August 2018 stocks rose 1.3% to 2.21m MT, below our 2.30m MT forecast and consensus’ 2.34m MT estimate on weaker-than-expected output (+12.8% to 1.50m MT), due to lingering effects of El Nino and La Nina in Sabah. Exports at 1.21m MT were weaker than our forecast (1.33m MT) but above consensus (1.14m MT). Looking ahead, we anticipate moderate production growth (+13.0% to 1.70m MT) as the impact from El Nino and La Nina subsides while exports should improve (+14.7% to 1.38m MT) with better demand from India, EU and China. All-in, we expect August 2018 stocks to rise 3.6% to 2.30m MT on higher supply (1.70m MT), exceeding demand improvement (1.38m MT). Reiterate NEUTRAL on the sector as production improvements and low CPO price downside should support planters’ margins. No change to our FY18E CPO price of RM2,400/MT although we continue to expect muted 3Q18 prices (averaging RM2,250/MT) as risks outweigh opportunities. We maintain our 3Q18 trading range of RM2,200-2,400/MT. We expect low and stable CPO prices to benefit downstream players such as IOICORP (OP; TP: RM5.00), PPB (OP; TP: RM22.30) and GENP (OP; TP: RM10.75).

July 2018 stocks increased 1.3% MoM to 2.21m metric tons (MT), 4.7% lower than our forecast of 2.30m MT and 6.6% lower than consensus’ 2.34m MT. This was largely due to weaker-than-expected production of 1.50m MT (+12.8% MoM) vs. our projected 1.64m MT (+23.0% MoM) and consensus’ 1.54m MT (+15.9% MoM), which was likely attributed to the lingering effect of El Nino in 2015 and La Nina in 2016/2017 in Sabah. Exports at 1.21m MT (+6.8% MoM) were stronger than consensus (1.14m MT), but below our forecast (1.33m MT). The growth was mainly driven by the EU region (+16.2% MoM to 157k MT) and non-key markets (+30.2% MoM to 695k MT). Meanwhile, export to India declined 17.7% MoM to 131k MT due to unfavourable tax structure and export to China was also down 28.2% MoM to 112k MT as buyers likely held back purchases amid trade war concerns.

August 2018 production to grow 13.0% MoM to 1.70m MT. While the August-October period is typically a peak production season, we believe August’s output would fall short of its 5-year average production of 1.87m MT (see Exhibit 5). From our channel checks, we gather that the lingering effects of El Nino in 2015 and La Nina in 2016/2017 in Sabah are still affecting pollination and fruit sets, but are subsiding. As such, we believe this year’s peak production period would only take place in October-November; and we forecast August output to grow moderately at 13.0% MoM to 1.70m MT.

Exports to recover 14.7% to 1.38m MT in August 2018. Despite a 6.8% MoM increase, July exports at 1.21m MT was the lowest in more than 10 years for the month of July (see Exhibit 6), likely due to an unfavouable tax structure in India and lukewarm demand from China. However, we believe India’s recent move to raise import taxes on other vegetable oils (crude soyoil: from 30% to 35%, crude canola and sunflower oils: from 25% to 35%) should allieviate the situation. In addition, Reuters reported that some edible oil traders have been circumventing India’s import tax by sourcing from South Asian Free Trade Agreement (SAFTA) member countries, including Bangladesh and Sri Lanka, which are exempted from CPO import tax. That aside, the current CPO price and weak MYR environments are supportive of August exports volume. Data from Bloomberg show that the CPO-to-gasoil discount is currently at c.US$110/MT (vs. 1-year average premium of c.US$27), making biodiesel blending profitable (cost of production typically ranges from US$100-150/MT). Therefore, there should be increasingly more discretionary biodiesel blending, supporting exports volume to EU. Exports to China are also expected to pick up ahead of winter (Nov-Mar). As such, we forecast August exports volume to grow 14.7% MoM.

August 2018 stocks to rise 3.6% to 2.30m MT. We anticipate supply growth of 1.75m MT to exceed demand improvement of 1.67m MT, leading to higher ending stocks of 2.30m MT in August 2018. The anticipation of peak production in Oct-Nov should limit the upside of CPO prices in 2H18, while other risks such as weak soybean prices and higher Indonesian supply continue to outweigh opportunities (supportive crude oil price, better Indian and biodiesel demand). As such, we continue to expect muted 3Q18 CPO prices at RM2,250/MT. The average CPO price YTD is RM2,378/MT.

Maintain NEUTRAL on plantations despite the lackluster immediate outlook as we think production improvements and limited downside risk could support planters’ margins in 2H. Our FY18E CPO price forecast is unchanged at RM2,400/MT, and we maintain our 3Q18 trading range of RM2,200-2,400/MT. Low but stable CPO prices should benefit integrated planters due to lower input costs. Among these, we like IOICORP (OP; TP: RM5.00) and PPB (OP; TP: RM22.30) while GENP (OP; TP: RM10.75) with its new refinery and above-average FFB growth could also benefit from rising production trends.

Source: Kenanga Research - 13 Aug 2018