Dec 2023 palm oil output of 1.551m MT (-13% MoM, -4% YoY) was seasonally down, and 4% below both Kenanga and consensus’ estimates. Dec exports stayed soft (-4% MoM, -9% YoY) but within 1% of both our and market expectations while end-Dec inventory of 2.291m MT (-5% MoM, +4% YoY), was 2%- 3% lower than our and market forecasts. Average CPO price in Dec 2023 slipped to RM3,657 per MT (-1% MoM, -8% YoY) due to weaker soyabean oil prices. Full 12-month 2023 palm oil output of 18.552m (+1% YoY) came just slightly (1%) below our and consensus expectations while average CPO price of RM3,829 (- 25% YoY) was 1% firmer than our RM3,800 per MT assumption for CY23 and CY24. Maintain NEUTRAL for the sector as 1.1x PBV is supportive against further substantial downside but there is no strong upside lift either. KLK (OP; TP: RM24.50) is our preferred pick given its good track record and potential to expand upstream and downstream beyond Malaysia

Secular slowdown in palm oil production. CY23 edible oil output grew 2%-3% YoY but worldwide demand rose faster, by 3%-4% YoY. Year-end inventory thus nudged up only 1m-2m MT which may not be sufficient to cover for a possible CY24 shortfall as demand should continue growing 3%-4% YoY against limited supply improvement. Market leader palm oil should see some production growth though only mildly.

After doubling almost every single decade since the 1970s, the growth in palm oil output started moderating around a decade ago and looks set to stay slow for the foreseeable future due to several factors:

a) A decline in new planting. While palm oil has been used in Africa for centuries, palm oil grew rapidly in Malaysia (1960s-1990s) and Indonesia (1980s-2010s). However, Malaysian oil palm planting has started contracting marginally while Indonesia’s expansion has slowed since mid-2010s.

b) Falling yields from older trees. FFB yields start trending down after peaking at year 8-10, and then harvesting becomes challenging by 25-30 years old. Replanting is needed and is no issue to large, well capitalised groups with cash flows from other younger estates. However, for smaller players, replanting is costly with no income for two to three years; hence, replanting is often delayed, causing industry yields to fall as smallholders make up around 40% of oil palm planting.

c) Older fields face more pests and diseases. A typical oil palm field starts with 136 to 148 trees per hectare but the density tends to thin out over time, lowering FFB yields with it. The causes vary, mainly from pests and diseases but also destruction by wild animals or prolonged floods.

Tight edible oil outlook for CY24, with risks of a supply deficit. Demand is expected to continue growing at 3%-4% YoY with the likes of top palm oil producer and also leading user, Indonesia, set to limit exports pending a Feb 2024 election followed by Hari Raya in April. India, a big buyer of palm oil, is also due to hold election in 1H CY24, while US and Brazilian’s biodiesel demand has been spurring demand for soyabean oil. On 19 Dec 2023, Brazil announced further hike of its mandated March 2024 biodiesel blend, from 12% presently to 14% instead of earlier indication of 13%. Meanwhile, rapeseed and sunflower supply are encountering setbacks, from late sowing to logistics. Altogether, CY24 CPO prices should to stay at CY23’s average of RM3,800 per MT.

Margins should improve on easier production costs. With flattish CPO prices expected coupled with prospects of lower input costs, CY24 upstream margins is expected to improve YoY. Fertiliser prices are now 30%-40% lower than a year ago while fuel cost has eased nearly 40% YoY. At the same time, FFB yield is improving in Malaysia with the return of guest workers, helping to lower unit cost further. El Nino is also muted thus far in Malaysia compared to parts of Indonesia. Further ahead, palm kernel (PK), a by-product of FFB milling, should see demand recovering. PK sales help offset 5%-10% of overall CPO cost but PK prices have been soft since mid-CY22. However, the downtrend could be stabilising and any PK price recovery over CY24-25 should contain CPO cost further. Prices of PKO (oil extracted from PK) tend to enjoy a 20%- 30% premium to CPO whereas it is trading at par currently.

Maintain NEUTRAL as current PBV of 1.1x suggest limited price downside but near-term upside catalyst is absent. Longer term, the plantation sector can be defensive as (i) palm oil is largely (70%) consumed as food despite growing use as biofuel, (ii) players’ gearings are manageable, ranging from average borrowing levels to surplus cash holdings, and (iii) the value of agriculture land, especially those along the west coast of Peninsular Malaysia, are often significantly higher than their book value.

Within the sector, we prefer growth over income for the next 3-6 months. We like:

a) KLK (OP; TP: RM24.50) for its track record in expanding upstream regionally and our preferred pick for the sector. Rating-wise, it offers more value than its other large market cap integrated peers.

b) PPB (OP; TP: RM18.40) on FY24F earnings recovery on decent associate Wilmar’s earnings as well as its own businesses in regional flour, feed and film exhibition whilst trading at decade low PBV.

c) TSH (OP; TP: RM1.30), which has recapitalised after paring down debt and is now ready to expand its oil palm area by 30%-40% over the next few years.

Source: Kenanga Research - 11 Jan 2024