Stay NEUTRAL on the plantation sector, while our CY20 CPO price target of RM2,300/MT remains. The market could be underestimating production growth for 2HCY20 - MPOB estimated CY20 CPO production at 19.0m MT (- 4.3% YoY). However, we believe there is upside risk based on our observation of above-average 2H production recovery trend after El Niño impact in 2015-2016. CPO production growth for 2HCY16 and 2HCY17 were above average at 28% HoH and 29% HoH, respectively (vs. 5-year average of 20%). We estimate 2020 CPO production to come in at 19.5m MT (-1.8% YoY), suggesting 19% HoH growth (assuming June 2020 production of 1.74m MT) compared to MPOB’s 13% HoH growth. Meanwhile data from cargo surveyors revealed a surge in June 2020 exports (+18.8% MoM) mainly from China and India due to: (i) pent-up demand, and (ii) 0% palm oil export tax for Jun-Dec 2020. We caution that the surge in demand could be unsustainable after stockpiling activities are completed. Demand disruption from a COVID-19 second-wave remains an undeniable risk. China, however, is a wild card. We expect China to ramp up U.S. soybean purchases to honour the U.S.-China phase 1 trade deal but do not discount the possibility of stronger palm oil demand as a substitute to soybean oil, in the event of a U.S.- China trade deal fallout. The potential of a new swine flu virus resulting in: (i) outbreak among the swine herds, and (ii) transmission to humans which could discourage the consumption of pork – ultimately reducing soybean crushing activities, also builds a case for palm oil as a substitute to soybean oil. On biodiesel, B30 uncertainties have been addressed but a shortfall of 1.4m MT is expected. On the other hand, Malaysia’s B20 (additional c.0.6m MT CPO absorption) has been delayed. A potential La Niña (WMO model predicts 40% probability) in SeptemberNovember 2020 could be a redeeming feature to boost CPO price. For now, our CY20 CPO price forecast of RM2,300/MT remains, implying an average CPO price of RM2,100/MT in 2HCY20. We expect pressure on CPO price in 2HCY20 on rising inventory and narrow soybean oil-palm oil (SBO-CPO) spread of USD49/MT (vs. 1-year average of USD134/MT), which undermines CPO’s competitive edge. Nevertheless, we believe there is still value to be found in the sector. For investors seeking exposure to the plantation sector, we recommend taking positions in bashed down names like HSPLANT (OP; TP: RM1.85) and TSH (OP; TP: RM0.950), both being traded at -1.0SD valuation level (vs. peers’ at -0.5 to mean valuation).

2HCY20 production growth potentially stronger than expected. The 2019 El Niño impact (June to early October) is evident, based on production figures of Malaysian Palm Oil Board (MPOB). YTD- 5MCY20 production has fallen to 7.16m MT (-13% YoY), while CPO production for 2020 is estimated at 19.0m MT (-4.3% YoY). Having said that, we believe that there is upside risk towards MPOB’s figure based on the above-average 2H production recovery trend we observed from the past El Niño impact in 2015-2016. CPO production growth for 2HCY16 and 2HCY17 were above average at 28% HoH and 29% HoH, respectively (vs. 5-year average of 20%). In light of that, we estimate 2020 CPO production to come in at 19.5m MT (-1.8% YoY). Our estimate suggests 19% HoH growth (assuming June 2020 production of 1.74m MT) compared to MPOB’s 13% HoH growth.

Exports surged – but too soon to celebrate. Data from cargo surveyors (AmSpec and Intertek) for June revealed a spike in palm oil exports registering an average 18.8% MoM increase. We attribute the surge mainly to China and India due to: (i) pent-up demand from re-opening of economies, (ii) reported 200k MT palm oil purchase by India to be delivered in June-July, and (iii) 0% palm oil export tax for Jun-Dec 2020 (making Malaysian palm oil more competitive than Indonesia). While acknowledging inventory replenishment efforts from countries like India (YTD inventory at lowest level), we caution that the pent-up demand could dissipate after stockpiling activities are completed. Additionally, demand disruption from a COVID-19 second-wave remains an undeniable risk. To elucidate our point, we highlight that India has added 23,932 new COVID-19 cases (as of 5 July 20), while the country has only tested 0.7% of its population (vs. Malaysia’s 2.5%), outlining the disparity and the undeniable potential of a second-wave. In fact, major countries in Asia that import Malaysian palm oil have all (with the exception of Saudi Arabia and Turkey) only tested <1% of their population. Bangladesh and Pakistan (which collectively accounted for c.10% of Malaysia’s YTD-5MCY20 palm oil exports), have reported 2,738 and 3,191 new COVID-19 cases and have only tested 0.5% and 0.6% of their population respectively (as of 5 July 2020). Overall, we expect supply to outstrip demand in 2HCY20, leading to burgeoning stockpiles, which should exert pressure on CPO prices.

Source: Kenanga Research - 9 Jul 2020