Malaysia’s Feb-15 palm oil stocks of 1.74m MT were higher than consensus (1.67m MT) and our expectations (1.65m MT) by 4% and 5%, respectively. This was mainly due to lower MoM export volume (-18% to 0.97m MT) which declined for all major importers except India. Notably, demand from China fell 70% to 65k MT which we think was due to weaker price competitiveness of CPO against soybean oil (SBO). We forecast exports to stay soft (+6% to 1.03m MT) as the SBO-CPO premium remains low, while production recovery is expected in Mar-15 (+12% to 1.26m MT), in line with seasonal trends. Thus, Mar-15 inventory should slightly increase to 1.78m MT (+2%). No change to our FY15E CPO price at RM2,200/MT as we expect CPO prices to weaken due to competitive SBO prices and rising inventories. Reiterate NEUTRAL on the sector as downside should be limited by marginal production cost. Maintain OUTPERFORM on TAANN (TP: RM4.44) and MARKET PERFORM on SIME (TP: RM9.64), PPB (TP: RM15.42), TSH (TP: RM2.30), and UMCCA (TP: RM6.68). Maintain UNDERPERFORM on IOICORP (TP: RM4.40), KLK (TP: RM20.34), FGV (TP: RM2.85), GENP (TP: RM9.57), IJMP (TP: RM3.57), and CBIP (TP: RM2.05).

Feb-15 stocks of 1.74m MT higher than expected. Feb-15 ending stocks of 1.74m MT was above both consensus (1.67m MT) and our expectations (1.65m MT) by 4% and 5%, respectively. Although production at 1.12m MT was within 1% of consensus and our expectation (1.13m MT), the sharply lower export volume (- 18% to 0.97m MT) made up only 89% of both consensus and our expectation (1.09m MT). This was mainly due to the significant drop in exports to China (-70% to 65k MT) which we think is due to higher usage of soybean oil (SBO) in the country as a result of declining SBO prices.

Falling CPO exports due to narrowing SBO-CPO premium. Exports declined (- 18% to 972m MT) as demand weakened in all major CPO importing countries except India (+39% to 222m MT). We believe exports to India improved in Feb-15 due to stock replenishment activity. The drop in Chinese CPO demand (-70% to 65k MT) was particularly significant. We think this was due to higher Chinese soybean imports (+16% to 6.88m MT in Jan-15, according to Oilworld) which reflects the shift towards SBO processing as the narrowing premium of SBO-CPO prices reduces the attractiveness of importing CPO. We note that the SBO-CPO premium has been on a declining trend since Dec-15 with the Feb-15 premium at USD69/MT (-5% MoM). Given that month-to-date (MTD) SBO-CPO premium has narrowed further to USD67/MT (-3%), we think exports may not recover rapidly in the coming months. Overall, we expect export demand to increase only 6% in Mar- 15 to 1.03m MT, less than the +11% trend historically seen for March.

Expecting production recovery in Mar-15. Feb-15 production at 1.12m MT marks six consecutive months of CPO production decline since last year’s peak in Aug-14. Note that Peninsular Malaysia’s production improved in Feb-15 (+10% to 606k MT) while East Malaysia’s production declined (-15% to 516k MT). Based on historical production patterns, we observe that the 6-month declining trend is actually longer than the average seasonal downtrend of 3-5 months. Hence we think that CPO production is overdue for recovery and should see improvement in Mar-15 by at least 12% to 1.26m MT, in line with seasonal production patterns.

Estimating flattish Mar-15 inventory at 1.78m MT (+2%). We expect total supply at 1.32m MT to slightly exceed total demand at 1.28m MT in Mar-15. On the supply side, we expect production to rise 12% to 1.26m MT in line with seasonal trends. Demand-wise, we think exports could slow drop further by 6% to 1.03m MT due to higher competition from SBO as outlined above. Hence we forecast Mar-15 inventory to rise slightly by 2% to 1.78m MT.

CPO prices likely to soften. We think the news of higher-than-expected inventory level in Feb-15 will have a negative impact on CPO prices in the near-term as it seems the market has priced in expectation of weaker CPO production in 1H15. We concur with the market view as we expect 1Q15 production at 3.54m MT to be 17% lower YoY. However, given the weaker-than-expected export demand resulting in higher stock levels overall, we believe that the risk for CPO price downside is currently greater than any upside potential. Hence, we reiterate our FY15E CPO price outlook of RM2,200/MT, which is lower than the year-to-date CPO price average of RM2,287/MT as we expect CPO prices to remain soft in the nearto- mid-term. Nevertheless, we reiterate our NEUTRAL call on the sector as we expect CPO prices to be range-bound this year with downside limited by marginal production cost per ton. Furthermore, planters’ share prices should remain relatively resilient given their heavy weighting in the FBMKLCI and Shariah-compliant status. 

Source: Kenanga