Dec-15 palm oil inventory declined for the first time in 6 months, falling 10% to 2.63m MT to beat both consensus (2.76m MT) and our forecast (2.86m MT) on stronger-than-expected local demand (+36% MoM), likely from early festive demand. We expect Jan-16 production to continue declining (-11% to 1.25m MT) in line with seasonal trends, while exports are likely to stay soft (-7% to 1.38m MT) on weaker winter demand and stiff competition from ample soybean stocks. Local demand is likely to normalize (-27% to 203k MT). All-in, we expect Jan-16 inventory to decline 9% to 2.39m MT. No change to our NEUTRAL plantation outlook and FY16E CPO price forecast (RM2,400/MT). CPO prices should trade higher in 1Q16 (RM2,150- 2,400/MT) on the declining stocks outlook and continuation of El Nino. However, weak crude oil prices could limit upside. We upgrade our Top Pick TAANN's Target Price to RM6.57 (from RM5.70) as we raise our Fwd. PER to 17.5x (from 15.0x) implying +0.5SD valuation (from -0.5SD) in light of the rising USD/MYR which should further expand its Timber margins. We also have OUTPERFORM on CBIP (TP: RM2.49) and UMCCA (TP: RM7.05); MARKET PERFORM on IOICORP (TP: RM4.52), KLK (TP: RM22.80), PPB (TP: RM16.92), and IJMPLNT (TP: RM3.64); UNDERPERFORM on SIME (TP: RM8.00), FGV (TP: RM1.47), GENP (TP: RM9.40), and TSH (TP: RM1.95).

Dec-15 stock declines 10% to 2.63m MT. Dec-15 inventory closed at 2.63m MT (-10% MoM), marking the first decline in 6 months. This was 5% below consensus (2.76m MT) and 8% below our forecast (2.86m MT) as domestic demand spiked to 276k MT (+36% MoM), likely due to earlier-than-expected pre-festivals demand. Exports (1.48m MT) were also slightly better than anticipated, at 5%/4% above consensus/our forecast. This was in spite of surprisingly soft China demand (95k MT or -63% YoY), as EU demand (266k MT or +10% YoY) picked up some of the slack. Meanwhile, production at 1.40m MT (-15% M/M) came in between consensus (1.36m MT) and our forecast (1.45m MT).

Production weakness to continue. We deem Dec-15’s production (-15%) in line as it came in between consensus and our forecast of -12% and -18%, respectively, due to seasonal production weakness. Going forward, we think the production downtrend could persist into Feb-16, in line with historical production trends. Production uptrend should resume in Mar-16 onwards, although we expect production in 1H16 to be weaker than 1H15 due to lagged production impact from the droughts seen around Aug-15. Thus for Jan-16, we expect production to continue declining 11% to 1.25m MT, in line with the 8-year’s historical average.

Exports to decline as well (-7% to 1.38m MT). Dec-15 exports were flattish at 1.48m MT (-1% MoM), sustained by stronger EU exports (+24% MoM) despite very weak China demand at only 95k MT. This was the second weakest month of Chinese exports in 5 years, with the weakest month being Feb-15 (65k MT). Nevertheless, with Chinese New Year coming up, we think Chinese exports should pick up in Jan-16, while EU demand is likely to taper off in line with historical January trends. Overall, demand is likely to be softer due to seasonally weaker demand during the winter months. Palm oil could also see stiffer competition from soybean oil (SBO) as the recent Oilworld report noted a “pick-up in farmer selling in Argentina”. Hence, we expect Jan-16 exports to weaken 7% to 1.38m MT.

Expecting domestic demand to normalize. Dec-15 domestic disappearances were much higher-than-expected at 276k MT, 63% and 59% above consensus (169k MT) and our forecast (174k MT), respectively. We think that pre-festivals demand kicked in earlier than usual this time, as historical December demand tends to be below the full-year’s average. With this round of festival demand likely filled in Dec-15, we expect Jan-16 local usage to revert to normal levels, and hence forecast domestic disappearances at 203k MT (-27%).

Jan-16 inventory drawdown to continue (-9% to 2.39m MT). We expect Jan-16 inventory to continue declining as demand at 1.58m MT exceeds supply at 1.34m MT. On the supply side, we expect production to weaken 11% to 1.25m MT in line with historical trends. Meanwhile, exports could also soften 7% to 1.38m MT due to weaker winter demand and competition from SBO. Overall, Jan-16 inventory should decline 9% to 2.39m MT.

Maintain NEUTRAL on plantations with no change to our FY16E CPO price forecast of RM2,400/MT. As noted in our 1Q16 Strategy report (published 7-Jan-16), we expect inventories to normalize to <2.0m MT by end-1Q16 because of high existing stock levels. Furthermore, weather forecasters generally agree that El Nino is likely to continue over 1Q16. In the short-term, continued dry weather should further boost CPO prices in 1H16 due to positive investment sentiment, while in the medium-term, the potential production impact would be felt in 4Q16. We believe the declining stock trend and weaker production outlook should provide a shortterm catalyst to lift CPO prices in 1H16. However, weak crude oil prices and the subsequent poor biodiesel demand may limit upside. We expect 1Q16 CPO prices to trade between RM2,150-2,400/MT based on our SBO/gasoil standard deviations study, slightly higher than 4Q15’s range of RM2,050-2,300/MT. We doubt that short-term CPO prices can trade above RM2,600/MT (implying USD50/MT discount to SBO) despite optimism on El Nino, as soybean stocks remain at record highs, leading to a high risk of substitution.

Upgrading TAANN TP to RM6.57 (from RM5.70) as we revise up our Fwd. PER to 17.5x (from 15.0x) applied to an unchanged 38.0 sen FY16E EPS. Our updated Fwd. PER is based on a higher valuation basis of +0.5SD (previously -0.5SD) as we expect the strong USD/MYR to be sustained at least through 1H16 on the back of weak crude oil prices. With the bulk of TAANN's timber products exported overseas, we expect a rising USD/MYR to expand TAANN's solid 22% net margin seen in 3Q15. However, investors should remain cautious of any reversal in the USD/MYR, which could reverse its Timber's earning trajectory. We maintain TAANN as our Top Pick for 1Q16.

Source: Kenanga Research - 12 Jan 2016