MPOB-reported palm oil production of 1.615m MT (-5% MoM, +12% YoY) for June 2024 was a tad above the 10-year average level, and within market estimate but 6% poorer than Kenanga’s estimate. However, poorer exports of 1.205m MT came in slightly (3%) below market and 13% lower than our expectation which led to higher QoQ and YoY closing inventory. Altogether, end-June inventory of 1.829m MT (+4% MoM, +6% YoY) was at historic average and met both Kenanga and market expectations with <1% variance. Average CPO price in June 2024 strengthened MoM to RM3,958/MT (+1% MoM, +12% YoY) to end 1HCY24 at RM4,011 (+2% YoY), a tad (2%) better than Kenanga had expected. Nonetheless, CPO prices should ease in 2H on seasonally higher edible oil supply from: (a) seasonally higher FFB harvest, (b) conclusion of South American soyabean harvest, and (c) impending 3Q harvest of US soyabean.

Maintain CPO price of RM3,800/MT for CY24-25 along with our NEUTRAL call. Sector’s PBV of 1.1x is defensive but lacks strong upside catalyst given flattish CPO price prospects. Planters with more growth potentials remain our preference, such as PPB (OP; TP: RM17.50) for its regional consumer agri and food operations, TSH (OP; TP RM1.30) and its ongoing upstream expansion, and UMCCA (OP; TP: RM6.00) for its maturing Indonesian estates.

CPO prices should dip in 3Q due to seasonal uptick in production. Historically, within a calendar year, 1Q is the least productive quarter with the slowest month being Feb due to seasonal factors but a short working month does not help. The most productive of all the quarters is often 3Q even though monthly production usually peaks in Oct after bottoming out in Feb.

Quarterly price-wise, the reverse holds with 1Q often enjoying the best CPO price to ease marginally in the 2Q before dipping in 3Q, the weakest quarter in term of prices. As a consequence, 3Q CPO prices can sometimes prove crucial in determining the average price for the full year and the subsequent flow through onto sector earnings.

Nonetheless, CY24-25 CPO prices are likely to stay firm. Despite record soya bean season harvest in South America, edible oil demand is still expected to outgrow supply in CY24 due to flattish palm oil output and only small increase in rapeseed production. Consequently, inventory level is expected to fall YoY but staying manageable in CY24. This supply-demand scenario is expected to repeat in CY25 thus CY24-25 CPO prices are expected to stay firm, averaging around RM3,800 per MT with a slightly upward bias.

Better upstream from firm CPO prices and easier costs. Energy and fertiliser prices have fallen by 15%-35% YoY while palm kernel (PK) prices could have bottomed out - a byproduct when milling FFB for CPO – helping to lower CPO cost further. Labour cost pressure is rising but still manageable. Indonesia has seen higher minimum wages and Malaysia is to follow suit. However, many planters have progressively raised productivity, from replanting with higher yielding planting materials to automation and upgraded infrastructure including mills. Coupled with easing production cost and flattish CPO prices, upstream margins have inched up 2%-3% on average in 1QCY24 and should stay so for the rest of the year.

Downstream still face headwinds but could be abating. Some oleo-chemical re-stockings have been taking place but overall demand remains soft. However, refining margins are not expected to recover soon due to excess capacity in the region as Indonesia is promoting the integration of the country oil palm sector with its own downstream capability.  

Maintain NEUTRAL. Valuation of the plantation sector is not excessive, trading at 1.1x PBV and 16x prospective PER. However, there is no strong upside catalyst in sight, with flattish rather than bullish CPO price expectation. Nevertheless, the sector does provide defensive exposure as: (i) palm oil is largely (70%) used as food usage followed by growing biofuel demand, (ii) gearing is between net cash to manageable levels, and (iii) the value of agriculture land, especially those along the west coast of Peninsular Malaysia, are often much higher than their book value.

Within the sector, we prefer growth over income for the next 3-6 months. We like:

PPB (OP; TP: RM17.50). Despite a weak 1QFY24 due to weaker commodity trading at associate Wilmar, the group’s exposure to the region’s expanding middle class consumer remains attractive. Wilmar looks set to grow from its entrenched market position in the Chinese and Indian edible oils segment as well as processed food markets. PPB’s own flour, feed and food businesses are also expected to grow and so are its cinema chains in Malaysia and Vietnam. Trading at below both book value and market PER, we believe PPB provides longer upside amidst some volatility in the nearer term.

TSH (OP; TP: RM1.30). After selling down some assets over the past two years, TSH has started work to plant up 8k-10k Ha of oil palm which it could not develop previously due to limited funds. When matured, this area would expand the group’s profit-base by another 20%-25%.

UMCCA (OP; TP: RM6.00). Although UMCCA’s Indonesian earnings could still be volatile, its Sumatran estate is maturing; hence, forward yields are trending up. Coupled with lower unit cost, the group’s Indonesian earning base looks set to improve moving ahead.

Source: Kenanga Research - 11 Jul 2024