This article first appeared in The Edge Financial Daily on December 21, 2018

Plantation sector
Neutral: Despite seeing weaker palm oil production after hitting a peak last October, we think the Malaysian palm oil inventory is likely to remain at a high level in early 2019. We project palm oil inventories to stay in the range of 2.7 million to 2.9 million tonnes during the first quarter (1Q) of 2019 as demand from China is seen to be subdued while Indonesian counterparts will be more aggressive in flushing out their high stock levels.

We anticipate crude palm oil (CPO) prices to average at RM2,200/tonne in 2019, a 22% rise from the current spot price of RM1,801/tonne. For 2018, they are likely to end the year with a full-year average of RM2,200/tonne.

In the near term, CPO futures are likely to trade in the range of RM2,000/tonne to RM2,100/tonne due to weak demand from China with the long holiday period during the Chinese New Year celebration. Also, China may switch to purchase more US soybean following the temporary truce in the midst of trade war tension with the US. We believe CPO prices would start to recover when there are signs of continuous falling in Indonesian palm oil inventory.

The Indonesian palm oil inventory level has softened to 4.4 million tonnes after hitting a record level of 4.9 million tonnes in July. The high inventory level during 3Q was due to the transportation issue in the Kalimantan region as there were insufficient barges to transfer the CPO to refineries in other regions for further processing as local refineries had limited capacities to process the high production volume.

In addition, some plantation players prefer to hold up the CPO stocks due to the unattractive CPO prices, which were trading at barely break-even levels. Meanwhile, the Malaysian palm oil inventory level saw an increase for six straight months, surging to an all-time high of 3.01 million tonnes.

Indonesia’s discount to Malaysia’s CPO prices has narrowed from RM400/tonne in 3Q to the normalised level of RM70/tonne recently following the withdrawal of the US$50/tonne (RM209/tonne) levy and signs of easing inventory in the country. This would certainly give a huge boost to Indonesian planters, who have been struggling with the current poor CPO price performance.

Not only facing stiffer competition from their Indonesian counterparts, who are also facing excess supply, Malaysian plantation players are also experiencing various attacks from Europe, namely non-governmental organisations, activists and environmental friendly groups. We believe such negative publicity would continue to affect palm oil demand from Europe, which is the world’s third-largest consumer.

Following the slide in CPO price performance, most plantation companies under our coverage delivered weaker earnings and we have revised down the earnings forecasts by 10% to 30% following the revision in our CPO price forecasts from RM2,400/tonne to RM2,200/tonne for 2019.

Year to date, FGV’s share price has suffered the most, tumbling 63%, followed by TSH (-40%) and Ta Ann (-31%). Our preferred pick is Ta Ann due to its compelling valuations and decent dividend yield. On the sector valuation, it has also come off from a high of 34 times a year ago to the current level of 26 times. — PublicInvest Research, Dec 19