We believe El Nino’s impact on edible oil supply will be one of the largest ever, iven its current strength, and as such are raising our CPO price estimates to MYR2,700/tonne for 2016 (from MYR2,500). Our target price for Sarawak Oil Palms (SOP) is raised to MYR6.03, based on 17x FY16F earnings. Its production may surprise on the upside in early stages of El Nino as it helps to reduce Sarawak’s excessive rainfall.

Unprecedented impact. We believe El Nino’s impact on edible oil supply will be its biggest ever, given its strength and high global reliance on palm oil. In the last mild El Nino in 2009-2010, the palm oil price went ballistic as production stagnated. Given that the current episode is a strong one and could match the 1997-1998 El Nino, the impact on production will be more severe, with Indonesia potentially experiencing a decline in production next year. Unlike the last two episodes, there will be little or no mitigating factor from an increase in oil palm hectarage,since Indonesia’s new planting has been slowing in the past few years.

Production expectation. We have lowered production growth to 3% from 7% for 2016, to build in conservatism due to drought impact. Nevertheless, we point out that SOP’s production could surprise on the upside in the early stages of drought, as Sarawak is typically plagued by too much rain, which depresses yield.

Earnings revision. We are raising our 2016 average CPO price assumption to MYR2,700/tonne from MYR2,500/tonne previously, while 2017 average is raised to MYR2,750/tonne from MYR2,600/tonnepreviously. Our FY16 earnings forecast is raised by 24.4% while our FY17 forecast is raised by 11.6%.

TP revision. We expect the CPO price to rally throughout 2016, resulting in an expansion in P/E multiple. As such, we have raised our target P/E for SOP to 17x from 15x previously. This, coupled with the increase in earnings forecasts, results in us raising our TP to MYR6.03 (from MYR4.84). We deem our MYR4.84 TP reached as SOP has been trading at MYR4.80 for the past month.

Source: RHB Research - 21 Oct 2015