We maintain our NEUTRAL call for the sector. We project flattish CPO prices of RM3,800/MT in CY24 with demand growth normalising at 3%-4% YoY and supply looking to stay tight. Meanwhile, production cost has been easing since mid-CY23 and should stay soft into CY24. El Nino has been mild so far but ageing trees are now expected to dampen palm oil yields instead. Given firm CPO prices with softer costs outlook, the sector’s CY24 profit should recover while the valuation of 1.1x sector PBV is not demanding either. Gearing is moderate to good and the sector is Shariah compliant. For stock picks, we prefer growth over income, hence KLK (OP; TP: RM24.50) given its flexibility to expand upstream and downstream internationally, PPB (OP; TP: RM19.30) on FY24F earnings recovery while TSH (OP; TP: RM1.30) is set to plant up 30%-40% additional area.

Healthy edible oil demand should keep palm oil prices firm. We project flattish CPO prices of RM3,800/MT in CY24 as demand recovers to either keep pace or even outrun the growth in supply. CY24 is looking to start the season with flattish inventory levels whilst supply may tighten on poor weather and oil palm yields as demand continue to inch up by another 3%-4% YoY. Specifically, demand for palm oil is expected to remain healthy on the back of:

1. Huge and growing regional edible oil market. Rising demographic and affluence are driving Asia Pacific as the world’s largestedible oil consumer. China’s market alone is 1.3x larger than EU which is the second largest market whilst India and Indonesiashould surpass the US in a decade or so. With India and Indonesia set to hold elections in CY24, both governments are likely toensure food supply to be as widely available as possible, thus demand for palm oil can be expected to stay buoyant in CY24.

2. Affordable and flexible. About half of all the edible oils traded internationally are palm oil. This dominance is supported bycompetitive prices, year-round availability and multiple uses for the oil, from solid vanaspati to liquid frying oil and even biodiesel.

3. Biofuel demand. Indonesia has adopted a biofuel policy, akin to the EU, to improve energy security and the environment whilstconcurrently supporting its rural economy. Today, Indonesia is the 3rd biggest biofuel market after the EU and US. More importantly,Indonesia is the single largest palm-based biodiesel market in the world.

This follows an estimated 3%-4% YoY increase in demand in CY23, which is consistent with the long-term trendline growth, after stagnating for three years as Covid-19 affected travel, airlines, horeca (hotels-restaurants-cafés) as well as supply chain, and an estimated 2%-3% growth in global edible oil supply, which is the highest for the past three years.

Better margins ahead. We expect firmer upstream plantation margins in CY24 on easier input costs and higher yields, but a mixed outlook for downstream (oleochemicals) performance as personal care, cosmetics and industrial oil/grease segments can be more sensitive to economic slowdown while food-related products hold better (e.g. refined cooking oils or specialty oils and fats). This is consistent with observations in the recently announced 3QCY23 results.

Oil palm output is also facing long-term structural headwinds. Unlike the three other major edible oil crops (soya, rapeseed and sunflower) which are sown and harvested annually, palm oil is a fruit-bearing tree which can live for many years. However, as it ages, it grows taller making harvesting more difficult, slower and costlier; hence, the practice is to re-plant every 25 years. For large, well-capitalised plantation groups, such replanting is part of the planting cycle but not so for small holders who find replanting costly (RM20,000-30,000 per Ha) with no income thereafter for two to three years if not longer. As small holding constitutes around half of oil palm planting in the world (approximately 30m Ha), ageing trees in smaller plots are probably one factor behind the decline in palm oil yields since CY18. The timing of this decline in yields can be traced to the sizeable new oil palm area developed during the 1990s (4.3m Ha) and 2000s (5.43m Ha). This challenge is also set to become larger in the coming decades as plantings during the 2010s (7.72m Ha) ages.

Costs of agriculture input are lower YoY. After having peaked in 2Q of last year, input costs such as fertiliser have been trending down. YTD, CY23 fertiliser prices are lower by 30% YoY (nearly 40% below peak 2QCY22 prices). Likewise, despite recent uptick in crude oil prices, overall energy cost has also trended down compared to a year ago. At the same time, FFB yields have improved in Malaysia, thanks to the arrival of guest workers after borders were reopened last year and recruitment procedures were improved.

Source: Kenanga Research - 13 Dec 2023