Fragile supply recovery for CY23 may now extend into CY24 on a subdued inventory outlook following smaller-than-expected soyabean surplus in South America. Fortunately, palm oil supply should recover in CY23 with CPO prices likely to stay relatively firm over CY23 and into CY24 unless palm, soy or rapeseed harvests prove exceptionally good later in CY23. We are keeping our CY23F CPO price of RM3,800 per MT intact but revising up CY24F CPO price from RM3,500 to RM3,800 per MT. Positive factors for the sector include: (i) palm oil being an essential food and fuel for markets in emerging economies such as China, India and Indonesia, (ii) players’ asset-rich NTA, and (iii) share valuation at 1.1x PBV with a lot of the bad news already priced in. It is also Shariah compliance (9.6% of FBM Shariah Index, 9.4% of FBMKLCI) but we are keeping our NEUTRAL weight intact in the absence of a strong upside catalyst. Our CPO price upgrade for CY24 is a positive but not enough to justify an upgrade. Our sector pick is KLK (OP; TP: RM27.00) and PPB (OP, RM19.30).

Recovery of edible oil supply in CY23 is underway but less robust than expected. Record outlook for a Brazilian soyabean harvest is likely but so is for a very poor Argentinean harvest. While Brazil is the top producer, Argentina is actually more important for international trade, often ranking as the 3rd or 4th largest edible oil exporter in the world after Indonesia, Malaysia and sometimes Russia. Fortunately for the edible oil supply market, palm oil supply should also improve. However, even as supply recovers, demand is also expected to recover, potentially at a faster pace:

1. Asia Pacific’s demand for food and fuel. Asia Pacific is the world’s biggest market for edible oil. Notable users such as China - the world’s no. 1 market - is already consuming almost as much as the EU and US combined while India should surpass the US soon with Indonesia close behind. Demand from the region is also expected get higher on demographic growth and rising affluence. Among the most widely used edible oil in the region is palm oil.

2. Abundant, affordable and flexible. Before it overtook soyabean oil to become the leading edible oil by volume around the turn of this century, palm oil used to enjoy premium prices. Commanding around 35% of market share currently and half of all edible oil traded internationally, palm oil is often more affordable than many other alternatives.

3. Biofuel demand. Much like the EU, Indonesia’s biofuel policy aims to improve energy security and preserve the environment but also to support the rural economy. Today, US and Indonesia are near equal as the 2nd and 3rd biggest biofuel users after EU. Biofuels such as bioethanol is derived from sugar/starch-rich crops (sugarcane or corn) while biodiesel is from edible oils. The main palm-based biodiesel market is Indonesia which just raised its B30 blend to B35 in Feb this year. Brazil also recently raised its soy-based biodiesel B10 blend to B12 last week with B15 as the target by 2026.

With robust demand recovery, we maintain a fragile CY23 supply-demand outlook with firm CPO prices likely. Our present concern is that the tight balance may extend into CY24 on likely smaller-than-expected South American soyabean surplus. Higher palm oil production of 3-5% YoY in CY23 should ease oil supply, even if on a limited scale.

Source: Kenanga Research - 23 Mar 2023