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This article first appeared in The Edge Malaysia Weekly, on September 28 - October 4, 2015.

 

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THE incoming El Niño weather may be supporting crude palm oil (CPO) prices, but the outlook for the plantation sector remains subdued since the drier-than-normal weather in the coming months will mean lower yields for planters.

Since the beginning of the month, CPO prices have gained over 23%, to close at RM2,302 per tonne last week. Arguably, some of the impact could be due to the depreciation of the ringgit. In US dollar terms, CPO prices have gained 19.37% to US$525 per tonne.

The rebound in CPO prices would have been even sharper if not for the high palm oil and soybean stocks, which are dampening the El Niño effect on CPO prices. Recall that Malaysian palm oil inventories hit a 31-month high of 2.49 million tonnes in August, driven by high production.

While analysts continue to be “neutral” on the sector overall, not all planters are created equal. Some will be better able to maintain palm oil yields to fully benefit from the El Niño-driven CPO prices.

Crude-Palm-Oil_16_TEM1077_theedgemarkets“The El Niño event is typically positive for CPO prices, as the shortfall in supply caused by the drought has boosted palm oil prices in the past. The CPO price reaction to El Niño has been weak so far due to high soybean and palm oil stocks. We expect the current El Nino to boost the average CPO price in 2016 to RM2,450 per tonne,” writes CIMB in a research report last week.

El Niño refers to the large-scale ocean atmosphere climate phenomenon linked to a periodic warming of sea-surface temperatures across the central and east-central equatorial Pacific. El Niño episodes typically occur every three to five years and can last between 9 and 12 months, developing around March to June for peak intensity in December to April.

The phenomenon typically shifts rainfall patterns, causing less rainfall in Indonesia and South America, and excess rainfall in southeastern South America and in the southern US.

Research reports point out that that El Niño conditions began developing in March and are expected to last till May 2016. California in the US and Riau in Indonesia have already declared states of emergency due to forest fires, which have been attributed to El Niño-led dryness.

Looking ahead, Indonesia’s Meteorology Department is already forecasting a drier October and warns that the drought might last till February with areas in southeast Indonesia expected to be far drier than the west coast. (See weather forecast map)

“For Malaysia, we have established that Sabah is the worst hit, while for Indonesia, we believe that Kalimantan is worst hit. Companies with the largest exposure to these two areas are IJM Plantations Bhd (fundamental: 1.60; valuation: 0.80), Goldern Agri-Resources Ltd (fundamental: 0.55; valuation: 1.40), PT Dharma Satya Nusantara, Bumitama Agri Ltd (fundamental: 1.15; valuation: 0.50), Wilmar International Ltd (fundamental: 0.80; valuation: 2.60) and Genting Plantations Bhd (fundamental: 2.70; valuation: 0.80),” writes Credit Suisse in a report. (See table)

Indonesia’s PT Eagle High Plantations Tbk and Malaysia’s TSH Resources Bhd (fundamental: 0.30; valuation: 0.50) also have high exposures to these regions.

The length and the severity of the dry spell will also play a big role in CPO prices as well as planters’ earnings

“Approximately 8 to 20 weeks of low rainfall or prolonged drought can induce moisture stress on palm and impact subsequent FFB [fresh fruit bunch] yields from the oil palm trees,” writes CIMB Research.

This could lead to multiple lagged effects on palm oil production in the coming months, adds the report. FFB failure can occur four to six months later, floral abortion 10 to 12 months later and sex differentiation as long as 22 to 24 months after the drought.

Notably, planters with younger trees are expected to do better, since the younger trees would be more robust in a drought. For this reason, CIMB Research’s top picks include First Resources Ltd (fundamental: 1.15; valuation: 1.20) and Genting Plantations.

Genting Plantations, for example, has an exposure of 85% to the aforementioned drought-prone areas of Sabah and Kalimantan. Yet, young trees, coupled with a strong balance sheet, have made the planter CIMB’s top Malaysian pick with a target price of RM10.50.

Malaysia-Palm-Oil-Stocks_16_TEM1077_theedgemarketsInterestingly, the Ministry of Plantation Industries and Commodities last Friday announced an RM100 million Oil Palm Replanting Scheme (SITS 2015), that will begin on Oct 1, with a goal of replanting some 83,000ha.

Under the scheme, eligible applicants may apply for a RM1,500 per hectare incentive to replant the first 33,000ha under the scheme as part of Phase 1. Phase 2 will see an incentive of RM1,000 per hectare for the remaining 50,000ha.

SITS 2015 is expected to reduce CPO production by 250,000 tonnes, to help ease the oversupply challenges that the sector is grappling with. The impact of the scheme however, is relatively mild compared to the El Niño effect (which could reduce CPO production by more than two million tonnes per annum by 2016.

However, it depends on how severe El Niño will be. Current sea surface temperatures over the central Pacific Ocean are showing that a moderate El Niño is present. However, the latest indicators presented at an El Niño seminar in Kuala Lumpur last week, suggest that it will strengthen in the next few weeks. This could lead to extremely dry weather in Sumatra, as well as Sabah.

According to CIMB Research, a moderate El Niño is expected to decelerate global palm oil production growth to 3% and 1% year on year (y-o-y) to 62.7 million tonnes in 2015 and 63.3 million tonnes in   2016. (Note: the El Niño effect straddles the end of 2015 and the beginning of 2016.)

Meanwhile, a strong El Niño would cause global palm oil production to decelerate to 2.3% y-o-y growth to 62.24 million tonnes in 2015, and a contraction of 1.8% growth to 61.11 million tonnes in 2016.

In the meantime, El Niño might be good for the production of soybeans — an oilseed crop that competes with palm oil. CIMB Research points out that four of the past six El Niño events saw strong output growth in soy.

While a stronger soybean crop would put downward pressure on CPO prices, “shortages in rapeseed oil and gradual progress in Indonesia’s bio-diesel blending targets (subsidies in place since July 2015) will likely help provide support to CPO prices amid ample supply of palm oil and soybean,” writes JP Morgan in a report.

“We prefer upstream plays with strong non-price drivers and/or integrated companies with a competitive edge downstream. Our top picks are First Resources and Genting Plantations,” writes JP Morgan.

The research house’s top avoids, meanwhile, are IOI Corp Bhd (fundamental: 1.05; valuation: 0.50) and Golden Agri-Resources.

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Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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