The Indonesian government has begun the collection of CPO and processed palm oil levies on 16-Jul. We believe the impact on CPO prices is NEUTRAL but expect Malaysian exports to benefit due to lesser supply coming from Indonesia. Accordingly, we revise down our Jul-15 closing inventory estimate by 2% to 2.13m MT after adjusting for higher exports. We also expect the Indonesian downstream industry to record better margins, hence PPB (MP; TP: RM16.50) could be a winner due to its associate stake in Wilmar. As for biodiesel; by estimating FY15 levy collection of USD250-300m with 40% used for subsidies, we calculate that the additional subsidy of IDR600-700/liter could subsidise 1.8-2.2m MT of biodiesel. However, we expect these subsidies to be applied on top of the existing budgeted subsidy of c.1.4m MT. Since unsubsidised biodiesel production remains unviable, we think the target consumption of 4.3m MT is a long shot. Given minimal inventory as well as neutral long-term price impact, we reiterate our NEUTRAL call with an unchanged FY15-16E CPO price targets of RM2,200-RM2,400/MT. Maintain OUTPERFORM on IOICORP (TP: RM4.50), TAANN (TP: RM4.80) and CBIP (TP: RM2.49); MARKET PERFORM on SIME (TP: RM9.04), KLK (TP: RM21.80), PPB (TP: RM16.50),FGV (TP: RM1.75), GENP (TP: RM10.42), IJMPLNT (TP: RM3.73), TSH (TP: RM2.45) and UMCCA (TP: RM6.70).

Levy collection commences. According to recent media reports, the Indonesian palm oil levies were expected to be imposed on 16-Jul. Based on our channel checks, the authorities there have indeed started collecting the USD50/metric ton (MT) CPO levy and USD30/MT processed palm oil (PPO) levy. The Jakarta Post added that the Indonesia Oil Palm Estate Fund (BPDP) aims to "generate between IDR3.5t and IDR4.5t (c.USD261.9m-USD336.7m) up to the end of this year from palm oil shipments". Furthermore, the agency first "plans to replant at least 2k hectares (ha) of oil palm plantations run by smallholders" for around IDR60.0m/ha or c.USD4.5k/ha. Their next priority is to subsidize biodiesel by another IDR600-700/liter (US cents 4.5-5.2 /liter) to help domestic consumption reach 1.8m to 2.0m kiloliters (KL) in the next four months, with 2015 targeted total consumption of 5.2m KL.

Neutral on CPO prices, but Malaysian exports to benefit. We are neutral on the CPO price impact as the levy has long been anticipated by the market since it was introduced in May-15. As highlighted in our Sector Update (published 13-Jul), we expect the Indonesian levy to boost up Malaysian exports in the latter half of Jul-15. Thus we revise our Jul-15 export forecast up to 1.71m MT (+1% MoM) from 1.68m MT. Accordingly, we also lower our Jul-15 closing inventory forecast to 2.13m MT (-1% MoM) from 2.18m MT. Note that our new forecast indicates lower Jul-15 inventory against Jun-15 (2.15m MT).

Immediate winner: Indonesian refiners. We think the key beneficiary from this measure is the Indonesian downstream industry, where PPB (MP; TP: RM16.50)’s associate Wilmar operates 25 refineries and 9 biodiesel plants as of 2014. Note that other companies under our coverage with refinery operations in Indonesia include SIME (MP; TP: RM9.04) and KLK (MP; TP: RM21.80). Based on latest CPO prices at c.USD575, the USD50/MT CPO levy implies taxation of 8.7%, compared to 0% tax imposed before the levy was implemented. Higher export tax rates generally translate to better margins for refiners due to better bargaining power against upstream producers. Hence, we think the news could lead to recurring interest in PPB which share price has been stagnating in the last few months while the levy implementation was delayed.

For biodiesel, seeing is believing. We estimate the levy could collect an amount of USD250-300m in 2015, within the lower end of the BPDP forecasted range. Assuming 40% of the funds is used for subsidies at IDR600-700/liter, we calculate that 2.2-2.6m KL (or 1.8-2.2m MT) of biodiesel could be subsidised by the BPDP. We think this is likely to be applied on top of the existing 1.7m KL (or 1.4m MT) of subsidised biodiesel as budgeted by the Indonesian government earlier this year. Note that unsubsidised biodiesel production is not economically viable currently because CPO price at c.USD580/MT is higher than both Brent crude oil (USD440/MT) and gasoil prices (USD545/MT). Since the subsidised 1.7m KL is only 0.1m KL above 2014 domestic consumption and far below targeted consumption of 5.2m KL (or 4.3m MT), we think that CPO price will not appreciate substantially until stronger evidence such as mandated enforcement and infrastructure development are seen.

Reiterate NEUTRAL on plantations. We maintain our NEUTRAL call on plantations with an unchanged FY15-16E CPO price forecasts of RM2,200-RM2,400/MT. While we expect the levy to help boost Malaysian CPO exports, we expect minimal near term inventory impact (-1% MoM) post our revised estimates due to rising production. In the short-term, we expect the move to favor planters with Indonesian refining operations, chiefly PPB (MP; TP: RM16.50) due to its 18% stake in Wilmar. Long-term impact is neutral as we think the additional subsidy only supports the existing budget, and a lack of infrastructure and enforcement could limit domestic biodiesel growth.

Source: Kenanga Research - 20 Jul 2015