By Voon Yee Ping / voonyp@kenanga.com.my; Sarah Lim / sarahlim@kenanga.com.my

 

Jan 2016 palm oil inventory declined again, dropping 12% to 2.31m MT, in line with consensus (2.33m MT) but slightly below our forecast (2.39m MT) on weaker-than-expected production (-19%). This was partly offset by weaker exports (-14%) as tepid Chinese festival demand could not make up for falling seasonal demand in other regions. In Feb 2016, the production downtrend should taper off (-2% to 1.11m MT) while exports are likely to weaken further (-8% to 1.18m MT). However, overall demand (1.41m MT) still exceeds overall supply (1.17m MT). Hence, we expect inventory level to extend its downtrend to 2.07m MT (-10%) in Feb 2016. The tighter supply should continue to narrow the CPO-soybean oil (SBO) discount. However, we maintain our long-term NEUTRAL stance on plantation with unchanged FY16E CPO price at RM2,400/MT. While the tight supply may temporarily boost CPO prices, upside is limited by weak short-term demand, ample soybean supply and weak crude oil prices. We expect 1Q16 CPO prices to trade between RM2,100-2,500/MT, with a potential peak of RM2,675/MT (implying USD45/MT CPO/SBO discount). However, prices are likely to weaken once production picks up in Mar- Apr 2016. Our Top Pick remains TAANN (OP; TP: RM6.57) on timber segment upside due to the strong USD. We also have OUTPERFORM on CBIP (TP: RM2.49) and UMCCA (TP: RM7.05); MARKET PERFORM on SIME (TP: RM7.80), IOICORP (TP: RM4.52), KLK (TP: RM22.80), PPB (TP: RM16.92), and IJMPLNT (TP: RM3.64); UNDERPERFORM on FGV (TP: RM1.47), GENP (TP: RM9.40), and TSH (TP: RM1.95).

 

Jan 2016 stock at 2.31m MT (-12% MoM) within expectations. Jan 2016 stock came in at 2.31m MT (-12% MoM), which was within consensus forecast (2.33m MT or 1% below) and slightly below ours (2.39m MT or 3% below). Production at 1.13m MT was 5% and 9% below consensus/our expectation (1.19m MT/1.25m MT) reflecting 2H15’s drought impact, particularly in Sabah, where production fell to 338.1k MT (-16% YoY). However, this was offset by weaker-thanexpected exports (1.28m MT), which was 5%/7% below consensus/our forecast (1.35m MT/1.38m MT) as a soft pick-up in China demand (+11% MoM) ahead of the Chinese New Year could not make up for weaker India (-16% MoM), EU (-30% MoM) and US (-20% MoM) demand.

 

Production decline to moderate to 2% to 1.11m MT. Jan 2016 production declined by 19% MoM to 1.13m MT which was sharper than expected, against consensus and our expectation of 15% and 11%, respectively. We observe this was the sharpest January monthly production drop in the last 12 years, as seasonal downtrend was compounded by the 2H15’s lagged drought impact. However, we think that this trend is unlikely to persist as historically, the month following sharp production drop (>-15%) averaged only 4% production decline subsequently. For our Feb 2016 forecast, we expect moderate production decline (-2%) to 1.11m MT as we think the higher working days in Feb-16 (a leap year) could help increase workers’ monthly productivity.

 

Exports likely to weaken (-8% to 1.18m MT). Exports in Jan 2016 (-14% MoM to 1.28m MT) were weaker-than-expected, against consensus and our forecast of -9% and -7%, respectively. We think tepid MoM demand growth in China at 104.6k MT (+11% MoM; an 8-year’s low for January exports) was partly due to high Dec 2015 soybean imports reducing palm oil demand. With most key markets historically showing weaker MoM February demand, we believe Feb 2016 is likely to see a similar trend, especially as soybean supplies remain ample. Hence, we expect Feb 2016 exports to weaken by a further 8% to 1.18m MT.

 

Feb 2016 stock approaching 2.0m MT (-10% to 2.07m MT). We expect Feb 2016 inventory to continue its downtrend as total demand at 1.41m MT exceeds total supply of 1.17m MT. On the supply side, we think production will only be slightly weaker (-2% to 1.11m MT) in line with historical trends after a sharp production drop. As for demand, we believe exports will continue weakening (-8% to 1.18m MT) on high soybean supplies and seasonal demand trends. All-in, we expect Feb-16 inventory to fall 10% to 2.07m MT, closer to the psychological 2.00m MT mark which signifies normalised stock levels.

 

CPO prices to rise, narrowing Soybean Oil (SBO) price discount. CPO prices continued to appreciate in Jan 2016, rising 5% MoM and another 3% in month-to-date (MTD) Feb 2016 driven by expectations of weak production and declining inventory. This was well above SBO and crude oil price performance at +1% and -7%, respectively. As a result, the CPO-SBO price discount declined to USD140/MT in Jan 2016, against USD175/MT in Dec 2015. With our expectation of declining inventory, we think the narrowing CPOSBO discount trend is likely to continue, especially since the MTD Feb 2016 discount is currently averaging USD115/MT.

 

Reiterate NEUTRAL on plantations. We maintain our NEUTRAL long-term outlook on plantation. Although declining inventory and weak production expectations are likely to boost prices in 1Q16, we think that upside remains limited considering the lacklustre shortterm demand outlook, ample soybean supply, and weak crude oil prices. Nevertheless, based on ourSBO/gasoil standard deviations study, we update our 1Q16 CPO trading range to RM2,100-RM2,500 (from RM2,150-2,400/MT) where the upper range implies a USD85/MT CPO-SBO price discount. We think that CPO prices are likely to continue appreciating in the near-term on weaker supply, with a potential short-term peak of RM2,675/MT (implying c.USD45/MT CPO-SBO discount). However, prices are likely to soften as production uptrend resumes around Mar-Apr 16. Thus, we maintain our FY16E CPO price forecast at RM2,400/MT. Our Top Pick remains TAANN (OP; TP: RM6.57) as we expect solid timber earnings upside on the back of the strong USD. However, investors should remain cautious of any reversal in the USD/MYR, which could reverse its timber's earning trajectory.