Sep-16 stocks at 1.55m MT (+6% MoM) came in 2% above consensus and 5% above our forecast on weaker-than-expected exports (-20%) offsetting lower-than-expected production (+1%). Going forward, we expect production to trend up (+10% to 1.89m MT), closer to the 5-year low, while demand should pick up (+14% to 1.65m MT) on wider soybean oil (SBO) premiums and festival demand. All-in, stocks should increase 3% to 1.59m MT as supply (1.89m MT) exceeds demand (1.84m MT). Prices should remain volatile between RM2,400-2,900/MT on mixed catalysts. Overall, we remain NEUTRAL on the sector with unchanged FY16-17E CPO prices of RM2,500-2,400/MT. We prefer younger planters TAANN (OP; TP: RM3.94) and UMCCA (OP; TP: RM6.50) on above average FFB growth prospects. We maintain our remaining calls: MARKET PERFORM on SIME (TP: RM7.90), IOICORP (TP: RM4.60), KLK (TP: RM25.00), FGV (TP: RM2.65), IJMPLNT (TP: RM3.60), TSH (TP: RM1.95) and CBIP (TP: RM2.15); and UNDERPERFORM on PPB (TP: RM15.00) and GENP (TP: RM9.80).

Sep 2016 stocks higher-than-expected. Sep 2016 stocks at 1.55m MT increased more than expected, by 6% month-on-month (MoM) to 1.55m MT. This was 2% higher than consensus’ 1.51m MT and 5% above our forecast of 1.47m MT. Although production (+1% to 1.72m MT) was weaker than both consensus (+4%) and our expectation (+7%), demand dropped more than expected, by 20% to 1.45m MT compared to consensus’s -16% and our - 12%. Both Indian (-39%) and Chinese (-34%) demand fell, likely owing to the narrow soybean oil (SBO) to CPO premium prompting traders to favour SBO for the month.

Targeting 1.89m MT production (+10%) in Oct-16. Sep 2016 production remained surprisingly weak at +1% to 1.71m MT, which was the lowest September production since 2010’s 1.56m MT. Monthly production in Peninsular Malaysia shows signs of gradual recovery, at -15% YoY compared to an average of -24% YoY in the 6-month period between Mar-Aug-16. However, Sarawak and Sabah production dragged at -8% and -11% YoY, respectively. We think that with the drought delaying typical production patterns by c.2 months, the slow production appears consistent with the typical ‘rest’ pattern seen before the peak production month. As a result, we expect to see strong production growth in Oct-16 at 10% to 1.89m MT, which is in line with the 5-year low, also 1.89m MT.

Low imports indicative of Indonesia’s tight stock situation. In tandem with weak Malaysian production, we observe that CPO imports have been on a remarkable downtrend in 2016, crashing 97% from this year’s peak imports of 74k MT down to 1.8k MT in Sep 2016. This could be mainly due to weak Indonesian stocks which fell to 1.7m MT as of Jul 2016, from 4.5m MT as at end- 2015. Looking ahead, we expect the tight stock situation to continue suppressing Malaysian imports, which in turn limits supply growth. Thus, we expect Oct 2016 imports to remain <10k MT, at c.4k MT, for total Oct 2016 supply of 1.89m MT (+10% MoM).

Expect export recovery (+14% to 1.65m MT). Export demand weakened more than expected, with a 20% fall to 1.45m MT led by India (-39% to 262k MT) and China (-34% to 198k MT). We believe this was due to the SBO-CPO price premium briefly equalizing in mid-September which prompted some buyers to switch to soybean oil. Looking ahead, we expect the widening SBO-CPO premium, currently averaging c.USD80/MT month-to-date (MTD) to improve palm oil’s attractiveness against SBO. Accordingly, cargo surveyor ITS has reported +11% MoM exports for the first 10 days of Oct-16 in spite of weaker buying in China due to the “Golden Week” holiday between 1-7 Oct. We also note that October is historically the strongest month for export as buyers stock up for year-end festivities. As a result, we expect exports to continue strengthening, by 14% to 1.65m MT in October.

Gradual stock recovery (+3% to 1.59m MT). We expect total supply at 1.89m MT to exceed total demand of 1.84m MT. On the supply side, we expect production to continue recovering 10% to 1.89m MT while imports will likely be inconsequential at 4k MT. Meanwhile, demand should improve 14% to 1.65m MT on increasingly favourable CPO prices compared to SBO, and year-end demand pickup. Overall, we expect stocks to edge up 3% to 1.59m MT.

Stock figures a mixed catalyst awaiting production recovery. While the above-average stock increase should be negative to prices, the weak production improvement and expected demand improvement should provide comfort to investors. Meanwhile, the market continues to expect a CPO price decline with futures priced at c.RM2,550/MT in the next 3 months followed by gradual price increases towards RM2,600/MT (please refer to chart on page 3). The downtrend is in line with our expectation of production improvements up to Oct/Nov.

Reiterate NEUTRAL and trading view. We maintain our expectation of volatile CPO prices on mixed catalysts, with our 4Q16 trading range of RM2,400-2,900/MT unchanged based on an SBO premium of USD20-150/MT. Positives include weak production numbers and widening SBO-CPO premiums leading to better demand. Negatives include CPO production recovery and another year of bumper US soy production. In view of volatile prices and weak regional production, we continue to favour upstream planters with solid FFB growth such as TAANN (OP; TP: RM3.94) and UMCCA (OP; TP: RM6.50).

Source: Kenanga Research - 11 Oct 2016