Jul-2016 stocks surprised with a slight decline (-0.2%) to 1.77m MT on higher-than-expected exports (+21% to 1.38m MT). Production improvement was slow at +3% to 1.59m MT on lower working days during the month. Looking ahead, we expect continued production pickup (+10% to 1.74m MT) while exports are likely to be flat (+1% to 1.40m MT). As supply (1.76m MT) surpasses demand (1.66m MT), we expect Aug-2016 stocks to rise 6% to 1.87m MT. While the stock decline surprise could be short-term positive to CPO prices, we remain bearish due to expected production uptrend. Meanwhile, planters could face some headwinds as we expect 2Q16 results to miss expectations due to setbacks in 1Q16. Overall, we remain NEUTRAL on the sector with unchanged FY16-17E CPO price of RM2,400/MT; while for 2H16, it should trade between RM2,000- 2,500/MT. We prefer KLK (OP; TP: RM26.17) as its positive production outlook should provide upside while downside is limited by its big-cap status. We also maintain OUTPERFORM on TSH (TP: RM2.05), TAANN (TP: RM3.63), UMCCA (TP: RM7.42), and CBIP (OP; TP: RM2.34), MARKET PERFORM on SIME (TP: RM7.75), IOICORP (TP: RM4.80), and FGV (TP: RM2.10); and UNDERPERFORM on PPB (TP: RM15.50), GENP (TP: RM10.60), and IJMPLNT (TP: RM3.15).

Jul-2016 stocks came in stronger than expected with a surprise slight decline of 0.2% to 1.77m MT. This was driven by stronger-than-expected exports, which rose 21% to 1.38m MT, or 7% above consensus and 6% above our expectation. However, domestic usage dropped 24% to 218k MT, 17% below consensus and 24% below our forecast, as delays in B10 biodiesel implementation led to a normalisation of local demand. Meanwhile, production improved by only 3% to 1.59m MT, within consensus’ 1.59m MT but 3% below our expected 1.64m MT.

Expect a stronger production pickup in Aug-2016 (+10% to 1.74m MT). Jul-2016 production rose by only 3% to 1.59m MT which we think is partly due to lower working days in a festive month. While we note that Sabah production is improving with Jul-2016 production only 0.2% below Jul-2015 production, Peninsular Malaysia production remained weak at 24% below Jul-2015 production. Looking forward to Aug-2016, we think Peninsular Malaysia production will remain c.25% below Aug-2015, while Sarawak production is likely to be slightly higher YoY and Sabah production should be slightly lower. Nevertheless, as seasonal trends remain positive, we still expect production to pick up in Aug-2016 by 10% to 1.74m MT.

Exports to remain flat (+1% to 1.40m MT). Although export demand grew above expectations at 21% to 1.38m MT, we note that it remains below the 8-year July average of 1.48m MT, and 14% below Jul-2015 exports of 1.61m MT. In particular, although China’s restocking activity led to a 109% month-on-month (MoM) jump to 211k MT, exports remained well below the 8-year July average of 317k MT due to the economic slowdown and a switch to soybeans. As a result, we think the pickup may not be sustainable and expect Chinese demand to decelerate over Aug-2016. However, India and Pakistan demand could strengthen over the next 1-2 months on improving festive demand. Overall, we expect flattish exports in Aug-2016 at 1.40m MT or +1% MoM.

Aug-2016 stocks to rise 6% to 1.87m MT. We expect supply at 1.76m MT to exceed demand at 1.66m MT. Supply-wise, we think production should continue improving by 10% to 1.74m MT on seasonal pickup. Meanwhile, we expect exports to be flat at +1% to 1.40m MT as we think waning Chinese demand should be offset by better Indian demand on coming festival seasons. As a result, we forecast Aug-2016 stocks to increase 6% to 1.87m MT.

Short-term positive to CPO prices, but downside likely. While the surprising decline in stock levels could be positive to near-term CPO prices, we believe this may be short-lived as production is likely to continue its uptrend heading into Sep/Oct-2016. Based on our study of CPO price to soybean oil (SBO) discounts and gasoil premiums, we expect CPO prices to range between RM2,330 to RM2,600 in the near-term, based on a -3SD SBO premium and +8SD gasoil discount. This implies a higher downside of 9% against an upside of 1%. With the greater short-term CPO price risk, we think investors should consider taking profit for now, in anticipation of lower CPO prices over the next 2-3 months.

Planters’ 2Q16 results likely within-to-below expectations. We expect the upcoming 2Q16 results to improve QoQ and flattish YoY. QoQ, CPO prices have improved 8% to an average of RM2,601/MT while Malaysian production improved 15% to 3.89m MT. YoY, although CPO prices improved 19%, production dropped significantly by 26%, reflecting mid-2015 drought impact. In terms of expectations, we think that many planters could miss consensus estimates in the upcoming results season as better 2Q16 results may not make up for a very weak showing in 1Q16.

Reiterate NEUTRAL on Plantation sector as we remain bearish on the likely stock uptrend over the next quarter which will be negative for CPO prices. However, near-term optimism on lower Jul-2016 stocks and better demand could provide temporary upside. We maintain our 2H16 expected CPO price range of RM2,000-2,500/MT assuming a soybean oil premium of USD40/MT (-3.0SD on historical average) and gasoil discount of USD90/MT (+3.0SD on historical average). With CPO prices expected to remain volatile in the mid-term, we believe KLK (OP; TP: RM26.17) holds less downside risk given its big-cap status and integrated operations, while positive FFB growth prospect could provide some earnings upside.

Source: Kenanga Research - 11 Aug 2016