While we believe the trajectory for CPO price is heading downwards, we are turning less bearish. Our NEUTRAL call is justified as (i) post-expected decline, prices are still higher than CY20 level (Our CY21E CPO price: RM3,000/MT) and (ii) valuations of planters under our coverage and KLPLN index (both at -1.0SD from mean) seem to have priced in the negatives. We do not expect the KLPLN index to come under severe pressure when CPO prices correct as it has not tracked the gains in CPO prices since the commodity exceeded RM3,500/MT. We continue to believe in our case of CPO prices peaking in 1QCY21 (historical trend). Indonesia’s biodiesel policies are to be watched closely. Any changes that will increase the levy (to fund B40) will be bullish for CPO prices but the impact on planters will favour Malaysia upstream planters and Indonesia refiners. Our upstream preferred pick to capitalise on the current strong CPO price and yet able to soften the impact of subsequent price decline due to output growth is HSPLANT (OP; TP: RM2.15). Our integrated pick with defensive overall margin against the CPO price variability is KLK (OP; RM25.40).

Review of CPO and KLPLN Index. Crude palm oil (CPO) continued to shine in 1QCY21 (refer to Exhibit 1), climbing (+12%) from around RM3,800/MT to a high of RM4,252/MT in March. However, the same cannot be said about the KLPLN index which actually slipped 3%. The correlation between the KLPLN index and CPO price in 1QCY21 is a negative 21% (vs. positive 88% in 4QCY20 and 75% in CY20). We can think of two reasons – the first being ESG concerns as KLPLN’s bellwether SIMEPLT, in late December 2020, was issued a Withhold Release Order by the U.S. Customs and Border Protection, and the second being market participants’ view that CPO prices at these elevated levels are unsustainable. As CPO prices exceeded RM3,500/MT, KLPLN index has remained a stubborn laggard suggesting to us that investors could be trying to price in a correction in the commodity price.

How low can CPO go? To answer this, we reference our Virtual POC 2021 Takeaways report (https://bit.ly/2PAoDab), where we noted that CPO price forecasts by key speakers were mostly above RM3,000/MT (at an average of c.RM3,400/MT). In other words, most speakers believe that CPO price is unlikely to go below RM3,000/MT, with an exception – Mr. Dorab Mistry who thinks that CPO price (July onwards) will bottom at RM2,700/MT. The CPO forward curve (Exhibit 2), in backwardation suggests downside of c.RM800/MT (-20%) by Dec 2021.

The case for CPO price peak in 1QCY21. During the Virtual POC 2021, Mr. Thomas Mielke (Oil World) stated that he believes we have seen the peak, and if not, it will happen in the next four weeks. This is aligned with our view which is built upon our peak-to-trough CPO price study. From this (Exhibit 3), we observed that the peak of major CPO price rallies all occurred in 1QCY and we believe that the same historical trend could happen this time as well.

Inventory is set to be on an upward trajectory. As of February 2021, Peninsular Malaysia’s production downtrend has reversed while we believe East Malaysia could see its production beginning to recover as early as March 2021, which will drive inventory higher and pressure CPO prices. As of February 2021, inventory level is at 1.30m MT, while stock-to-usage (STU) ratio was at 9% (Exhibit 4). We expect an average STU ratio of 9% in 2021. Based on Exhibit 5, the implied CPO price is RM2,924/MT, close to our CY21 forecast of RM3,000/MT.

Don’t look to soybean oil (SBO) for support. In light of record soybean prices, U.S. farmers are more incentivized to increase soybean planting area. In its February Outlook Forum, USDA estimated soybean planting area to increase (+8.3% YoY) to 90m acres in 2021-22 (SepAug) period. Coupled with improving weather in South America (especially in Argentina) this should weigh on soybean oil price. Considering the high SBO-CPO premium (Exhibit 6) of c.USD200/MT (vs. 3-year average of c.USD90/MT), SBO price is unlikely to provide support for CPO prices.

Biodiesel mandates uncertainty remains. During the previous POTS Digital 2021 in Jan 2021 (https://bit.ly/3d9igmc), Mr. Togar Sitanggang (Vice-Chairman of GAPKI) made a remark that if CPO price remains at c.RM4,000/MT or higher, there may be a need to re-evaluate biodiesel levy structures. However, during the Virtual POC 2021, he mentioned that based on the current situation and levy structure, the biodiesel fund is able to support the Indonesian B30 mandate until the end of 2021. That said, based on our Biodiesel Fund Simulation, we believe that the current biodiesel levy and export tax structure may not be enough to fully support Indonesia’s B40 ambition should price moderate to <RM3,700/MT (refer to Exhibit 8). Considering Indonesia’s determined stance to push forward with B40, the risk of changes to its biodiesel policies remains. Any changes that will increase the levy (to fund B40) will be a bullish factor for CPO price. Zooming in to the planters, it is likely to be detrimental to Indonesian upstream planters but beneficial to Indonesian refineries. Indonesian upstream planters will see realised CPO prices capped further and this will add to the Malaysian upstream planters’ advantage. The key winners of Indonesia’s current biodiesel levy structure and any increase in the levy structure are pure Malaysian upstream planters like HSPLANT (OP; RM2.15), and TAANN (MP; RM3.00) that are able to enjoy the full benefits of the rise in CPO prices.

Nothing to shout about for 1QCY21 earnings cycle. After a good 4QCY20 results season, investors should not be too excited about 1QCY21. We believe improvement in CPO prices will likely be muted by the seasonal decline in output. Based on MPOB’s data, 1QCY21 average CPO price rose (+16% QoQ) to RM3,919/MT (vs. RM3,366/MT in 4QCY20), while we expect a c.25% decline for Malaysia’s 1QCY21 production.

Stay NEUTRAL on the plantation sector. While CPO price is expected to trend downwards, we are turning less bearish as post-expected decline, prices are still above CY20 level (our CY21E CPO price: RM3,000/MT) and as valuations of planters under our coverage and KLPLN index (both at -1.0SD from mean) seem to have somewhat priced in the negatives. Also, considering how the KLPLN index has not tracked the gains in CPO price since the commodity exceeded RM3,500/MT, we think that the index is unlikely to come under severe pressure when CPO price corrects. Our upstream preferred pick to capitalise on higher CPO price is HSPLANT (OP; TP: RM2.15), while our integrated pick to weather through the expected CPO price decline is KLK (OP; RM25.40).

Source: Kenanga Research - 5 Apr 2021