Maintain  NEUTRAL  on  the  sector,  with  selective  buys.  Looking  into 2015, we believe the single key catalyst for palm oil price is the weather since  food  demand  growth  remains  muted  and  non-mandatory biodiesel usage slows due to a decline in crude oil price. Nevertheless, we  suspect  that  sometimes  throughout  2015,  the  sector  could  turn bullish again although it may be too early to position for it now.  
 
Weather  as  the  single  catalyst  for  2015.  With  only  a  single  potential driver  going  into  2015,  being  bullish  currently  on  the  sector  is  a  risky proposition.  Nevertheless,  the  weather  is  traditionally  the  single  biggest driver  of  agricultural  prices  and  by  itself  is  sufficient  to  result  in  a sustained upswing in prices. Even if El Nino – currently at “alert” level –fails  to  materialize,  may  be  unlikely  to  change  sector  sentiment.  This  is because the market has been ignoring the development of  El Nino after its  earlier  failures  to  develop.  In  any  case,  damage  to  2015  production has already been done by 2HCY14 dryness in Kalimantan, Indonesia.  

Indonesia’s growth slowdown.  We  expect  a  structural  slowdown  in Indonesia’s  production  growth  in  2017  the  latest,  but  this  could materialise  sooner  due  to  poor  developments  of  plantation  and infrastructure.  This  is  a  factor  to  position  for  in  late  2015  even  in  the absence of adverse weather impacting the sector.  

Crude  oil  factor.  The  weaker  crude  oil  price  has  wiped  out  biodiesel margin  and  could  impact  non-mandatory  usage.  Net impact  on  palm  oil demand  will  probably  be  muted  given  the  compensatory  effect  from Indonesia’s significant increase in mandatory biodiesel usage in 2015.  

Average  price.  With  the  YTD  average  CPO  price  at  MYR2,434/tonne, our full-year average of MYR2,400 remains on track. We expect prices to strengthen next year, averaging MYR2,500/tonne.  

Still NEUTRAL. We remain NEUTRAL on the sector with Bumitama Agri (BAL SP, BUY, TP: SGD1.48) as our Top Pick. We also like Astra Agro Lestari  (AALI  IJ,  BUY,  TP:  SGD30,003)  particularly  after  its  significant  share  price  decline.  We  also  find  value  in  Genting  Plantations  (GENP MK, BUY,  TP:  MYR11.60) and Sarawak Oil Palms (SOP MK, BUY, TP: MYR6.60).

Sector Outlook 2015

Demand growth is muted

Demand  growth  will  remain  lacklustre  much  like  2014,  especially  from  China  where edible oil imports have slowed due to the availability of soybean in the global market as well as slower economic growth. 

Supply growth will likely slow even more

We believe  palm oil  supply growth  will  be  even  slower  than  in 2014  due  to  adverse weather  effects.  In  1Q,  production  in  Sumatra  and  West  Malaysia  will  likely  suffer from  the  extreme  dryness  in  1QCY14,  while  2H  will  see  the  impact  of  dryness experienced in a large part of Kalimantan, Indonesia in 2HCY14.  

El Nino threat is very much intact

El Nino did not materialise in 2014 even following four straight months at “alert” level. Nevertheless, the Southern Oscillation Index (SOI) did hover in the El Nino zone with corresponding warmer sea. This was sufficient to cause drier-than-usual conditions in Australia and Kalimantan. As the effects are relatively localised, it did not negatively affect oilseed production in India, North and South America, resulting in limited price impact. An actual El Nino, should it materialise, will have more far-reaching effects as it  will  also  affect  oilseed  production.  We  note  that  the  Australian  Bureau  of Meteorology  has  again  raised  El  Nino  status from “watch” to “alert” and sea sub-surface temperature showed significant warming in October and worsened further in November.

Average palm oil price will be higher in 2015 but only marginally

Our  CY15  CPO  price  assumption  of  MYR2,500/tonne  implies  a  MYR2,700  high needs  to  be  reached  sometime  during  the  year,  a  sizeable  MYR500  from  current levels but will only lift average palm oil price by some MYR100/tonne vs 2014 levels. We  believe  most  of  the  price  action  will  be  seen  in  2H  especially  if  El  Nino  takes shape.  For  the  time  being,  we  assume  that 2016 average palm oil  price  will  remain flat from 2015. However, there could be significant upside driven by adverse weather.

Input cost could be slightly higher in 2015

We expect input cost to be higher in 2015 due partly to the increase in fertiliser costs amid  flooding  at  a  major  potash  mine.  Although  the  supply  constraint  may  not  last, plantation companies are now buying fertilisers for 1H consumption and  will have to pay the current elevated price.  

Crude oil impact

Crude  oil  price  weakness  is  a  drag  on  palm  oil  price,  at  least  psychologically. Biodiesel margin is now close to zero hence non-mandatory usage will be curtailed. However, if brent crude does not fall significantly further from here, mandatory usage will likely continue. Indonesia’s biodiesel usage should increase significantly in 2015 from this year’s dismal 1.6m tonnes, hence mitigating a slowdown in non-mandatory usage. Indonesia’s mandatory usage requires at least 3m tonnes per year. 

Sector positioning in 2015 and beyond

While  interest  in  the  plantation  sector  remains  thin,  we  believe  the  worst  is  over  for the sector and downside is limited. Investors with long investment horizon could start buying. We  believe  most excitement  will  take  place in  2H when  production  starts  to suffer from the 12-month impact of this year’s dry weather. We believe the impact will be significant given that 3Q is a high-crop quarter.

Sector News Flow

El Nino update 
(Australia’s Bureau of Meteorology, 2 Dec 2014)

Many  climate  indicators  remain  close  to  El  Nino  thresholds,  with  climate  model outlooks suggesting further intensification of conditions remains likely. The Bureau’s El Nino Southern Oscillation (ENSO) Tracker status is currently at ALERT, indicating at least a 70% chance that El Nino will be declared in the coming months. Whether or not  an  El  Nino  fully  develops,  a  number  of  El  Nino-like  impacts  have  already emerged.  Several  ENSO  indicators  are  currently  close  to,  or  exceed,  El  Nino thresholds.  These  include  tropical  Pacific  Ocean  temperatures,  which  have  now exceeded El Nino levels for a month, and the Southern Oscillation Index, which has remained at or near El Nino levels for three months. Other indicators, such as tropical cloud,  trade  winds  and  rainfall  patterns,  have  either  remained  near  average  or  only temporarily  approached  thresholds.  This  indicates  a  typical  El  Nino  ocean-atmosphere interaction may not be fully locked in.

Brazil’s soybean planting (Agrimoney, 27 Nov 2014)

Malaysia’s  November  palm  oil  shipments  fell  10.5%  MoM  to  1.310m  tonnes, according  to  cargo  surveyor  Societe  Generale  de  Surveillance.  The  16.2%  rise  in shipments  to  China  was  offset  by  a  decline  in  shipments  to  India  (-19.3%)  and  EU (-9.7%).

Brazil’s soybean planting (Agrimoney, 27 Nov 2014)

The US Department of Agriculture (USDA) bureau in Brazil pegged Brazilian soybean crop at 92.0m tonnes. While still a record and up 5.3m tonnes YoY, a harvest at that level would be 2.0m tonnes lower than the USDA’s current official estimate, which is up for revision in two weeks’ time. The revision follows downgrades from the likes of respected  crop  scout  Michael  Cordonnier,  Oil  World,  which  has  forecasted  a  sub-90m-tonne  crop. Brazil’s crop bureau  Conab  has  forecasted  of  89.3-91.7m  tonnes. Agrural  estimates  that  as  of  24  Nov,  farmers  had  planted  76%  of  their  crop,  which was 3ppts behind last year level

China’s October biodiesel imports plunges 58% MoM (Hellenic Shipping News, 26 Nov 2014)

China imported 51,507 tonnes of biodiesel in October, down 58.3% from September, data released by the General Administration of Customs showed.  YTD total stood at 765,871m tonnes. Exports from Indonesia, China’s main source of palm methyl ester (PME),  fell  56%  MoM  to  46,500  tonnes  in  October  (vs  52,010  tonnes  by  Intertek), while  used  cooking  oil  methyl  ester  exports  from  Hong  Kong  fell  28.2%  to  4,972 tonnes.  PME  shipments  from  Malaysia  dived  to  33  tonnes  in  October  from  10,994 tonnes in September. Several biodiesel traders said Chinese buyers faced problems with  financing  in  September  and  October,  and  Chinese  demand  for  PME  also typically fades as winter approaches. 

Oil World: Vegetable oil balance normalises   (Oil World Monthly, 21 Nov 2014)

Oil  World  sees  vegetable  oil  balance  normalising  in  Oct/Sept  2014/2015  after excessive  supplies  in  2013/2014.  World  production  of  eight  major  vegetable  oils  is forecasted  to  increase  by only  3.3-3.4m  tonnes  vs  9.7m  tonnes  in  2013/2014.  Palm oil world production will be 60.8m tonnes for Oct/Sept 2014/2015, an increase of only 1.8m  tonnes  which  were  sharply  below  past  5-year  average  annual  growth  of  2.9m tonnes. 

Indonesia to continue biodiesel mixing despite low realisation    (Jakarta Post, 13 Nov 2014)

Indonesia’s Energy and  Mineral Resources Ministry’s renewable energy directorate general Rida Mulyana is optimistic that the ministry can maintain its policy of blending biodiesel  with  diesel  fuel,  despite  the  programme’s  realisation  remaining  below target.  In  the  first  nine  months,  only  1.2m  kiloliters  of  biodiesel  were  blended,  far below the Government’s initial target of blending 4m kilolitres by year-end. Rida said the  mandatory  10%  blending  is  ongoing  but  slower  than  expected  due  to  a  lack  of supporting  infrastructure  such  as  facilities  to  carry  the  product,  as  well  as  blending and  storage  facilities.  Next  year,  the  target  is  to  blend  around  4m-5m  kilolitres  of biodiesel into diesel fuel. 

India starts using biodiesel for locomotives   (Domestic Fuel, 12 Nov 2014)

India’s train company Railways decided to use biodiesel to power a fleet of 4,000 locomotives. Railway Minister Sadanand Gowda said, “Railways is the single largest bulk consumer of diesel in the country and as mentioned in railway budget 2014-15, it will start using biodiesel up to 5% of the total fuel consumption in diesel locomotives.” The national transporter annually consumes over 2bn litres of diesel.  Separately, the road  transport  ministry  is  pushing  for  more  use  of  clean  and  domestically-produced fuel and would take up the issue of allowing biodiesel producers to sell directly to bulk consumers in India. At present, only 20% of biodiesel produced is used locally.

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Source: RHB