This article first appeared in The Edge Malaysia Weekly on August 10, 2020 - August 16, 2020

CRUDE palm oil (CPO) prices may have bounced back since their slump three months ago, but it has not been enough for a blanket “buy” call on the sector by analysts.

For perspective, both spot CPO prices and futures contracts had increased 40% to RM2,844 per tonne and RM2,720 per tonne respectively since May as at last Thursday. In that same three-month window, Bursa Malaysia-listed plantation stocks saw gains ranging from 7% to 50%.

However, this was not enough to convince analysts. In a note last Friday, AmInvestment Bank had a “neutral” call on the plantation sector, stating that most of the companies — which are due to release their financial results for 2Q2020 in the coming weeks — will be recording lower earnings due to weaker palm product prices.

“On a quarterly basis, upstream and downstream earnings are expected to be softer in 2Q. Although FFB (fresh fruit bunches) output was higher quarter-on-quarter (q-o-q) in 2Q, we believe that for most companies, this would not be enough to offset the quarterly drop in palm product prices,” says the brokerage.

AmInvestment adds that downstream earnings (refining and oleochemicals) will decline q-o-q in 2Q. “The lockdown in economic activities resulting from Covid-19 in March and April resulted in a fall in demand and logistics issues at the destination countries. Thus, we believe that downstream margins will be affected in 2Q. Companies with downstream activities include IOI Corp Bhd, Kuala Lumpur Kepong Bhd, Sime Darby Plantation Bhd and FGV Holdings Bhd.”

In a July 10 note, CGS-CIMB Research had a more sanguine take on planters’ 2Q earnings. “We expect planters to report higher earnings year on year (y-o-y) for 2Q, driven by a 14% y-o-y rise in average CPO prices and 7.4% y-o-y improvement in CPO output from Malaysian estates. We also project 2Q earnings to be much better than 1Q’s as a 34.5% q-o-q increase in output will more than offset the 16% q-o-q fall in CPO prices,” says the firm.

Meanwhile, UOB Kay Hian in a note last Monday maintained its “market weight” call on the regional plantation sector, comprising stocks in Malaysia, Singapore and Indonesia. “We maintain ‘market weight’ on the sector as we reckon CPO prices may soften when production starts to climb in late August, with an expected peak in September to October. Furthermore, palm oil demand from China and India is expected to fall after their inventory replenishment. With possible earnings disappointment on weaker production and potentially lower average selling prices due to forward selling, share prices could retrace,” says the brokerage.

Although analysts remain neutral on the plantation sector, they do have “buy” recommendations on selected counters. For instance, CGS-CIMB Research maintains its “add” call on Genting Plantations Bhd, with a target price of RM10.70.

“We like Genting Plantations for its rich land bank and young estates. The group has one of the youngest estate age profiles among its big-cap peers in Malaysia,” says the firm.

For its financial quarter ended March 31, Genting Plantations’ net profit more than doubled y-o-y to RM91.3 million, thanks to the higher selling prices of palm products. As at last Thursday, its share price had declined 3% year to date (YTD) to RM10.16. However, three months ago, the price increased 8%.

CGS-CIMB Research also has a “buy” call on Hap Seng Plantations Bhd, with a target price of RM1.85. The counter closed at RM1.58 last Thursday, down 25% YTD.

“Our ‘add’ rating on Hap Seng Plantations is premised on the view that the current implied low enterprise value per hectare of RM30,000/ha for its Roundtable on Sustainable Palm Oil-certified contiguous estates in Sabah could attract suitors, leading to a share price rerating in the medium term,” says the firm.

Hap Seng Plantations swung into the red in its first quarter ended March 31, with a reported a net loss of RM6.1 million, on lower CPO sales volume and FFB production that was further aggravated by the suspension of operations for the plantation sector in Tawau, Lahad Datu and Kinabatangan from March 25 to April 9 by the Sabah government following the Movement Control Order.

From a fund manager’s perspective, TA Investment Management chief investment officer Choo Swee Kee says he is generally not upbeat about plantation stocks. “If there is a need to buy a plantation stock, we believe Genting Plantations is as good as any other plantation counter and it has proved to be resilient so far.”

On the outlook for CPO prices for the rest of the year, Singapore-based independent online publisher of palm oil market news Palm Oil Analytics co-founder Dr Sathia Varqa says CPO futures contracts have been bullish since May on significant improvement in export demand in June.

“July looks set for another month of increase, estimated at a 5% to 6% rise over June. High exports, coupled with a lower production outlook in Indonesia and Malaysia, are supporting higher prices now. Prices on the futures benchmark should taper to RM2,500 to RM2,600 [per tonne] from September to December as palm enters peak production from August to October in Malaysia,” he tells The Edge.

Sathia says the strong rebound in prices at the start of 2H2020 will improve the financials of the plantation companies, but refiners’ margins will be under pressure from higher domestic CPO prices and reduced refined product exports to India. “Malaysia’s exports to India will remain robust for the rest of this year, mainly for CPO products after the Malaysian government reduced the export tax on crude products to zero in June and extended it from July to December. Improved diplomatic ties also helped.

“Exports to India will reach 2.3 million tonnes from July to December. This compares with 396,000 tonnes from January to June. Last year, Malaysia’s full-year export [to India] was 4.4 million tonnes.”

He adds that China will increasingly turn to palm oil instead of canola and soybean oil, due to political spats with Canada and Australia. “Canada and Australia — the two largest suppliers of canola to China — are facing political tensions spilling over to trade. Although China has been fulfilling the buying of soybeans from the US since the Phase 1 trade deal was signed, the progression of the deal is in question. From January to June, Malaysia exported 1.258 million tonnes of palm oil to China. [In 2H2020,] this is expected to rise to 1.6 million to 1.8 million tonnes.”

According to data from the Malaysian Palm Oil Board, palm oil exports to China increased 56% month on month (m-o-m) to 351,483 tonnes in June while exports to India increased more than 300% m-o-m to 246,045 tonnes.

Sathia says the soybean oil-to-palm oil spread will be crucial in dictating prices. “The spread in the physical market has been very volatile. Currently, it is at US$80 to US$100, but it was narrower at US$30 to US$50 in July. The spread in the futures market is even narrower at just US$30.

“The market will be cognisant of the fact that higher palm oil prices mean lower discounts to soybean oil. Lower palm discounts mean buyers moving to soybean oil. This is especially when soybeans are expected to see a bumper harvest in Brazil and the US.”

Meanwhile, UOB Kay Hian says a La Niña weather phenomenon could change the outlook for palm oil prices. “A potential La Niña in 2H2020 could shift the global outlook for vegetable oil supply, but it should favour palm oil. Based on past trends, the weather phenomenon is positive for palm oil production and prices at the expense of lower production of soybean as La Niña can cause a drought in soybean-growing regions and reduce supply. Although high rainfall could temporarily hurt palm oil production by delaying harvesting and causing damage to infrastructure, it will lift oil yields in the subsequent years.”

The firm adds that Australia’s Bureau of Meteorology in its latest El Niño-Southern Oscillation Outlook update maintained the chance of a La Niña event forming in the coming months at 50%.

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