Roller Coaster Ride in 1H

The CPO price started the year at around RM3,700/tonne. It surged in January, propelled by forecasts of reduced production in Malaysia and increase in exports, and extended the rally to RM4,535/tonne on Apr 4. This surge was fuelled by concerns over diminishing stockpiles, elevated prices of soybean oil, increased demand due to purchases for the Ramadan festival, and a weakened Ringgit, which tends to make palm oil cheaper compared to other competing oils. Additionally, the rally was bolstered by stronger crude oil prices too.

However, the CPO price lost its appeal and fell a low of RM3,845/tonne on May 16, as palm oil production improved, and exports faltered. The price weakness was also in tandem with declines in rival oils and lower crude oil prices. The situation has been exacerbated by dwindling demand from major buyers like India and China. In late-May, the CPO price rebounded and was hovering around RM3,900 to RM4,000 per tonne. This uptrend was backed by a positive demand outlook, a weakened Ringgit, and concerns over volatile weather conditions in the second half of the year, which could impact on the supply. Additionally, the recovery in crude oil prices has further enhanced the attractiveness of palm oil as a biofuel.

For the 1Q24 earnings report card, most plantation companies suffered from weaker earnings YoY, with exceptions of SD Guthrie Berhad (SDG, formerly known as Sime Darby Plantation Berhad), FGV, and TSH, which observed increased earnings contributions from the upstream division, primarily due to higher fresh fruit bunches (FFB) and reduced production costs. In contrast, in the downstream division, SDG was the only company to report higher profit compared to the previous year, attributed to increased demand for Asia Pacific bulk and differentiated refineries. Regarding FFB production, SDG, KLK, and KIML witnessed higher growth rates compared to the previous year, ranging from 3.5% to 8.5%. Conversely, the rest experienced negative FFB production growth, ranging from 1.4% to 9.8%

What to Watch Out for in 2H 2024?

Goodbye, El Nino. Hello, La Nina?

According to the World Meteorological Organization (WMO), the El Nino event of 2023/24, which contributed to a surge in global temperatures and widespread extreme weather events, is showing signs of tapering and a shift to La Nina conditions is expected later this year. The WMO predicts a 50% likelihood of either neutral conditions or a transition to La Nina from June to August 2024. The probability of La Nina conditions rises to 60% from July to September and further to 70% from August to November. However, there remains considerable uncertainty regarding the intensity and duration of these conditions.

In Malaysia, the Malaysian Meteorological Department (MetMalaysia) predicts that the La Nina phenomenon will begin between July and September this year. Based on international forecast models, this event is likely to persist for a duration ranging from 5 to 18 months, with expectations of it being relatively weak to moderate in intensity. To recap, the previous episode of La Nina, which began in 2020 was initially projected to last for a year, unexpectedly ended in early 2023.

La Nina typically brings more rainfall and prolonged heavy rains over several days can trigger flooding in low-lying areas that are prone to such occurrences. This could potentially disrupt palm oil production in the short term, as the heavy rain and floods are likely impeding harvesting progress and causing delays in evacuation of FFBs. However, the above-average rainfall is also expected to contribute to a significant increase in palm oil production in the 1H of 2025, thanks to enhanced growth conditions and yields. Additionally, the ease of labour shortages is anticipated to further boost CPO production. Nevertheless, it is important to note that the precise impact of La Nina on CPO prices can vary depending on factors such as its intensity, duration, the timing of its development, and its interaction with other climate variability patterns.

In Malaysia, CPO production during the first five months of 2024 grew by 9.4% YoY, reaching 7.26mn tonnes. YTD, the FFB yield increased by 11.1% MoM to 6.20 tonnes per hectare. Production improvements can be expected in the second half of 2024 due to the ease of foreign labour shortages and favourable weather patterns. All in, the CPO production for 2024 is projected to reach 20.2mn tonnes, marking an 8.7% increase compared to the previous year. Meanwhile, Indonesia's 2024 production is forecasted to increase slightly to 54.4mn tonnes from 53.2mn tonnes, as reported by the Indonesian Palm Oil Association (GAPKI).

According to the United States Department of Agriculture (USDA), global vegetable oil production is expected to increase by 2.5% in 2023/24 and by 2.0% in 2024/25. The growth in 2024/25 is primarily driven by soybean and palm oil production, with increases also anticipated in olive oil and peanut production. Meanwhile, cottonseed, palm kernel, and rapeseed oil production are forecasted to remain relatively stable, while sunflower seed oil production is projected to decline (refer to Figure 4).

Global consumption is forecasted to expand, leading to a decrease in ending stocks. Ending stocks are expected to decrease by 0.2% in 2023/24 and by 5.9% in 2024/25. The reduction in stocks is mainly projected for palm oil, followed by rapeseed oil. Meanwhile, the implied ending stocks-to-use ratios of 14.5% and 13.3% for 2023/24 and 2024/25, respectively, are 0.40 to 1.63 percentage points below the highs observed in 2019/20.

Indonesia Raises Biodiesel Allocation

In our observation, the Indonesia's biodiesel mandate has significantly boosted the demand for CPO. According to Indonesia's Ministry of Energy and Mineral Resources, the country plans to increase its allocation for palm-based biodiesel to 13.41mn kiloliters (kl) in 2024, a 1.96% increase from the previous year, to support its B35 blending mandate. Indonesia implemented the B35 biodiesel mandate on 1 February, with enforcement of B35 blending starting in August. The government aims to progress to a B40 biodiesel blending program by 2025.

For the first three months of this year, Indonesia's biodiesel consumption reached approximately 2.7mn kiloliters, as reported by GAPKI. Additionally, Indonesia's palm oil fund agency forecasts revenue collection of Rp29tn (USD1.87bn) from export levies in 2024. The agency anticipates that funds needed for B35 biodiesel incentives this year will also amount to Rp29tn.

The biodiesel program is expected to have positive implications for the industry as it has the potential to increase domestic consumption and alleviate growing stockpiles, which could provide some support to CPO prices. The recent drop in Palm Oil's price premium to gasoil (POGO) to approximately USD40/tonne contrasts sharply with the 3-year and 5-year averages of USD151/tonne and USD 187/tonne, respectively. This lower premium enhances the financial viability of the biodiesel program and may help mitigate the supply of CPO in the market, in our view.

Normalised Spread Between Soybean Oil and CPO

The price spreads between palm oil and soybean oil have normalised. The premium of soybean oil futures over palm oil futures has decreased from a peak of USD573/tonne in September 2023 to approximately USD130/tonne recently, which is within the typical range of USD 100 to USD 200/tonne (Figure 6). Therefore, palm oil would remain relatively appealing as an alternative, to some degree. This perspective could help mitigate potential declines in CPO prices, in our view. We anticipate the spread to remain stable at the current level in the 2H of the year.

Fertilizer Prices Decrease But Still Above Pre-Pandemic Levels

Fertiliser prices have decreased from record levels in 2022, following the decline in natural gas and coal prices, which are key inputs. According to the World Bank, the fertiliser price index fell by 20% QoQ in the 1Q 2024, driven by increased production and lower prices of raw materials. Compared to the same period last year, the index has dropped by nearly 30%. It is anticipated that the index will continue to soften throughout 2024 as supplies recover and new production capacities come online. Nevertheless, the prices are expected to remain above the average levels during 2015-2019 due to strong demand and export restrictions, particularly from China aimed at stabilising domestic prices.

The decline in fertilizer prices is expected to boost plantation companies’ profitability, although this benefit could be partially offset by increased labour costs. Key risks to the fertilizer sector include the trajectory of input costs, influenced by geopolitical tensions, export restrictions from China, and voluntary sanctions imposed by companies that trade Russian fertilizer.

Maintain Neutral

Reiterate our Neutral recommendation on the Plantation sector. No change to our CPO price assumptions of RM4,000/tonne for CY24 and RM3,800/tonne for CY25. With soybean supply expected to rise, we believe it would be tough to paint a bullish price outlook for CPO due to the substitution effect.

We reduced our overall PER multiple by one to two times since we anticipated that the price of CPO would decline soon because of rising supply and weak demand. Meanwhile, we do not expect another significant price adjustment like that of 2022. Indonesia’s government to reduce palm oil export tariff may also pose a threat to Malaysian palm oil exports, which are losing the export competitiveness. If the palm oil production were to maintain its robust growth momentum, it would lead to resurgent in stockpiles, which would potentially limit the CPO price increase, in our view.

We downgrade SDG to HOLD from Buy with a new TP of RM4.56, based on CY25 PER of 21x. Meanwhile, TSH (TP: RM1.22) has been downgraded from Buy to HOLD. On the other hand, KLK (TP: RM22.63) and UMCCA (TP: RM5.43) are still maintained as HOLD. No change to FGV’s (TP: RM1.34) stock recommendation of SELL.

IOICORP (TP: RM4.17) and KIML (TP: RM2.50) remain BUY and are our preferred picks in the sector. We are bullish on IOICORP (TP: RM4.17) due to its improving palm oil profile and expanding its downstream business segment to enhance its future earnings and cushion the impact of lower CPO prices on the plantation segment. We valued the stock based on CY25 PER of 19x.

Meanwhile, KIML (TP: RM2.50) remains our preferred pick in the upstream segment. We favour KIML for its robust balance sheet and net cash position, supporting a stable dividend yield of 5%–6% annually. Our valuation of the stock is based on a CY25 PER of 16x.

Key downside risks to our sector recommendation include: i) higher-thanexpected rise in soybean production, which would likely compress prices of other edible oils in the market; ii) weaker-than-expected demand in China and India, iii) delay in global economic recovery, and iv) unfavourable government policies that could impact the demand for palm oil.

Source: TA Research - 2 Jul 2024