UNLIKE the oil and gas stocks that surged on stronger crude oil prices in the wake of the Organization of the Petroleum Exporting Countries deal, plantations stocks hardly rallied when crude palm oil (CPO) prices went up from last November through mid-February. The inertia was due to scepticism over just how long the CPO price rally would last. After all, palm oil production had begun to recover from the impact of the 2015-2016 “mega El Niño” weather pattern that crimped palm oil production in Indonesia and Malaysia last year.
Experts’ anticipation of a recovery in production this year, similar to that of 1999 following the 1997-1998 “super El Niño”, was a bearish factor, and caused CPO prices to reach as high as RM3,348 on Feb 10 (Malaysian Palm Oil Board FOB spot). It settled at RM2,994 last Thursday.
But some experts now speak of a smaller CPO production recovery, pointing to what they call a 50% chance of the El Niño weather pattern emerging here in the second half or as early as June. At the time of writing, the chances for an El Niño from August through December this year have climbed above 50% (but below 55%), according to the data on US National Oceanic and Atmospheric Administration’s (NOAA) website on March 13.
“Depending on its severity, [an El Niño by 3Q2017] will have minimal impact on this year’s palm oil production because the impact will be on 2018’s numbers. If there is no El Niño in the second half, 2018 will be a fantastic year [in terms of production]. Now, we’re uncertain because if El Niño comes, production will be affected,” says Ling Ah Hong, director of Ganling Sdn Bhd, noting that there is an at least six-month delay in the impact on production.
“The lag effect on palm oil is scientifically proven. It’s been observed. There’s the first lag [six months], the second [nine to 12 months] and the third [22 to 24 months]. That’s how we are able to do the [forecast] model. Last year was so bad because the first and second lags coincided. If the drought is 12 months long, that meant the first effect was seen six months later. But the second drought came, so the effect was rolled down,” Ling tells The Edge, explaining how the 2015 drought hit production in 2016 and how the impact on trees can differ.
“Because the [recent mega] El Niño was so strong, the drop in yields lasted for nine months, from January [2016], and the worst hit was August. So, 3Q2016 [production] was bad and prices went up and up.”
The El Niño weather pattern can cause severe drought (dry weather) and water shortage in plantations in this region while La Niña usually brings abundant rain. Historically, a (mild) La Niña that follows an El Niño usually assists in yield recovery for oil palm trees, explains Ling.
“It is quite surprising that El Niño is emerging so fast. The shortest gap in the last 50 years was two years. The longest could be seven years. If it emerges this year, it will be two years [2015 was the last]. It is not unprecedented,” Ling says, adding that 2018’s CPO production “could be down 6% to 7% if we get a moderately strong El Niño in 2H2017”.
“Actually, it is good for prices. Plantations won’t be so badly affected with a 6% drop because they have young planting, which will help to mitigate [earnings],” says Ling, who expects this year’s CPO production to be above 2016’s but behind 2015’s.
What does this scenario mean for investors looking at plantation stocks?
Ivy Ng, head of research and regional plantations analyst at CIMB Research in Kuala Lumpur, expects a “flattish to marginal rise in planters’ earnings in 2017” as lower CPO prices are offset by higher output this year.
Ng — who retains a “neutral” stance on regional planters’ share prices and recommends that investors be selective in picking stocks in the sector in a March 9 note — likes Singapore-listed Indonesian planter First Resources Ltd (target price: S$2.32) for its young tree age profile, Indonesian-listed PT Astra Agro Lestari Tbk (target price: IDR18,000) for good corporate governance and Genting Plantations Bhd (target price: RM12.30) for its strong output growth prospects.
Another regional plantations analyst is also in favour of planters with younger palm trees as they not only stand to benefit from the expected production recovery but would also have more palm trees entering prime production (years seven to 18, although trees start bearing fruit in the third year). The increased production means the companies will have more fresh fruit bunches (FFB) and CPO to sell, a factor that can compensate for the lower average CPO selling prices achieved before, she explains.
CIMB’s Ng notes in her report that there were more bears than bulls this year in terms of CPO price predictions at the recent annual Palm and Lauric Oils Conference (POC). Price predictions ranged from RM2,200 to RM3,100 per tonne.
“We deduced the mean to be around RM2,649 per tonne,” Ng says, noting how the most bullish forecaster at POC, Dorab Mistry, director of Godrej International Ltd, projected that prices would touch RM3,000 a tonne in the near term before falling to RM2,500 in June to July. Meanwhile, James Fry, chairman of LMC International Ltd, expected CPO prices to fall as low as RM2,250 per tonne due to rising palm oil supplies.
Price predictions for 2016 ranged from RM2,200 to RM3,200 per tonne or an average of RM2,536, but the actual trading range was from RM2,181 to RM3,239 per tonne and the RM2,653 average price was 4.6% higher, as the speakers had not expected production to fall that much. In the past 11 years, actual average CPO prices were above the predictions made for POC2006, POC2007, POC2009 and POC2010, but came in below those for POC2008 as well as those for POC2011, POC2012, POC2013, POC2014 and POC2015, CIMB’s data show.
Other than the potential emergence of El Niño later this year, other key bullish factors for CPO prices mentioned by the speakers include Indonesia’s plan to expand its biodiesel usage to non-public service obligations (non-PSO) sectors, as well as expectations that China would halt the release of rapeseed oil reserves this year.
UOB Kay Hian Research in a March 15 note said Indonesia’s biodiesel uptake could surge to six million kilolitres this year, from about 3.3 million kilolitres last year, as the government makes adjustments in view of the potential downside pressure on CPO prices in 2H2017 on stronger CPO production. The Indonesia Estate Crop Fund (BPDP) expects the biodiesel procurement volume to match or be marginally higher this year, but could adjust the price of biodiesel lower and extend a subsidy to the non-PSO segment.
The research house — which expects CPO prices to average RM2,600 a tonne this year and RM2,500 a tonne next year (compared with RM2,653 last year) and acknowledges that there is a risk of a shortfall in biodiesel mandates on lower global crude oil prices — likes Singapore-listed Bumitama Agri (target price: S$1.25) for its young tree age profile and consistent delivery of high oil extraction rates (OER). “We also like First Resources (target price: S$2.15) for its efficiency in keeping costs low and strong FFB production growth, Kim Loong Resources Bhd (target price: RM4.20), Astra Agro Lestari (target price: IDR19,045) and Sampoerna Agri (target price: IDR2,190).”
Yet, the chances of an El Niño re-emerging later this year, in addition to the fact that the MPOB’s February stockpile of 1.46 million tonnes is a six-year low, seem to pale in comparison to the sharp contraction in CPO exports in early March.
Maybank Investment Bank regional plantations analyst Ong Chee Ting, for one, is not betting on an El Niño in 2H2017 just yet.
“Recall that the El Niño scare at the start of 2014 turned out to be a non-event,” Ong told clients in a March 13 note. He has “turned cautious” on the plantations sector although he reckons the recent CPO price selldown was “overdone given the low stockpile” and reckons a “short-term rebound in CPO prices is possible before prices resume their downward trend going into 2H2017”.
He is keeping an eye on CPO export trends after independent cargo surveyors Intertek and SGS’ preliminary export estimates for the first 10 days of March suggested a sharp 26% month-on-month decline. “While it is still early days, we suspect this sharp contraction in exports was due to a sudden pullback in purchase orders as importers were hoping to buy palm oil at lower prices when the price suddenly fell more than 10% month-on-month in February. Nonetheless, this trend is worth monitoring.”
Maybank Investment Bank has “buy” calls on Boustead Plantations Bhd (target price: RM1.78), Sarawak Oil Palms Bhd (target price: RM4.70), Singapore-listed Bumitama Agri (target price: S$0.96), Indonesia-listed Astra Agro Lestari (target price: IDR19,000), London Sumatra (target price: IDR1,470) and Tunas Baru Lampung (target price: IDR1,500).
Thomas Mielke, director and editor at ISTA Mielke GmbH, which publishes independent forecasting service Oil World, is less concerned about near-term export fluctuations. Speaking at the POC, Mielke predicted that global supplies of eight major edible oils will increase by 10 million tonnes this year but that would only partly replenish stock drawdowns in the previous year. He reckons that palm oil prices have peaked this year but deems that the February price declines were “overdone”, adding that CPO prices “have to be sufficiently attractive for producers to invest and expand”.
Ling does not think the pace of oil palm planting will return to that enjoyed at the height of the commodities boom, owing to greater pressures on sustainability and environment-related concerns.
“Up until 2020, we will see good production growth in Indonesia because planters are planting … but after 2020, most of these trees will have reached their peak. The slowdown in planting started in 2013 because that’s when the Indonesian government signed the [first] moratorium [with Norway]. The greatest slowdown was from 2014/2015 when the non-governmental organisations got very stringent and planters had to do a lot more sustainability studies … and there is the natural slowdown because of lower prices,” Ling says.
“Will people start planting more? My answer is no. In the next five years, there will be a major slowdown in supply, simply because Jokowi (Indonesian President Joko Widodo) is introducing another moratorium, which will include the ‘no deforestation, no peat’ policy. This moratorium is good for the industry to allow consolidation. The weaker ones will have to get out.”
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