Oct-15 palm oil inventory jumped 7% to hit a new all-time high at 2.83m MT. This is well above our (2.63m MT) and consensus (2.72m MT) forecasts, largely due to production increase (+4% to 2.04m MT) instead of an anticipated decline. Nevertheless, demand at 1.92m MT was in line. Looking ahead, we expect Nov-15 production to resume its downtrend to 1.89m MT (-7%) while demand should pick up to 1.76m MT (+3%) as higher Indonesian biodiesel production reduces Indonesian exports. All-in, we expect Nov-15 inventory to decrease 2% to 2.79m MT. Ahead of the upcoming 3Q15 results season, we anticipate flat-to-lower results overall as higher seasonal production is offset by lower 3Q15 CPO prices of RM2,058/MT (-6% QoQ, -7% YoY). We maintain our NEUTRAL outlook on the plantation sector as CPO prices are likely to range bound between RM2,100-2,450/MT. Upside is capped by high stock level and ample soybean oil supply, but downside is limited by stable consumption and rising biodiesel demand. Reiterate our Top Pick, TAANN (OP; TP: RM4.80) on undemanding valuations, high dividend yield (4.9%) and potential upside form its timber division. 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: RM6.30); UNDERPERFORM on FGV (TP: RM1.30) and GENP (TP: RM9.50).

Oct-15 ending stock at 2.83m MT hits an all-time high. Oct-15 inventory jumped 7% to 2.83m metric tons (MT) to hit another all-time high for the second month running. Oct-15 stocks closed 8% and 4% above our (2.63m MT) and consensus (2.72m MT) forecasts, respectively. This was mainly due to higher-than-expected supply at 2.04m MT, representing 4% MoM growth, in contrast with our (1.92m MT) and consensus (1.93m MT) forecasts which predicted marginal MoM decline. Total demand at 1.92m MT was in line with expectations (ours: 1.94m MT, consensus: 1.90m MT), as continued robust demand from India (+23% to 441k MT) offset below-average domestic demand at 207k MT (against Year-to-Date (YTD) average of 247k MT).

Production to resume downtrend. Although Oct-15 production at 2.04m MT hit a new monthly high, this is still below Aug-15 production of 2.05m MT. Thus, we reiterate our view that production has likely peaked in Aug-15, and should continue its seasonal downtrend from hereon. Assuming production declines in-line with the 8-year monthly average, we think Nov-15 production will fall 7% to 1.89m MT.

Counting on biodiesel for Nov-15 demand growth. Although the soy harvesting season is nearly complete, we note that the CPO-Soybean Oil (SBO) discount has held steady at USD115/MT in month-to-date (MTD) Nov-15, against USD110/MT in Oct- 15. With the CPO-SBO discount holding up, we expect demand for CPO to remain steady in the short-term. Meanwhile, we gather that Pertamina & AKR have recently contracted 1.87m kiloliters (KL) or 1.65m MT of biodiesel supply up to Apr-16. We think the higher biodiesel demand (250-300k MT monthly) could help reduce the Indonesian share of palm oil exports, thus benefiting Malaysian exports. As a result, we expect exports to improve 3% to 1.76m MT in Nov-15.

Nov-15 inventory to see slight decline (-2% to 2.79m MT). We forecast Nov-15 inventory to decline 2% to 2.79m MT as demand at 2.00m MT outstrips supply at 1.95m MT. On the supply side, we expect seasonally lower production (-7% to 1.89m MT), as well as lower imports (-32% to 50.3m MT) as the government decision in Oct-15 to temporarily restrict palm oil imports takes effect. Meanwhile, on the demand side, exports should improve 3% to 1.76m MT on higher Malaysian export share as Indonesian biodiesel production kicks in. Overall, Nov-15 ending inventory should decline 2% to 2.79m MT.

Expect another soft quarter in 3Q15. Although our expected Malaysia’s 3Q15 production at 5.96m MT makes up 30% of our FY15 estimate of 19.80m MT, this is offset by lower 3Q15 CPO prices at RM2,058/MT, which is 7% below our FY15E forecast of RM2,200/MT. QoQ, while Malaysia’s estimated 3Q15 production is 13% higher against 2Q15, 3Q15 CPO prices are 6% lower. Hence, we expect 3Q15 results to be generally flat QoQ. YoY, results are likely to be lower as 3Q15 CPO prices were 7% lower than 3Q14’s RM2,212/MT. Meanwhile, planters under our coverage saw YoY FFB growth of between -8% to +12%, which is unlikely to make up for the CPO price decline. Hence, we think 3Q15 results will be flat-to-lower YoY for most of them.

Maintain NEUTRAL on plantations. Based on our analysis of SBO and gasoil price trends, we think the short-term CPO prices should trade range-bound between RM2,100-2,450/MT. We believe that stubbornly high stocks and ample soybean oil supply will cap short-term CPO price upside. However, stable consumption and rising biodiesel demand should limit downside. Our Top Pick remains TAANN (OP; TP: RM4.80) on its undemanding valuations (14x PER vs peer average 21x), above-average FFB growth (15% vs. average 6%), highest dividend yield (4.9% vs. average 2.4%), and potential timber earnings upside.

Source: Kenanga Research - 12 Nov 2015