Reiterate NEUTRAL with unchanged 2018 CPO price estimate of RM2,400/metric ton (MT). We expect CPO price to improve in 4QCY18, accompanied by higher volatility with trading range broadening to RM2,100-2,550/MT from RM2,150-2,450/MT in 3QCY18. The price improvements are likely to be fuelled by rising demand for alternative vegetable oils from China, Indonesia’s extension of B20 mandate and increasing discretionary blending of biodiesel in the EU due to the current steep CPOgasoil discount. We believe these factors would overshadow the prospective production pick-up in 4QCY18 in the determination of CPO prices. Nevertheless, we note that sector sentiment could continue to be affected by uncertainties arising from the ongoing trade war between China and the US, instilling higher volatility into the CPO market. In addition, the improvement in CPO prices and output in 4QCY18 are unlikely to supercede the earnings shortfall in 1H18, leaving 2018 an unexciting year for most planters. To sum up, we see downside to CPO price limited at RM2,000/MT (based on smallholders’ cost of production) and upside capped at RM2,550/MT (based on USD60/MT discount to competing SBO). For 2019E, we are forecasting a flat CPO price average of RM2,400. 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.

A better quarter. We are NEUTRAL on the plantation sector for 4QCY18, but underscore its potential to be a better quarter relative to 2Q-3QCY18. In 4QCY18, opportunities for the sector are stronger exports to China and the EU, seasonal pick-up in production, as well as Indonesia’s extension of B20 mandate, which is supportive of CPO price and demand. However, we believe sentiment for the sector could continue to be dampened by the ongoing trade war between China and the US. Overall, we still expect an improvement in CPO price during 4QCY18.

Bumper crop to ease cost woes. We believe 4QCY18 would be an unconventional cropping season where CPO production is likely to reach its peak for the year, in lieu of typically occurring towards the tail-end of 3QCY18. Over the past five years, the peak monthly production averaged 2.0m MT, with the exception of 2016 during which production was adversely affected by El Nino. Given that recent rainfall in Malaysia has been favourable for the soil moisture profile of oil palm estates (according to Oil World), we believe this year’s peak is likely to reach 2.0m MT in Oct/Nov as well, vs. 1.3-1.6m MT/month up till August.

This should lead to lower unit cost structure, offering some respite to planters (especially pure upstream players) that have been hit by various production setbacks in 2QCY18, namely unfavourable weather conditions and extended Eid al-Fitr holidays. Planters with younger average age are particularly prone to production disruptions given high fixed costs and low-base yields in young mature tree areas. As such, margin improvement in companies with younger estates – such as IJMPLNT, TSH and UMCCA – should be more prominent, although this still hinges on the performance of CPO prices over 4QCY18.

Exports seeing light at the end of the tunnel. CPO exports volume is expected to recover to 1.3-1.5m MT levels in 4QCY18 from a 30-month low of 1.1m MT recorded in August, supported by China and the EU. According to The Straits Times, China has pledged to increase imports of palm oil and other agricultural products from Malaysia during Tun Dr Mahatir’s visit to the country. In addition, exports to China typically peak in November as the country hoard inventory ahead of holiday and winter seasons. For the EU region, demand is likely to be fuelled by biodiesel. We note that the current CPO-to-gasoil discount is fairly steep at c.USD191/MT (vs. 1-year average of c.USD12), which renders 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.

Meanwhile, exports to India could remain lacklustre as rupee continues to weaken against major currencies, which pressures the country to keep imports in check. In addition, 4QCY18 is typically a low season for exports to India as trade activities normally ease after Deepavali in November. Nonetheless, these are partially alleviated by 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%) in mid-June, which has made palm oil more competitive in the market. Overall, signs are pointing towards a gradual recovery in export volume in 4QCY18. The current low CPO price and weak MYR environments are also supportive of exports volume.

Source: Kenanga Research - 4 Oct 2018