Plantation

Poor January Production

Review of January 2022 figures:

With FFB production in low season, January 2022 CPO output fell by 14% MoM to 1.253m MT (+11% YoY), below our as well as market expectations of 1.36m MT and 1.30m MT, respectively. Exports were even more disappointing, slumping to 1.158m MT (-19% MoM) as buyers switched to alternative vegetable oils especially soyabean oil due to high palm oil prices. Domestic demand also dipped to 0.197m MT (-46% MoM, -31% YoY). However, despite weaker exports and local demand, January’s inventory closed flattish at 1.552m MT (-2% MoM) due to the lower-than-expected output.

January 2022 CPO prices reached record levels, averaging RM5,355 per MT (+6% MoM, +43% YoY) underpinned by the coming together of several key factors:

a) Palm oil inventory remains tight on seasonally low output and will probably stay so until middle of the year when new batches of guest workers to ease the Malaysian oil palm sector are expected to arrive.

b) Tighter soybean supply is now expected due to dry weather in Brazil (world’s top producer) and Argentina (key exporter). Harvest is still ongoing but cuts of 10-20m MT in soyabean has been made, dampening the prospects that stronger soyabean oil supply may ease the global oils & fats supply tightness.

c) A cold winter, supply constraints together with Russia - Ukraine tension nudged crude oil prices beyond US90 per barrel. With 5-6% of edible oils used for biodiesel, strong crude oil prices do support vegetable oil prices as well.

The poorer CPO production in January could be due to a combination of: (a) more acute labour shortages as some guest workers left for home while fresh intakes are still subject to entry restriction as Malaysia has not reopen its international borders, (b) subdued fruit yields, and (c) remnant disruptions following December’s flood in Peninsula Malaysia.

January’s exports weakness can largely be attributable to the high palm oil prices. The attractiveness of palm oil compared to alternative vegetable oils, notably, soyabean oil, tend to erode when the premium of soyabean oil price over palm oil shrinks to US$100 per MT or below, a situation which has prevailed since 4Q 2021.

Our projection for February:

With new batches of guest workers likely to arrive only in May or June, the ongoing labour shortfall coupled with fewer working days and Chinese New Year break in February are expected to result in lower palm oil production by 7% MoM to 1.166m MT. The key indicator though will be exports, for though CPO prices are set to stay elevated, international buyers nervous over policy uncertainty introduced by Indonesia requiring palm oil producer to reserve a portion for local buyers may start buying to hedge against unforeseen tightening. All in all, we are expecting February to be another tight month with output more or less just keeping up with exports. Lower closing inventory cannot be ruled out but we are expecting flattish MoM closing inventory.

Our thoughts on the sector:

Although monthly FFB production should start bottoming out seasonally in February, the supply and demand balance for palm oil is still looking tight in 1Q 2022 and increasingly so for 2Q 2022 as well, due to: (a) insufficient guest workers in Malaysia, (b) supply disruptions from Ramadan (starting in April), (c) pending Hari Raya demand in May, (d) biodiesel demand if crude oil price climbs even higher, and (e) size of pending soyabean planting in North America as South America’s harvest may be 5% lower than earlier expected.

In an effort to ensure adequate cooking oil supply and contain domestic cooking oil prices, the Indonesian Trade Ministry required its palm oil producers to set aside 20% of CPO production for local use effective 27 January 2022. On 7 February 2022, this rule was broadened beyond CPO to cover olein (cooking oil) as well as used cooking oil. Historically, Indonesia exports only around 60% of its palm oil output. Of the 40% used locally, about half is for biodiesel with the remaining half, largely for consumption, hence the basis for setting aside 20% for local consumption. While this requirement may not alter the overall global supply and demand outlook for palm oil, it does (a) introduce a limit to the availability of palm oil in the international market and (b) create policy uncertainty (and nervousness) among some international buyers.

While global oils & fats supply in 2022 should progressively improve, the current supply tightness may persist longer than we had expected a month ago. Consequently, our recently upgraded CPO price assumptions of RM3,500 and RM3,000 per MT for 2022 and 2023 may need further upgrading over the course of corporate results announcements in the next few weeks. However, the trend for CPO price is still downward (just staying more elevated) and we remain highly selective of our recommendations thus our NEUTRAL call on the sector. We favour planters that have either expanded significantly or those with potentials to pay higher dividends than their peers. KLK (OP, TP RM30.00) is our integrated pick following its significant acquisition of IJM Plantations while HSPLANT (OP, TP RM2.30) has potential for dividend surprises in view of its sizeable cash surplus which is set to grow further following the divestment of estates to its parent as well as strong operating cashflows.

Source: Kenanga Research - 11 Feb 2022