This article first appeared in The Edge Financial Daily on November 23, 2017

Plantation sector
Maintain positive: The Australia Bureau of Meteorology (AMB) activated its La Niña Alert (from WATCH) on Tuesday with a 70% chance (previously 50%) of La Niña forming in late 2017.

According to ABM, “The tropical Pacific is approaching La Niña thresholds. If the current progression continues, and thresholds are exceeded for a sustained period, 2017–2018 will be considered a La Niña event. As a result, the bureau’s El Niño–Southern Oscillation (ENSO) outlook has been raised to La Niña Alert, meaning there is approximately a 70% chance — or triple the normal likelihood — of La Niña occurring. Climate models suggest that any event is likely to be weak and short-lived.”

If La Niña is confirmed, we expect excessive rains in Malaysia and Indonesia, which usually cause floods. The production of palm oil in flood-prone states may be affected. Overall, the news is slightly positive for palm oil price but the magnitude of the impact will depend on whether La Niña eventually materialises and its strength.

As the guidance is now for a weak and short-lived La Niña, we have temporarily abandoned the possibility of palm oil price surging to RM3,500 per tonne.

While the impact of weak La Niña is limited on palm oil production, we believe that its impact will be more severe on soybean production in South America. Historically, La Niña has often led to drier planting seasons in South America.

The impact on soybean yield will be severe if the dryness happens from December 2017 to February 2018, which is the period when soybean plants in Brazil need water the most as it reaches its mid to late reproductive stages.

Hence, we believe that soybean oil price will appreciate if the weak La Niña materialises between December 2017 and February 2018. Accordingly, palm oil price is expected to increase to the range of RM2,900 to RM3,100 per tonne assuming a weak La Niña.

Our contrarian palm oil price estimate of an average of RM2,900 per tonne for 2018 is maintained. For 2017, we expect crude palm oil (CPO) price to be at RM2,825 per tonne. Our top pick for the plantation sector is IOI Corp Bhd.

We like IOI Corp for: i) its sale of a 70% stake in Loders Croklaan Group BV (a low-margin business) is likely to result in investment in upstream plantation business which commands much better margin; ii) special dividend of 13 sen in the next 12 months; and iii) substantial improvement in its balance sheet after the 70% stake sale in Loders.

We also have “buy” calls on Kuala Lumpur Kepong Bhd, Genting Plantations Bhd, TSH Resources, Ta Ann Holdings Bhd and Fima Corp Bhd. — MIDF Research, Nov 22