Aug 2016 stocks continued to slide, falling 17% to 1.46m MT on a 31% jump in exports to 1.81m MT and moderate production improvement (+7% to 1.70m MT). Going forward, we expect production to continue rising (+7% to 1.82m MT), on track for a seasonal peak in Oct-Nov-16, while exports are likely to trend down (-11% to 1.61m MT) post-restocking in China while high spot prices deter price-sensitive markets. All-in, supply (1.83m MT) should match demand (1.82m MT) for flat Sep-16 stocks (+1% to 1.48m MT). We expect price support to be temporary, given likely production uptrend and shrinking soybean oil (SBO) to CPO premium. We remain NEUTRAL on the sector with unchanged FY16-17E CPO price of RM2,400/MT, but with an upside bias in our coming 4Q16 strategy report. Meanwhile, 2H16 CPO prices should trade between RM2,500-2,900/MT. We still like KLK (OP; TP: RM25.00) as its positive 4Q16 production outlook and strong downstream demand should provide near-term upside. We also maintain OUTPERFORM on TAANN (TP: RM3.94) and UMCCA (TP: RM7.42), and, MARKET PERFORM on SIME (TP: RM7.90), IOICORP (TP: RM4.60), FGV (TP: RM2.10), IJMPLNT (TP: RM3.60), TSH (TP: RM1.95), and CBIP (OP; TP: RM2.15); and UNDERPERFORM on PPB (TP: RM15.00) and GENP (TP: RM9.80).

Aug 2016 stocks came in much lower than expected, with a 17% fall to 1.46m MT, or the lowest monthly inventory since Jan 2011. This is well below both consensus (1.60m MT) and our forecast (1.86m MT) by 8% and 22%, respectively. The drop was driven by a 31% jump in exports to 1.81m MT as Indian demand jumped 126% to 429k MT while China demand rose 42% to 299k MT on pre-festival demand and restocking activity. Production meanwhile was slightly below both consensus and our forecast (1.74m MT) by 2%, or 1.70m MT on lingering drought impact.

Monthly production growth to continue in Sep-16 (+7% to 1.82m MT). Aug 2016 production improved another 7% to 1.70m MT, marking the sixth straight monthly improvement since Feb 2016. However, we observe that production numbers have consistently recorded close to 5-year low levels, which implied that fullyear production may well come in at a 5-year low total of 17.5m MT, or -12% year-on-year (YoY). In the months ahead, we expect production to continue rising month-on-month (MoM), although Peninsular Malaysia and Sabah production is likely to remain weaker YoY due to large-scale replanting programs among major planters and lingering effects of 2014/15 droughts. All-in, we estimate Sep 2016 production of 1.82m MT (+7% MoM and -7% YoY), slightly below the 5-year low of 1.87m MT.

Exports to trend lower post-restocking (-11% to 1.61m MT). Export demand rebounded strongly in Aug 2016 to 1.81m MT, the highest since Sep 2011, driven by a massive jump in Indian festival demand and continued Chinese restocking activity (please refer to chart in page 4). Looking ahead we expect demand to moderate with Chinese palm oil stock levels stabilizing, while high spot prices likely to increase preference for soybean oil in markets such as India and Pakistan. We note that the recent run-up in CPO prices has sharply narrowed the soybean oil (SBO) to CPO price premium to c.USD20/MT in September, which we deem unsustainable at -1.5SD from the long-term historical average of c.USD150/MT. As a result, we think exports are likely to weaken 11% to 1.61m MT, mainly on softer demand from China and India.

Sep 2016 stocks to be flat at 1.48m MT (+1%). We expect supply at 1.83m MT to be even with demand at 1.82m MT in Sep 2016. On the supply side, we expect another 7% improvement to 1.82m MT, on track for a production peak in Oct/Nov 2016. On the demand side, we expect weaker exports at -11% to 1.61m MT post-festival demand and restocking activity, in addition to unsustainably low SBO-CPO premiums. Overall, we expect Sep 2016 stocks to be relatively flat at 1.48m MT or +1% MoM.

Expect only temporary price support despite bullish inventories. While the sharp drop in inventories could be supportive to CPO prices, we expect the effect to be short-lived. We observe that futures prices are indicating a sharp drop in CPO prices in the months ahead to RM2,500-2,600/MT (please refer to chart in page 4). Given our expectation of a wider SBO-CPO premium gap, we concur with the market’s bearish view and expect CPO prices to trade between RM2,700-2,900/MT in the short-term, which implies a SBOCPO premium range between USD20-80/MT.

Maintain NEUTRAL on Plantation sector. Although we expect low inventory numbers to be supportive of CPO prices, this could be negated by high CPO spot prices, which appear to have softened demand in the early days of September. In the mid-term, we maintain our bearish view on CPO prices in view of a continued production uptrend until mid-4Q16 and strong expectations of a US rate hike in the coming months. As a result, we expect CPO prices to remain volatile in the short term, with a wide 2H16 trading range of RM2,500-2,900/MT, assuming a SBO premium of USD20/MT (-1.5SD on historical average), and gasoil discount of USD180/MT (+4SD on historical average). Our FY16E CPO price forecast is maintained at RM2,400/MT for now, although with an upside bias in our upcoming 4Q16 strategy review, in consideration of supportive prices due to below-average supply recovery. With CPO prices expected to remain volatile in the mid-term, we believe KLK (OP; TP: RM25.00) holds less downside risk given its bigcap status and integrated operations, while positive 4Q16 FFB growth prospect could provide some earnings upside. While FY17E FFB growth (+8%) is in line with sector average (+9%), KLK’s growth compares favorably to the big-cap average (+6%).

Source: Kenanga Research - 14 Sep 2016