The  price  of  palm  oil  has  started  reacting  to  seasonally  weaker production and stronger exports with the resulting decline in inventory. Plantation  stocks,  on  the  other  hand,  are  still  weak  and  may  only appreciate  on  a  further  recovery  in  palm  oil  prices.  Meanwhile,  the weakening  price of brent  crude  is  negative for the sector as biodiesel margins  narrow  but  still  remain  profitable.  Maintain  NEUTRAL  on  the sector, with selective buys. 

Inventory  would  not  get  burdensome.  The  marginal  MoM  decline  in September  palm  oil  production  suggests  that  the  seasonal  downcycle has started. Indications from the bunch count suggest that there could be a rather drastic decline in production up to January.  This, coupled with  a recovery  in  exports,  means  that  inventory  may  not  get  to  burdensome levels. To recap, Malaysia’s Sep 2014 inventory was at 2.09m tonnes.  

Biodiesel  margin  drops.  Weakening  crude  oil  prices  have  dented biodiesel margins, which led to the  spread between gasoil and palm oil narrowing to USD9.7/bbl from USD33.4/bbl just five weeks ago. Still, thecurrent 13% margin is decent and should continue to encourage usage. 

Soybean  factor.  The  impact  of  an  abundant  harvest  from  the  US  is steadily being priced in. With the harvest at 53% in the US, the market is starting  to  worry  less  about  a  further  downside  –  as  indicated  by  the reduction  in  speculative  net short  positions.  Meanwhile,  dry  weather  in Mato Grosso has also cut Brazil’s production expectation this season. 

Average price. With the YTD average price of CPO at MYR2,475/tonne,our  full-year  average  of  MYR2,400  remains  achievable.  We  expect prices to strengthen next year, averaging MYR2,500/tonne and driven by stronger global demand for both food and fuel. 

Still NEUTRAL. We remain NEUTRAL on the sector with Bumitama Agri(BAL SP, BUY, TP: SGD1.45),  as our Top Pick. We also like Astra Agro Lestari  (AALI IJ, BUY, TP: SGD30,003)  particularly after the significantdecline  in  its  share  price.  These  stocks  are  trading  at  just  10x  CY15 earnings.  Malaysian  counters  are  still  pricier,  but  we  find  value  in Genting Plantations  (GENP MK, BUY, TP: MYR11.15)  and Sarawak Oil Palms (SOP MK, BUY, TP: MYR6.60).

Sector News Flow

El Nino-Southern Oscillation (ENSO) indicators as well as Australian rainfall patternscontinue  to  show  some  El  Nino-like  signs,  but  remain  in  the  neutral  range.  The tropical Pacific Ocean has remained warmer than average for more than six  months, while  the  Southern  Oscillation  Index  has  remained  negative  since  early  June. Warmer-than-average  tropical  Pacific  waters  are  likely  to  persist.  While  there  has been some easing in model outlooks over the past month, three out of eight  models may reach El Nino thresholds by January while  another two could remain just shy of the thresholds for an event.

The US Department of Agriculture said in its crop progress and condition update that the soybean harvest is at 53%, ie still trailing the 5-year average of 66%. A week ago, the  soybean harvest stood at 40% compared with the  5-year average of 53%.  Crops rated as good  to  excellent are at 73%,  which has been unchanged for the past twoweeks.  As for corn,  the  harvest is  31% completed compared with  24% a week ago,with  crop  conditions  remaining  unchanged  at  74%  -  which  is  rated  as  good  to excellent.

Comments:  Harvests,  which  have  slowed  down  due  to  the  rain  this  season,  areexpected  to  accelerate  this  week  on  drier  weather.  The  harvest  should  eventually catch  up  with  historical  averages.  As  harvesting  is  well  in  progress  and  could  be completed in the coming 2-3 weeks, soybean prices are holding up well despite the anticipation of a large crop coming in.

Government  forecaster  Conab  expects  Brazil’s  soybean  production  to  come  in  at 90.6m tonnes, topping the 86.1m tonnes  that was recorded  last season. Conab was earlier expecting a production of 92.4m. Dry weather has prompted analysts to curtail production forecast with Oil World expecting an increase of under 3m tonnes. Comments:  The  dryness  in  Brazil,  particularly  in  the  key  planting  area  of  Mato Grosso,  is  causing  delays  in  planting  which  may  result  in  reduced  yields  and  anincrease  in  the  risk  of  soybean  rust  attacks.  Despite  this  and  some  areasexperiencing  negative  margins,  areas  planted  could  still  be  up  YoY  due  to 
commitments that were made earlier. A reduction in planted area due to low soybean price is only expected to take place next season.

Solvent Extractors’ Association of India, in  a letter written to Prime Minister Narendra Modi,  seeks  to  raise  the  import  duty  on  refined  vegetable  oil  to  25%  from  10%currently.  Local vegetable  oil refiners  are  using 35%-40% capacity  in 2014  vs 65%-70% last year. Comments:  The increase of an import duty on refined oils may  simply divert importsto crude vegetable oils  such as CPO. India will still need to step up imports  as local oilseed production is insufficient to meet its growing consumption.

The US National Biodiesel Board (NBB) has called for the end of duties on green fuel being  sent  to  Europe.  NBB said  eliminating  these duties  will  level  the  playing  field and allow US producers to compete fairly in accordance with international law. US imports of biodiesel from the EU have grown in recent years while EU imports of US biodiesel  have been virtually eliminated. The duties were set  to expire this year but the European Commission has been delaying the expiration by conducting an “expir y review” that is expected to last 12-15 months.

Comment:  It  is  understandable  for  Europe  to  prolong  the  duties  on  US  biodiesel given that the biodiesel industry in Europe was at one point suffering from cheap US biodiesel, which was made possible by the USD1 per gallon tax credit.  In the unlikely scenario of a level playing field, palm oil could benefit as competition will result in the need for cheaper biodiesel feedstocks such as palm oil.

Indonesia approved a plantation bill that aims to maximise land usage and ope n up the sector to smallholders  –  with the controversial foreign ownership clause dr opped from  the  final  version.  However,  it  is  still  possible  to  introduce  foreign  ownership limitations later through government regulations. Comment:  Although the risk of foreign ownership limitations  still exists, dropping the clause from the bill suggests  a likely more moderate or watered down version if it  is introduced later. There could  be more clarity on these issues after  Indonesia’s  new president Joko  Widodo took office on 20 Oct.

Oil  World  has  raised  its  global  oilseed  production  estimate  by  3.7m  tonnes  for 2014/2015, driven by the US (+2.4m tonnes), Brazil (+2.0m), India (+0.7m) and the EU (+0.4m). This would  result in  the  stock/usage ratio rising to 20.3% from 17.5% in 2013/2014.

Source: RHB