Sep-15 palm oil inventory rose 5% to 2.63m MT, 3% below both our and consensus forecasts (2.70m metric tons (MT)). Production declined 4% to 1.96m MT marking the start of the seasonal downtrend, while exports improved 4% to 1.68m MT propped up by strong Indian demand (+35% MoM to 357k MT). Looking ahead, we expect slightly lower Oct-15 inventory at 2.62m MT. Production should decline 2% MoM to 1.92m MT in line with 2014 trends, while exports should be flat at 1.66m MT (-1%) on lower palm oil’s competitiveness against soybean oil (SBO). We expect range-bound CPO prices in the near-term between RM2,100-RM2,400/MT as long-term positives (lower production, dryness) are uncertain while short-term negatives (high stocks, limited demand) are tempering upside. Maintain NEUTRAL on plantations with no change to our FY15-16E CPO prices (RM2,200-2,400/MT). Our Top Pick is TAANN (OP; TP: RM4.80) on undemanding valuations, high dividend yield (5.4%) and potential upside from timber exposure. No change to our other calls: OUTPERFORM on CBIP (TP: RM2.13); MARKET PERFORM on SIME (TP: RM8.30), IOICORP (TP: RM4.36), KLK (TP: RM21.80), PPB (TP: RM16.92), IJMPLNT (TP: RM3.50), TSH (TP: RM1.95), and UMCCA (TP: RM6.70); UNDERPERFORM on FGV (TP: RM1.30) and GENP (TP: RM9.50).

Sep-15 ending stock at 2.63m MT below expectations. Sep-15 ending inventory rose 5% to 2.628m MT, below our and consensus forecasts of 2.70m MT. However, note that Sep-15 inventory represents a new all-time high, marginally above the previous high of 2.627m MT in Dec-12. Delving further, production figures declined 4% to 1.96m MT, 2% lower than consensus (2.00m MT) and 6% below our forecast (2.09m MT), indicating that peak production has indeed occurred in Aug-15, earlier than our Sep-15 expectation. Meanwhile, exports improved 4% to 1.68m MT, 4% higher than consensus (1.62m MT) but in line with our forecast (1.67m MT), propped up by strong Indian demand (+35% MoM to 357k MT).

Production to decline 2% MoM to 1.92m MT. Sep-15 production declined 4% after two months of growth and ending a fivemonth high production streak. We think this trend indicates that the seasonal downtrend is in full swing after peaking in Aug-15. Mirroring 2014 trends, we expect Oct-15 production decline to be at a lower magnitude than Sep-15. Hence, we forecast slower production decline of 2% to 1.92m MT in Oct-15.

Exports to be flat at 1.66m MT (-1%). Monthly exports rose 4% to 1.68m MT as strong Indian demand (+35% to 357m MT) offset weaker demand in all other markets. However, we observe that the CPO to soybean oil (SBO) discount has narrowed to USD100/MT (from USD120/MT in Sep-15) as CPO prices appreciated stronger than SBO prices due to productivity concerns from the ongoing El Nino. Meanwhile, month-to-date Oct-15 CPO prices at RM2,271/MT appreciated 12% from Sep-15, twice that of SBO (USD624/MT) which appreciated 6% from Sep-15. Consequently, we think CPO’s lower pricing competitiveness is likely to result in slightly weaker exports (-1%) to 1.66m MT.

Oct-15 inventory slightly lower at 2.62m MT. We believe Oct-15 inventory will likely to decline marginally to 2.62m MT (-0.3%) as supply at 1.93m MT is lower than demand at 1.94m MT. For supply, we expect slight production decline of 2% to 1.92m MT coupled with very low imports (8.9k MT or -88%) after the recent government decision to temporarily restrict palm oil imports from Indonesia. Demand-wise, we expect slightly weaker exports (-1% to 1.66m MT) due to the lower pricing competitiveness of CPO prices as compared to SBO. As a result, Oct-15 ending inventory should remain flat at 2.63m MT.

Expect range-bound CPO prices between RM2,100-RM2,400/MT. As highlighted in our recent 4Q15 sector outlook, we believe CPO prices are likely to trade range-bound going forward. CPO prices are likely to be capped by SBO prices (its closest competitor) while gasoil prices should be supportive due to CPO’s alternative use as biodiesel. Hence, based on the rolling standard deviation of both gasoil and SBO, we expect CPO prices to trade between RM2,100-RM2,400/MT.

Reiterate NEUTRAL on plantations given our unchanged view on short-term CPO prices. Although long-term positives such as declining production, dry weather and supportive government policies remain intact, there is very little visibility on their potential impact. Meanwhile, short-term negatives including stubbornly high stock levels, limited demand growth and a potentially weak 3Q15 results season will continue to cap planters’ upside, in our view. TAANN (OP; TP: RM4.80) remains our Top Pick, for its undemanding valuations (12x PER vs peer average 16x), above-average FFB growth (15% vs. average 6%), highest dividend yield (5.4% vs. average 2.7%) and potential timber earnings upside. 

Source: Kenanga Research - 13 Oct 2015