Nov-15 palm oil inventory hit another all-time high at 2.91m metric tons (MT) (+3%), above both consensus (2.85m MT) and our forecast (2.79m MT) on disappointing exports (-11% to 1.70m MT) which outweighed lower production (-19% to 1.65m MT). Looking ahead, we believe seasonal production downtrend will continue into Dec-15 at 1.45m MT (-12%), with possible downside depending on monsoon intensity. Exports should stay soft (- 1% to 1.48m MT) as we rule out biodiesel demand post the sharp crude oil price drop. However, soybean oil (SBO) to CPO price premium expanded to USD180/MT, which could help mid-Dec demand. Overall, we expect Dec-15 inventory to decline 4% to 2.80m MT. We maintain our NEUTRAL outlook with a volatile CPO price outlook between RM2,000-2,500/MT. No change to our FY15-16E average price forecast RM2,200-2,400/MT. Higher SBO-CPO premium and wet weather could be a catalysts, but headwinds arise from stubbornly high stocks and the looming US rate hike. Investors wishing to reduce CPO price volatility impact could consider our Top Pick, TAANN (OP; TP: RM5.70) due to undemanding valuations, high dividend yield (5.1%) and potential upside form its timber division. We also like CBIP (OP; TP: RM2.49) for better visibility on its orderbook-based earnings. No change to our other calls: MARKET PERFORM on IOICORP (TP: RM4.52), KLK (TP: RM22.80), PPB (TP: RM16.92), IJMPLNT (TP: RM3.64), and UMCCA (TP: RM6.30); UNDERPERFORM on SIME (TP: RM8.00), FGV (TP: RM1.30), GENP (TP: RM9.40), and TSH (TP: RM1.95).

Yet another all-time high. Nov-15 ending inventory rose 3% to 2.91m metric tons (MT) to hit another all-time high for three months running. Stocks closed 2% above consensus (2.85m MT) and 4% above our forecast (2.79m MT). Weaker demand at 1.70m MT (-11%) outweighed lower-than-expected production (-19% to 1.65m MT, compared to consensus’ 1.85m MT and our 1.89m MT). Lower demand was mainly due to disappointing exports (-12% to 1.50m MT) as we saw weaker Indian post-festival demand (-12% to 390k MT).

Seasonal production downtrend underway. Nov-15 production decline at -19% came as a surprise, with Peninsular and East Malaysia production falling 7% and 5% respectively. For Peninsular Malaysia, we think the decline could be due to above average rainfall in northern Peninsular Malaysia disrupting harvests. As for East Malaysia, we think the decline is due to wetter weather in central Sarawak as well as the lagged impact of drought in Sabah impacting production. As we approach peak monsoon season we expect seasonal production downtrend to persist, with Dec-15 forecast at 1.45m MT (-12%) in line with the historical average. In fact, production could see further downside if wet weather intensifies, as was seen in last year’s monthly decline of 22% (an 8-year low) to 1.36m MT.

Expect soft exports to persist (-1% to 1.48m MT). Exports were disappointing at 1.50m MT, well below consensus (1.60m MT) and our (1.76m MT) forecast as the anticipated biodiesel demand bump had limited impact on exports. With the recent sharp drop in Brent crude oil prices to USD40/barrel, we believe biodiesel production may well be cost-prohibitive despite subsidies. Hence we expect Dec-15 demand to revert to seasonal trends of soft winter demand, after counting out the biodiesel factor. Our expectation of weak demand is in line with data from cargo surveyor Intertek which noted that Dec 1-10 shipments fell 35% to 280k MT. Nevertheless, we expect Dec-15 exports to slip only 1% to 1.48m MT, as we think demand might pick up later in the month as explained below.

Soybean oil (SBO)-CPO premium widens. We observe that although Brent prices dropped from USD50/MT as of end-Oct to USD40/barrel as of 10-Dec (-18%), soybean oil prices rose 10% in the same span to USD683/MT. However, CPO prices were flat at RM2,150/MT. As a result, the SBO-CPO premium has broadened to USD180/MT in month-to-date Dec-15, compared to USD125/MT in Nov-16 and USD110/MT year-to-date 2015 average. We think the wider premium should support food demand for CPO as the cheaper alternative going forward.

Dec-15 inventory to decline 4% to 2.80m MT. We expect lower Dec-15 inventory as demand at 1.66m MT exceeds supply at 1.55m MT. On the supply side, we believe production will further drop 12% to 1.45m MT in line with seasonal trends. Meanwhile, exports should slip 1% to 1.48m MT as soft early-Dec exports should be bolstered by the wider SBO-CPO premium currently. Overall, Dec-15 inventory should decline 4% to 2.80m MT.

Reiterate NEUTRAL on plantations. With the divergence of SBO and gasoil prices we think CPO prices could turn volatile with a broader trading range between RM2,000-2,500/MT. Potential catalysts include (i) lower production due to heavy monsoon, and (ii) stronger demand as CPO is now cheap vs. SBO. However, negative factors could dampen CPO prices, including (i) persistently high stocks, and (ii) headwinds on general commodities due to US’s impending rate hike. We may re-visit our production assumptions in our upcoming strategy report depending on the intensity of year-end rainfall. For now, investors may wish to consider stocks partly shielded from CPO price volatility such as our Top Pick TAANN (OP; TP: RM5.70) which we like for its (i) potential timber earnings upside, (ii) undemanding valuations (10.5x PER vs. average 21.3x), and (iii) highest dividend yield (5.1% vs. average 2.3%). We also like CBIP (OP; TP: RM2.49) as its orderbook-based earnings provide better visibility and less volatility compared to planters.

Source: Kenanga Research - 11 Dec 2015