Plantation Sector - UOB Kay Hian 2015-09-30: CPO Prices See Stronger-than-expected Recovery

Plantation Sector - UOB Kay Hian 2015-09-30: CPO Prices See Stronger-than-expected Recovery Plantation Sector WILMAR INTERNATIONAL LIMITED F34.SI  FIRST RESOURCES LIMITED EB5.SI  GOLDEN AGRI-RESOURCES LTD E5H.SI  BUMITAMA AGRI LTD P8Z.SI 

Plantation – Regional CPO Prices See Stronger-than-expected Recovery 

  • CPO prices have finally recovered in response to increasing newsflow on dry weather impacting production and the weakening ringgit. 
  • However, the strong rebound in the prices of CPO futures is yet to be fully reflected in the physical market. This has also opened up arbitrage opportunities for refiners who usually buy CPO at spot market prices and carry out forward selling based on futures prices. 
  • Maintain MARKET WEIGHT. 



WHAT’S NEW 


 Strong price recovery was beyond expectations. 

  • Although we were expecting CPO prices to recover as the market began to factor in the production risks arising from prolonged dryness, the sharp 28% recovery in CPO prices in a span of 1.5 months was way above our expectations. We partly attribute this to the weakening ringgit, given that palm oil and its competing edible oils are priced in US dollars internationally. 
  • In addition, CPO prices were also reacting to the strong newsflow from various media sources broadcasting the positive outlooks of participants of the Globoil India 2015 event in Mumbai - India and interviews with palm producers who expressed concerns on production. The price of CPO futures hit a high of RM2,450/tonne yesterday, up 28% from the recent low recorded on 28 Aug 15. 

 Physical prices yet to catch up. 

  • The strong pricing seen in futures contracts is yet to translate into spot prices for physical deliveries. In this situation two groups will benefit: 
    1. Refiners: Wider spread will lead to better margins. Most refiners are taking feedstock deliveries based on spot prices and carrying out forward selling based on future prices. Companies with greater downstream exposure are Wilmar, IOI Corporation, KL Kepong, First Resources, Golden Agri and Astra Agro Lestari. 
    2. Producers with exposure in Peninsular Malaysia will enjoy arbitrage opportunities. Producers can sell and deliver by selling in the futures market to enjoy higher selling prices vs spot prices. In some cases, profit can be made from arbitraging, ie buying at spot prices and selling in the futures market. 


ACTION 


 Maintain MARKET WEIGHT. 

  • Despite the recovery in CPO prices, plantation companies’ share prices did not react positively to the recent developments chiefly due to the negative sentiments on commodities and equity holdings. If CPO prices continue to strengthen, plantation companies’ share prices should eventually catch up accordingly. Based on past events, the decline in production should be well compensated by the higher selling prices. 


ESSENTIALS 


 A replay of the events of 1997/98: El Nino + Currency? 

  • The industry’s current situation echoes events of the Asia Financial Crisis 1997/98, ie the arrival of a strong El Nino led to lower production in Malaysia and at the same time the ringgit was on a trend of sharp depreciation. CPO prices are highly correlated to the ringgit in times of sharp movement (refer to charts on the right). We partly attribute the recent rally in CPO prices to the weakening ringgit but more so due to fears of low production. 

 If history repeats itself, CPO prices could hit US$700/tonne … 

  • Based on the events of 1997/98, we found that excluding forex impact (refer to table below), CPO prices in US dollar terms, were up by 51%. If history repeats itself, the current prices could see an additional upside of 30% (driven by impact from the El Nino) to hit a high of US$700/tonne. 

 … but soybean market was tighter back then. 

  • The soybean market faced tighter supply in 1997/98, which is in contrast to the oversupplied market now. This factor could cap the upside to CPO prices. Despite the low soybean prices, farmers in Brazil are still planting at a record-high rate, evidenced by more areas sowed, due largely to the weakening currency as well. The weak currency has been supporting Brazilian soybean prices. This has led to expectations of an increased scale of sowings this year once again. Farmers will prefer to have more soybeans in hand (traded in US dollars) compared with holding cash in local currency. 

 Key views from James Fry, Chairman of LMC International Paper at Globoil India 2015: 

  • CPO prices are likely to surge to US$700/tonne by mid-16 as the El Nino is expected to dent output and as top producer Indonesia uses more palm-based biodiesel. Even in the absence of El Nino, prices should surpass US$600 in 1H16. This is based on the assumption that the Indonesian fund for biodiesel subsidies is utilised in full. 


SECTOR CATALYSTS 


 Catalysts revolve around crude oil prices. 

  • Non-mandated biodiesel demand will turn around if crude oil prices recover to above US$80/bbl. Biodiesel usage now forms about 16% of total palm oil consumption (9.5m tonnes). Out of this, about 3m-4m tonnes cater to discretionary demand which is sensitive to crude oil prices. 


ASSUMPTION CHANGES 

  • Our CPO price assumptions are at RM2,200/tonne for 2015 and RM2,300/tonne for 2016. 


RISKS 


 Pullback of biodiesel policy. 

  • A pullback of the policy on the reduction of biodiesel blending volume will hurt CPO prices as extra supply will need to find new “homes” in a short period of time and this might not be easy at the moment.


PEER COMPARISON 



Regional Research Team UOB Kay Hian | http://research.uobkayhian.com/ 2015-09-30
UOB Kay Hian Analyst Report BUY Maintain BUY 3.60 Same 3.60
BUY Maintain BUY 2.40 Same 2.40
BUY Maintain BUY 0.48 Same 0.48
BUY Maintain BUY 1.35 Same 1.35


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