August 2018 stocks rose 12.4% MoM to 2.49m MT, above our 2.30m MT forecast and consensus’ 2.41m MT estimate due to weaker-than-expected exports (-8.1% MoM to 1.10m MT), as buyers in the EU region likely hoarded inventory previously amid low CPO prices. Production at 1.62m MT (+7.9% MoM) was below our forecast (1.70m MT) and consensus estimate (1.65m MT). Looking ahead, we expect output to increase 9.0% MoM to 1.77m MT as the impact from El Nino and La Nina subsides while exports should improve 11.0% MoM to 1.22m MT with better demand from EU and China. All-in, we expect September 2018 stocks to rise 12.4% MoM to 2.80m MT on higher supply (1.84m MT), exceeding demand improvement (1.53m MT). Reiterate

NEUTRAL on the sector as production improvements and low CPO price downside should support planters’ margins in 2H. No change to our FY18E CPO price of RM2,400/MT as we expect minor improvements in CPO prices in the near term, supported by the current steep CPO-gasoil discount and India’s move to raise import taxes on other vegetable oils. We expect low and stable CPO prices to benefit integrated planters such as GENP (OP: TP: RM10.75) and PPB (OP; TP: RM18.60).

August 2018 stocks increased 12.4% MoM to 2.49m metric tons (MT), 8.1% above our forecast of 2.30m MT and 3.1% above consensus’ 2.41m MT. This was largely due to weaker-than-expected exports of 1.10m MT (-8.1% MoM) vs. our projected 1.37m MT and consensus’ 1.23m MT, as exports to the EU region shrank by half. We believe this was because buyers in the region had been hoarding inventory over the past few months amid low CPO prices – as elucidated by a 4.6% YoY increase for 7M18 exports to the EU. Positively, exports to India recovered slightly to 139k MT (+5.4% MoM) after it raised import taxes on other vegetable oils (crude soyoil: from 30% to 35%, crude canola and sunflower oils: from 25% to 35%) in mid-June, which has made palm oil more competitive in the market. Exports to China remained flat from the previous month after two consecutive months of sequential decline. Meanwhile, CPO production rose 7.9% MoM to 1.62m MT, below our forecast of 1.70m MT and consensus’ 1.65m MT, likely due to the lingering effect of El Nino in 2015 and La Nina in 2016/2017 in Sabah.

September 2018 production to grow 9.0% MoM to 1.77m MT. While the August-October period is typically a peak production season, we believe September’s output would fall short of its 5-year average production of 1.85m MT (see Exhibit 5). From our channel checks with planters, we gather that there has been a change in cropping patterns in Sabah plantations, due to El Nino and La Nina as noted. This has adversely affected pollination and fruit sets, resulting in weaker-than-usual production for the past few months. However, most of the planters said that the effect is already subsiding, and production is likely to pick up in the coming months. As such, we believe this year’s peak production period would take place in October-November; and we forecast September output to increase 9.0% MoM to 1.77m MT.

Exports to recover 11.0% MoM to 1.22m MT in September 2018. We believe exports would recover in September 2018 as the EU resumes imports of palm oil for biodiesel use. Data from Bloomberg show that the CPO-to-gasoil discount is currently at c.US$152/MT (vs. 1-year average premium of c.US$1), making biodiesel blending profitable (cost of production typically ranges from US$100-150/MT). This should incentivise discretionary biodiesel blending, thus supporting exports volume to the EU. Additionally, exports to China are expected to pick up ahead of the winter season in Nov-Mar. Meanwhile, exports to India could remain flat as rupee continues to weaken against major currencies, which pressures the country to keep imports in check. Overall, we forecast September exports volume to grow moderately at 11.0% MoM to 1.22m MT.

September 2018 stocks to rise 12.4% to 2.80m MT. We anticipate supply growth of 1.84m MT to exceed demand improvement of 1.53m MT, leading to higher ending stocks of 2.80m MT in September 2018. We believe near-term CPO prices are supported by the current steep CPO-gasoil discount and India’s move to raise import taxes on other vegetable oils as noted. However, we do not see momentous price catalysts either given a likely seasonal production pick-up in 2H18, which limits CPO price improvements. As such, we expect minor improvements in CPO prices in the near term, with downside limited to RM2,000/MT (based on small-holders'’ cost of production) and upside capped at RM2,530/MT (based on USD60/MT discount to competing SBO).

Maintain NEUTRAL on plantations despite the lackluster immediate outlook as we think production improvements and limited downside risk to CPO prices could support planters’ margins in 2H. Our FY18E CPO price forecast is unchanged at RM2,400/MT (vs. YTD average of RM2,356/MT). Low but stable CPO prices should benefit integrated planters due to lower input costs. Among the companies under our coverage, we continue to favour GENP (OP: TP: RM10.75) due to likely FFB production pickup in Indonesia for 2HCY18 and PPB (OP; TP: RM18.60) as its associate, Wilmar, is likely to post stronger 2HCY18 with the commencement of sugar crushing season.

Source: Kenanga Research - 13 Sept 2018