Malaysia’s palm oil production rose in July 2024, marking the start of this year’s higher yielding season with a palm oil output of 1.841m MT (+14% MoM, +14% YoY). This came within market estimate, though 6% above Kenanga’s expectation. Compared to June where exports were weak, July exports of 1.689m MT positively surprised both market and our expectations to hit a tad below the historical 10- year high probably due to tighter Indonesian exports. As a result, inventory at 1.733m MT (flat YoY and -5% MoM) closed 6% below Kenanga’s expectation (but within market estimate). Average CPO price for July 2024 continued to stay slightly firmer than our expectation, averaging RM4,034/MT (+2% MoM, +5%YoY). However, CPO prices are expected to ease in the coming months on seasonally stronger FFB harvest coupled with 3QCY24 US soyabean harvest.

Maintain CPO price of RM3,800/MT for CY24-25 along with our NEUTRAL call. The sector is highly defensive, trading at PBV of 1.1x but still missing a strong compelling upside catalysts. Upstream costs are easing and downstream margins should be stabilizing but flattish CPO prices are still likely. Planters with growth potential is our preference, for example, PPB (OP; TP: RM17.50) and its consumer agri and food essentials exposure in the region, ongoing upstream expansion at TSH (OP; TP RM1.30), and UMCCA (OP; TP: RM6.00) with rising contributions from maturing Indonesian estates.

Some 3Q CPOprice softness is likely.Thus far, 1H CY24 CPO price of RM4,011 per MT came in slightly firmer (6%) than our expected average of RM3,800 per MT for the year. However, CPO prices tend to soften in the 3Q on the back of seasonal uptick in FFB output. Historically, MPOB quarterly CPO price is softest in 3Q which may be a key determinant towards the full-year average price and the subsequent flow through onto sector earnings. 3Q also coincides with the harvesting season for US soyabean and European and Canadian rapeseed oil which further add to the global supply of edible oil in the 3Q as well as into the 4Q.

Nonetheless, CY24-25 CPO prices should stay firm. Despite record soyabean season harvest in South America earlier this year, edible oil demand is still likely to grow faster than supply in CY24 due to flattish palm oil and rapeseed harvest. Therefore, inventory level is set to decline in CY24 but staying manageable. A repeat of this supply shortfall is likely in CY25, thus Kenanga is expecting CPO prices to trade sideways around RM3,800 per MT over CY24-25.

Margins mixed with likely better upstream performance, albeit still weak downstream. Lower energy and fertiliser prices are supportive of better upstream margins. Firmer palm kernel (PK) prices - YTD price is up 17% YoY – further helped, providing offset to any increase in minimum wages pending CY25. However, downstream headwind remains even if abating. Some oleo-chemical restocking is taking place but demand remains soft. Meanwhile, refining margins are set to stay weak due to excess capacity in the region as Indonesia is expanding into downstream as well.

Maintain NEUTRAL. Valuation of the plantation sector is not excessive, trading at 1.1x PBV and 16x PER prospective which suggest downside could be limited. The sector is also defensive as: (i) palm oil is largely (70%) used as food ingredient 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. However, a strong upside catalyst such as CPO prices spiking to trade at RM4,000 – RM4,500 per MT or a strong recovery in downstream performance is still not very clear at this juncture.

Within the sector, we prefer those with earnings growth:

PPB (OP; TP: RM17.50). PPB group’s earnings can be volatile due to associate Wilmar’s commodity (palm oil and sugar) exposures but the group has attractive agri-food businesses catering to the region’s growing middle-class consumers. Wilmar is strong in the Chinese and Indian edible oil and processed food segments while PPB has its own flour, feed and food businesses in SE Asia. PPB is also trading below both book value and market PER; hence, believe PPB provides longer upside amidst some volatility in the nearer term.

TSH (OP; TP: RM1.30). After having divested some assets over the past two years to de-gear, TSH ended 1QFY24 with only 2% net gearing and has embarked on planting 8k-10k Ha of it estates with palm trees 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 Kalimantan estates are 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 - 14 Aug 2024