This article first appeared in The Edge Financial Daily on April 4, 2019
Plantation sector
Maintain neutral on respective sectors: While some positive factors are developing in the plantation sector, negative news flows have diffused negative sentiments and weighed on crude palm oil (CPO) prices, dampening near-term prospects of planters under our coverage.
In addition, the stockpiles have not eased as quickly as we had hoped in the January-February 2019 period, no thanks to the shorter working month during Chinese New Year (CNY). However, as the negative news flows subside in the coming months, we believe CPO price will return to the recovery trajectory.
Over the next three months, the key positive factors that we are monitoring closely are: easing stockpiles in both Malaysia and Indonesia; higher exports to China given its pledge to buy 50% more palm oil from Malaysia; and, further clarity on new biodiesel blending initiatives (B30 in Indonesia and B20 in Malaysia).
Nevertheless, we believe these positive factors have been largely priced in with the KL Plantation Index (KLPLN) which staged a handsome 11% recovery from the low in December 2018. As such, we maintain our “neutral” stance for now as well as our 2019 CPO price target of RM2,400/tonne.
Currently, the planters under our coverage are on average trading at -1.0 standard deviation (SD) (range: -2.0 to +0.5 SD) from their respective mean price-earning ratio, which is consistent with the uncertain environment but lacks a comfortable margin of error for us to turn positive on the sector at this juncture.
However, should the biodiesel initiatives and palm oil offtake from the Chinese pan out better than expected, we would relook our valuation basis with an upward bias. On the other hand, if the European Union (EU) and the Philippines’ palm oil biodiesel ban escalate further, we are likely to downgrade our CPO price assumption.
We expect the coming results season in May to see a sequential recovery in most planters’ earnings as improvements in CPO prices likely outweighed a seasonal drop in fresh fruit bunches (FFB) output in the first quarter of calendar year 2019.
Locally, we believe that the production of FFB will continue to see a decline (to 1.3-1.4 million tonnes) up to March 2019 in an unusual phenomenon (versus a typical 16-17% increase during the month), given that February 2019 production remained exceptionally high at 1.54 million tonnes (versus five-year February average of 1.21 million tonnes).
Coupled with a potential demand pick-up from China post-CNY, we anticipate that Malaysian stockpiles will fall from 3.05 million tonnes in February 2019 to 2.7 million tonnes in March 2019, and edge down further to 2.5 million tonnes by May-June 2019 as demand continues to outstrip supply.
Exports to the EU should remain stable given the recent recovery in crude oil prices, making CPO more attractive for feedstock in biofuels. In Indonesia, consensus expectations from Bloomberg suggest that stockpiles have likely declined of about 7% to 2.8 million tonnes in February 2019 from a 3.02 million tonnes in January 2019. As such, we believe the dwindling stockpiles both locally and in Indonesia should lend some support to CPO prices.
The European Commission has recently drafted a regulation to limit palm oil consumption for biofuel use at 2019 levels up to 2023, and gradually reduce further through 2030 until an eventual phase-out.
According to data from the EU Parliament, 46% of total palm oil imports into the grouping is used for biofuels. The proposal has triggered a backlash among Malaysian and Indonesian leaders, who are currently deliberating undesirable options such as boycotting imports from the EU or taking the matter to the World Trade Organisation.
For both Malaysia and Indonesia, we believe boycotting will be unavailing seeing that both the countries are net exporters to the EU, while there is little clarity on the latter course of action. The slight comfort we currently derive is that the implementation timeline allows some breathing space for both the countries to explore new markets.
Adding fuel to the fire, the Philippines’ Department of Agriculture recently sought a temporary ban on palm oil imports from Indonesia and Malaysia in a bid to protect local farmers. Malaysian palm oil exports to the Philippines constituted about 5% of total palm oil exports in 2018.
Shortly later, Reuters reported that the three countries would form a “technical working group” to tackle alleged smuggling and dumping of palm oil in the Philippines.
We are hopeful that a favourable outcome or mutual understanding could be reached eventually.
Indonesia’s extension of 20% biodiesel blending (B20) mandate to the non-public sector obligation and Malaysia’s implementation of B10/B7 for the transport/industrial sector should play an important role in reducing stockpiles this year.
According to the World Meteorological Organisation, sea surface temperatures (SSTs) in the tropical Pacific Ocean were at weak El Niño levels from October to December 2018 and subsequently cooled to slightly below El Niño thresholds during late January up to mid-February 2019.
However, current signs are pointing towards the return of a weak El Niño (0.6-0.9°C above average SST) in March-May 2019 with a 50-60% probability, while a strong event appears unlikely at this juncture.
After agreeing to a 90-day trade truce on Dec 1, 2018, China has resumed purchases of US soybeans on a large scale, showing good gestures to ease tensions between the two countries. This bodes well for US soybean oil (SBO) prices as lower soybean supply curbs crushing activities and reduces SBO availability in the country. This augurs well for CPO prices in the near term given that the two commodities are close substitutes and their prices are highly correlated (more than 0.90).
Another supporting factor is a stretched CPO-to-SBO discount presently, which has arisen from swelling CPO stockpiles in both Indonesia and Malaysia previously.
We are maintaining the 2019 CPO price forecast at RM2,400/tonne (versus. spot price of RM1,904/tonne and year-to-date average of RM2,012/tonne) as we expect the negative news flows regarding palm oil to subside, while the current steep CPO futures premium of about RM303/tonne and CPO-to-SBO discount of US$173/tonne (versus. one-year average of US$121/tonne) will continue to lend support to CPO prices in the near term.
However, should the CPO price fail to recover by first half of 2019, we are likely to downgrade our CPO price forecast.
For investors who would like to gain exposure to the plantation sector, we recommend TSH (OP; TP: RM1.30), our only OP call, due to its above-average production outlook of +12% (versus. industry average of +5%), its higher earnings sensitivity to a potential CPO price recovery, if any, and it is the only pure upstream planter under our coverage that is still profitable. — Kenanga Research, April 3