For the month of Jan 2023, Malaysia produced 1.38m MT palm oil, 5% below Kenanga’s expectation but just short by 1% of consensus’ 1.390m MT. However, export was 15% weaker than our 1.322m MT estimate though 1% above consensus. Closing inventory thus swelled by 4% to 2.268m MT, above our expectation of 2.178m MT and consensus’ 2.180m MT. Compared to historical average and pattern, though production came in line, export was slower, possibly due to disruptions from the early Chinese New Year in January this year versus February as was the norm; hence, the higher-than-average end-inventory level for this January. CPO price weakened by 27% YoY but by only 1% MoM to RM3,922/MT for Jan 2023. Respective CPO prices of RM3,800-3,500MT for 2023-24 are still expected. Maintain NEUTRAL as the sector’s defensive earnings, asset rich NTA and low P/BV ratings are offset by limited margin upside due to cost pressures. With range-bound CPO prices, we are very selective on stock picks with KLK as our large integrated play, TSH for long-term expansion growth, and HSPLANT for income yield.

Outlook: Edible oil supply is seen improving in 2023 but demand is likely to recover by 3-5% YoY on: (a) broad base consumption recovery post Covid after stagnating since 2020, (b) China – the world largest edible oil market – recently relaxing its zero Covid stance, and (c) robust demand for biodiesel as nations such as Indonesia (3rd largest biodiesel user) has just raised its B30 blend to B35 on 1 Feb 2023. As such, we expect CPO prices to hover between RM3,500-4,000 per MT. Rising production cost is a concern though as despite average fertiliser price has eased by about 20% since a peak in May 2022 it is still 70% higher YoY. Another pressure-point on unit cost is FFB production which is being weighed down by ageing palm trees and replanting. Altogether, upside potential for margin is expected to stay limited.

Recommendation: Maintain NEUTRAL given the sector’s defensive qualities such as: (i) the wide and versatile usage of palm oil as food, manufacturing ingredient and fuel, and (ii) asset-rich books and undemanding valuations are counter balanced by: (i) capped margins upside due to rising costs, and (ii) sideways palm oil prices. Selectively, we like stocks with the flexibility to expand upstream such as KLK (OP, TP: RM25.50) or TSH (OP, TP: RM1.35) which has recapitalised and expanding its planted area by circa 30- 50% while for investors seeking yields, HSPLNT (OP, TP: RM2.50) looks attractive.

Source: Kenanga Research - 13 Feb 2023