Recent news from Jakarta Post and AsiaOne reported that the Indonesian government is proposing to increase the biodiesel subsidy to IDR4.0k/litre from IDR1.5k/litre (l) currently. The proposal is pending approval and due for a verdict later this month. The current IDR1.5k/l subsidy implies a crude oil breakeven price of USD75/barrel (bbl) which is higher than current Brent prices of USD55/bbl and thus economically infeasible. However, the proposed subsidy of IDR5.0k/l implies a breakeven price of USD43/bbl making biodiesel production attractive. We view that the proposed subsidy could help Indonesia achieve its 4.3m MT target biodiesel consumption (+2.7m MT YoY) for 2015. However, we think the impact on CPO prices is neutral because the additional CPO required for the new biodiesel production only represents <1% of global CPO production. Hence we maintain our FY15E CPO price of RM2,200/MT and reiterate our NEUTRAL view on the sector as we think the near-term upside impact from this news should be short-lived. Our Top Pick and only OUTPERFORM call is SIME (TP: RM9.92) catalysed by news flow on its motors division’s IPO. Maintain MARKET PERFORM on KLK (TP: RM21.50), PPB (TP: RM15.26), FGV (TP: RM2.30), IJMP (TP: RM3.30), TSH (TP: RM2.18), TAANN (TP: RM3.70), UMCCA (TP: RM6.68), and CBIP (TP: RM2.05); and maintain UNDERPERFORM on IOICORP (TP: RM4.40) and GENP (TP: RM9.20).

Indonesia proposes higher biodiesel subsidy of IDR4.0k per liter. The Jakarta Post reported on 2-Feb-15 that the Indonesian government has proposed to increase the biodiesel subsidy to IDR5.0k/l or USD0.39/l from IDR1.5k/l (USD0.12/l) previously. On 5-Feb-15, AsiaOne reported that the Indonesian parliamentary committee agreed to an increase of IDR4.0k/l (USD0.31/l). The news also said that “the subsidy increase proposal still needs approval from the parliamentary budget committee, which is due to give its verdict later this month. Government ministry officials say they are confident of a smooth passage.”

A boost for biodiesel production? Based on FY15E CPO prices of RM2,200/MT and USD/MYR rate of RM3.53, we estimate the breakeven level for biodiesel to be approximately USD85/bbl of crude oil without subsidies. At the existing subsidy of IDR1.5k/l, we calculate the crude oil breakeven price to be USD75/bbl which is above the current Brent crude oil price of USD55/bbl. Hence with the existing subsidies, biodiesel production is economically infeasible. The updated proposed subsidy of IDR4.0k/l translates to a breakeven price of USD43/barrel which is lower than the current Brent crude oil prices of about USD55/barrel. At this level, biodiesel production becomes attractive with an implied gross margin of USD3.5/barrel. Thus, we view that the proposed subsidy could help Indonesia achieve its targeted 2015 biodiesel consumption of 4.3m MT (compared to 2014 actual consumption of 1.6m MT), should crude oil prices hold above USD43/barrel during the year.

But NEUTRAL on CPO price impact. We are neutral on the impact on CPO prices from potentially higher Indonesian biodiesel production. This is because, assuming the 4.3m MT target is met, the additional 2.7m biodiesel translates to approximately 270k MT additional CPO demand, which is <1% of global CPO production of 60.9m MT. Therefore, we think that the additional demand is unlikely to boost global CPO demand significantly, and the near-term upside impact on CPO price is likely to be short-lived. Hence we leave our FY15E CPO forecast of RM2,200/MT unchanged.

Maintain NEUTRAL on plantations sector. We reiterate our NEUTRAL call as we believe the news is unlikely to significantly impact CPO prices over the long-term. Generally, upside for planters is limited as we think the coming 4QCY14 results season is likely to be lower YoY due to lower CPO prices. However, share prices should be supported due to the high number of big-cap planters and scarcity of Shariah-compliant stocks. Our Top Pick for the sector is SIME (OP; TP: RM9.92) on news flow catalyst arising from its motor division’s IPO which we think would surpass the expected softer plantation division’s performance. 

Source: Kenanga