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This article first appeared in The Edge Financial Daily, on December 31, 2015.

 

2016-outlook

KUALA LUMPUR: Analysts expect the palm oil sector to be stronger next year with an expected 10% to 15% earnings growth, as they look to crude palm oil (CPO) prices rising about 6% next year.

MIDF Research analyst Alan Lim said Malaysia’s CPO exports are likely to grow by 1% to 3%, supported by increases in global population  and higher per capita consumption in China and India.

However, he said CPO output will be lower than usual in the first half of 2016 due to El Nino, based on the southern oscillating index, which tracks the phenomenon, which has been strongest historically.

Speaking to The Edge Financial Daily, Lim was bullish about CPO prices improving to an average of RM2,300 per tonne in 2016 against an expected RM2,175 per tonne this year.

In a sector note recently, Lim expects CPO prices to surge above RM2,500 per tonne in the first quarter of next year (1Q16), as the CPO to soybean oil (SBO) discount shrinks to US$100 (RM429) per tonne.

He said the current CPO-SBO discount of US$153 per tonne is caused by high inventory, and this should shrink to a 12-month average of US$100 per tonne in 1Q16, due to reduction in stock levels.

A strong depletion of stock levels for CPO in 1Q16 is deemed due significantly to reduced supply, as the lagged impact from El Nino is expected to hit during the seasonal low-production period.

Therefore, Lim said CPO prices should appreciate towards RM2,550 per tonne or US$600 per tonne, assuming a US dollar to ringgit rate of 4.25.

“We believe CPO prices will benefit from the weak ringgit, due to its competitive edge against soybean oil that is expected to see inventory declining. Although [the] ringgit has appreciated slightly to the level of 4.30 recently (from 4.40 to 4.50), it is still significantly weaker than last year’s level of about 3.50. We believe that [the] weak ringgit should lead to improved CPO competitiveness against other vegetable oils (especially SBO).

“According to the US Department of Agriculture, soybean oil is expected to drop to 3.46 million tonnes by September next year, pushing up prices,” he said, adding that CPO prices would actually benefit from the SBO price rally.

As a result of the improved demand prospect and weakened production outlook for SBO, its price has surged 17% to the recent high of 32.08 US cents per pound (or US$707 per tonne) as of Dec 4, compared to three weeks ago, he explained.

“For the same period, CPO has gained by only 3% to RM2,410 per tonne (or US$567 per tonne). We believe that the slower price appreciation of CPO at 3% (against SBO’s 17%) is due to ample inventory of CPO at this juncture.

“However, the supply fundamentals are likely to change in the next three months, as [the] lagged impact from El Nino kicks in. Note that palm oil trees usually produce less fresh fruit bunches (FFB) six to nine months after the dry spell,” he said.

Lim picked IOI Corp Bhd as the stock is due for a rerating, after it regained its syariah status on Nov 30, had a strong earnings growth of more than 41% year-on-year to RM338 million in the first quarter of financial year 2016, and its earnings profile had the most pure (100%) exposure to palm oil among the big-cap index-linked planters.

He also chose Ta Ann Holdings Bhd for its strong earnings underpinned by growth in its timber division, strengthened by the appreciation in the US dollar.

Kenanga Investment Bank Bhd analyst Voon Yee Ping said she is positive on the sector, due to lower production after experiencing significant drought conditions, with better prices based on current price trends.

She added that exports of local CPO would also increase from rising demand, as Indonesian state-owned PT Pertamina and PT AKR Corporindo had tendered to supply their own biodiesel production sector.

“Therefore, there will be more demand for Malaysian CPO overseas because Indonesia would be using its own CPO for the biodiesel sector. Coupled with lower inventory due to the drought, CPO pricing is expected to be better,” she said.

Speaking to The Edge Financial Daily, Voon pointed out that Ta Ann remains Kenanga’s top pick for its undemanding valuation (14 times price-earnings ratio versus peers’ average of 21 times), above-average FFB growth (15% versus an average of 6%), highest dividend yield (4.9% versus an average of 2.4%) and potential timber earnings upside.

Meanwhile, Affin Hwang Investment Bank Bhd analyst Ong Keng Wee said exports had yet to peak despite low prices, due to high inventory.

He expects inventory to be about three million tonnes, rising about 7% from the 2.8 million tonnes in November, depending on the impact of El Nino.

However, he agrees that CPO prices could rise to an average of RM2,400 per tonne, although it is reliant on the stock level.

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