May 2016 stocks declined for the sixth month in a row, by 9% Month-on-Month (MoM) to 1.65m MT (metric tons). This was within consensus (1.66m MT) but below our forecast (1.74m MT), driven by +9% exports to 1.28m MT, while production (+5% to 1.36m MT) remained weak at -25% Year-on-Year (YoY). Going forward, we see production gradually improving (+5% to 1.43m MT) but still near the five-year lows. Meanwhile, demand should strengthen on higher exports (+4% to 1.33m MT) due to sustained festive demand, and better domestic use (+4% to 272k MT) on B10 biodiesel implementation. Overall stocks should continue declining by 8% to 1.52m MT as demand growth outpaces supply improvement. However, we reiterate our NEUTRAL call as weak demand (excluding India) limits CPO price upside. FY16E CPO price is maintained at RM2,400/MT as 2H16 prices should trend downwards on coming US rate hikes and production increase. Our Top Pick remains KLK (OP; TP: RM26.17) given its positive upstream and stable downstream prospects, while downside is limited by its big-cap status. We also have OUTPERFORM call on UMCCA (TP: RM7.42) and CBIP (OP; TP: RM2.34); MARKET PERFORM on SIME (TP: RM7.75), IOICORP (TP: RM4.57), PPB (TP: RM16.60), FGV (TP: RM1.40), TSH (TP: RM2.05), and TAANN (TP: RM4.35); UNDERPERFORM on GENP (TP: RM10.60), and IJMPLNT (TP: RM3.15).

May 2016 stocks fell for 6 months running, to 1.65m MT (-9% MoM), coming in within consensus (1.66m MT) and 5% below our forecast (1.74m MT). This was driven by a 9% pick-up in exports to 1.28m MT which, nevertheless, remained 3% below consensus (1.32m MT) and 7% below our forecast (1.39m MT) on persistently soft demand in China (-71% YoY to 106k MT) and the EU (-56% YoY to 117k MT). Meanwhile, production (+5% to 1.36m MT) was close to consensus (1.35m MT) but 8% below our forecast (1.48m MT).

Expect the gradual uptrend in production (+5% to 1.43m MT). May 2016 production growth remained relatively slow, increasing 5% to 1.36m MT. This was below the previous five-year May production low of 1.38m MT, reflecting the after-effect of droughts in 2014-15. Production in Peninsular Malaysia and Sabah was seriously affected, dropping 28% and 25% YoY, respectively. Looking ahead, we expect seasonal production to gradually improve in line with the seasonal trend, with a Jun 2016 forecast of +5% to 1.43m MT (19% below Jun-15 production).

Exports to pick up on festive demand (+4% to 1.33m MT). May 2016 demand remained below the 8-year average in China, EU, Pakistan and USA, reflecting a general preference for soy or Indonesian palm oil. India remained a bright spot, however, with YTD exports coming in 88% above the 8-year average and 12% above May 2015 YTD exports. In Jun 2016, we expect this trend to continue, with below-average demand seen in all key markets except India. Nevertheless, festive demand should sustain exports in the near term. Hence, we believe Jun 2016 exports to strengthen 4% to 1.33m MT, driven by stronger Indian demand and flat demand in the remaining key markets. Push for B10 to improve local usage (+4% to 272k MT). In May 2016, the government announced that Malaysia would raise its biodiesel mandate to 10% for the transport sector, and to 7% for the industrial sector beginning 2 Jun 2016, which is expected to increase local consumption by 709k MT. This translates to 59k additional monthly demand. We conservatively reflect this in our Jun 2016 domestic consumption forecast of 272k MT, or c.50k additional demand above YTD 2016 average local demand of 225k MT.

Jun 2016 stocks to approach 1.5m MT (-8% to 1.52m MT). We expect demand at 1.61m MT to outweigh supply at 1.48m MT. For the supply side, production is likely to improve gradually by 5%, in line with the seasonal trend but well below 2016 performance. Meanwhile, on the demand side, exports are likely to improve 7% to 1.37m MT on sustained festive demand, while we believe local usage is likely to pick up on the implementation of B10 biodiesel. As a result, Jun 2016 stocks should continue declining, by 8% to 1.52m MT, the lowest level since Feb 2011.

Reiterate NEUTRAL. Despite the consistent decline in stock levels, weak demand ex-India continues to limit CPO price upside. Nevertheless, we believe the slow production recovery and weakening ringgit should support CPO prices above RM2,500/MT over the next 1-2 months. However, we maintain our view that 2H16 CPO prices are likely to trend downwards as rising production and US rate hikes put pressure on commodity prices. Our Top Pick remains KLK (OP; TP: RM26.17) on its positive upstream outlook and stable downstream margins, while the downside is limited given its big-cap status.

Source: Kenanga Research - 13 Jun 2016