We  view  Malaysia’s  plantation  statistics  released  yesterday  as supportive of further strengthening CPO prices. Inventory, which is still at  comfortable  levels,  could  climb  a  little  more  before  year-end.  We maintain that sector fundamentals are improving, with stronger palm oil prices and flat production costs expected next year. We see upside risk to our price assumption for CY14, currently at MYR2,600/tonne.

• Marginal  climb  in  inventory.  Malaysia’s  palm  oil  inventory  rose  by 3.5% m-o-m to 1.845m tonnes. Some  marginal  increase during the  high crop season could not be ruled out  but we believe ending inventory will remain sharply below the end-CY12 level of 2.628m tonnes.  The onset of  the  low  production  season,  steady  export s  and  strong  local consumption will keep inventory levels relatively low.
• Production likely  to  have peaked.  Production rose by 60.1k tonnes or 3.1% m-o-m to 1.972m tonnes, largely driven by  Sabah state. November production tapered off, marking the start of the low crop season.
• Biodiesel  forms  price  floor.  Pertamina’s  tender  for  6m  tonnes  of biodiesel closed yesterday evening, which we believe received support from all major players. This will remove  the  downside for palm oil prices.
• Note that Malaysia will be raising its biodiesel blend from 5% currently to 7% in December. It is likely that biodiesel has been responsible for the strong local consumption in Malaysia. Locking in cheaper fertiliser prices. Plantation companies are in the midst  of  locking  in  fertiliser  prices  for  1HCY14  consumption  and  early indications suggest that prices  could be  lower  by 10% from 2013  levels.
• We believe the real number could be  lower, as  the  free-on-board (FOB) composite fertiliser price in September was already some 20% lower y-oy.  Taking  the  strength  of  the  USD  into  consideration,  prices  would still have been some 15% lower. Still  NEUTRAL.  We  maintain  our  NEUTRAL  call  on  the  sector,  with selective  buying  on  quality  stocks  trading  at  reasonable  multiples.  Our sector  favourites  are  First  Resources  (FR  SP,  BUY,  TP:  SGD2.44),  Bumitama  Agri  (BAL  SP,  BUY,  TP:  SGD1.16)  and  Astra  Agro  Lestari (AALI IJ, BUY, TP: IDR25,245). 

YTD realised CPO price at MYR2,340 per tonne

2013  realised  CPO  price  could  fall  slightly  short.  With  the  YTD  realised  price  at MYR2,340 per tonne, the full-year average could fall marginally short of our assumption of MYR2,400. Assuming prices remain flat at the current level of MYR2,540 for the rest of the year,  the full-year average will be MYR2,381 or 0.8% below our assumption. For  the average price to hit  MYR2,400, Malaysia’s physical price will need to be 5%  higher from the current level for the remaining trading days.

2014 price assumption of MYR2,600 vulnerable

Upside  risk  to  CY14  price  assumption.  We  believe  there  is  upside  risk  to  our  CPO price  assumption  of  MYR2,600  for  2014.  This  hinges  on  the  execution  of  Indonesia’s mandatory  biodiesel  programme,  which  is  expected  to  use  up  3m  tonnes  of  palm  oil. Should 3m tonnes be consumed for biodiesel, Indonesia will have less palm oil available for  export  next  year.  This  will  create  upward  pressure  on  the  price  as  palm  oil consumption as  food will continue  to grow  regardless of prices. We will revisit our price assumption should the CPO price clear the MYR2,600 level convincingly.

While US biodiesel tax credit will likely be discontinued, it will be more than mitigated by Indonesia’s usage

US’ biodiesel tax credit to end next year.  The US’ tax credit for biodiesel amounting to USD300 per tonne will likely be discontinued  in 2014 given its fiscal state. However, we believe  this  will  be  more  than  mitigated  by  Indonesia’s  own  biodiesel  needs.  Between March–July this year, the US imported 714k tonnes of biodiesel from Indonesia or at an annualised rate of 1.7m tonnes.

Pertamina’s tender ended yesterday

Biodiesel pricing.  Based on industry sources, Pertamina’s tender for biodiesel will be based on Singapore’s MOPS benchmark  price  for gasoil with/without margin. Gasoil is currently trading at about a USD12 per barrel premium to the physical palm oil price.

Malaysia’s palm oil consumption has been strong since June this year, sustaining above 200k tonnes per month

Had it not been for weak 1H consumption, Malaysia’s CY13 consumption could have hit record high (consumption hit the highest in 2008 at 2.59m tonnes)

On average, inventory levels rose by 6.9% qo-q in 4Q

Malaysia’s year-end stock usage ratio could fall below 10%, its lowest in three years

Lower fertiliser prices in 2014 will help boost sector profitability

Palm oil price has surpassed brent crude but remains below benchmark prices for biodiesel production

Source: RHB