Jan 13, 2016

Malaysia Plantations Sector - Better Time Ahead

Highlights
We expect CPO prices to recover on the back of slower supply growth and better demand outlook. However, upside in prices is likely to be capped by the concern about high soybean supply and low crude oil prices as well as rising cost pressure. Thus, we maintain Neutral on the plantation sector with average CPO price assumption of RM2,400/tonne for 2016.

Slower supply growth. CPO production in 2016 is likely to be affected by the El Nino-induced dry weather in 2015. Oil World expects global CPO production will only increase by 0.32m tonne in 2016 (2015: +3.2m). This would help to support CPO prices, drawing down the high palm oil inventory in 1Q16 when demand picks up while production stays weak.

Better biodiesel demand. Palm oil demand catalyst in 2016 is mainly from the higher biodiesel demand in Indonesia. Media highlighted that Indonesia started to use B20 on 1 Jan 2015. Pertamina expects biodiesel consumption to jump significantly to 5.54m kls from 1.2m kls in 2015.
Rising cost pressure. Increase in production cost, i.e. labour and fertiliser, will partly offset the positive of higher CPO prices. Companies with strong production growth would be able to mitigate the cost pressure, while other companies are likely to carry out measures to improve efficiency. The impact will be more evident for companies with low production affected by the drought.

External pressures to cap CPO price rally. Although El Nino is stronger than earlier expected, strong rally in CPO prices in 1997/98 is unlikely to repeat in 2016. This is mainly due to the high soybean supply and low crude oil price. Given the above-mentioned factors and relatively pricey valuation, we maintain Neutral on plantation sector. For exposure, we prefer well-managed companies with young tree profile that can withstand the impact from dry weather. Our top picks are Genting Plantation and CB Industrial Products.

Catalysts
Better than expected take up rate of biodiesel demand in Malaysia and Indonesia.
Weather uncertainties revisit, which would result in supply distortion, hence boosting prices of edible oil.

Risks
Higher-than-expected soybean yield and soybean planting, resulting in lower soybean prices, hence prices of CPO.
India imposes higher import duty on CPO.
Escalating production cost (particularly labour cost).

Rating
NEUTRAL
Positives
Long term sector outlook remains favourable.

Negatives
Weak short-term demand and price outlook. Sector View
We maintain Neutral on the sector. Our top picks are Genting Plantation (BUY; TP: RM11.75) and CB Industrial Product (BUY; RM2.30)

Source: Hong Leong Investment Bank Research – 11/01/16