think its valuation should rerate higher due to potential spin off exercise within SIME’s business divisions. As it is, it has been reported by media quoting Tan Sri Mohd Bakke Salleh (SIME’s CEO) specifying that the listing of its motor unit is set to be executed in 1HCY15 subject to market conditions. The stock is also cum-dividend of 30.0 sen (subject to approval in the AGM).

Source: Kenanga