CPO prices will finally rebound, but risks are also rising.
Drought usually spells trouble for farmers across Asia, but the same could not be said for palm oil plantation companies across the region. After languishing for several quarters, analysts reckon that the fortunes of Singapore-listed planters are changing at long last.
With crude palm oil (CPO) prices expected to finally rebound this year as output drops, analysts note that investors should keep an eye on long-ignored agribusiness stocks. However, they also warn that despite a projected recovery in CPO prices, listed planters will continue to face heightened currency risks and persistently low commodity prices. These, in turn, could curb growth in the near term.
1. What’s your outlook on listed plantation players in 2016?
Conrad Werner, Managing Director, Equity Research, Macquarie:
The narrative for CPO planters will be better in 2016 than it has been for many years. The complex has been heavy for about four years now, but is set to tighten in 2016 on the back of slower production growth driven by this year’s El Nino (moisture deficit) and Southeast Asian haze (sunlight deficit). On the demand side, newsflow around the Indonesian biodiesel mandate suggests it is finally getting off the ground. Both catalysts have gone from brewing to bubbling.
We see stock-to-usage tightening to below the historical long term average of 18% in 2016, with 2017 poised to see further tightening. While inventories are high at the moment– MPOB [Malaysia Palm Oil Board] has been reporting record levels in Malaysia on a monthly basis both in absolute and relative terms— we see them dropping from December onwards with the MPOB releases set to become positive monthly sector catalysts rather than the performance impediments they are at present.
Our base case forecast is US$659 per ton for 2016, and we see US$560 to US$735 as a reasonable range of potential outcomes. On that basis, we see risk reward on share prices also skewed to the upside, especially with the preconditions for the bear case starting to look weaker than those supporting the bull case.
Patrick Yau, Analyst, Citi:
The CPO price recovery was helped by the confirmation of an El Niño comparable in strength with the 1997/98 occurrence, and the large reduction in forecasts (between -10% to -20%) of FFB growth for FY16.
El Niño conditions are now strong and weather experts are seeing conditions to rival 1997, leading to a severe/Super El Niño. Weather agencies suggest that strong El Niño conditions continue to progress, with some chance of this developing into a Super El Niño. Severe El Niño conditions, accompanied by dry conditions earlier in the year, have boosted CPO and stock prices of CPO-related firms as palm oil production yields get hurt 6-9 months later.
Historically, investors have to be watchful as price volatility has always increased when El Niño has struck, as price rises can quickly be followed by a sharp reversal. El Niños provide trading opportunities rather than long-term investments.
Ivy Ng Lee Fang, Analyst, CIMB:
Malaysia’s Meteorological Department expects the El Nino weather to peak in 1Q16. Malaysia will be hotter by up to 2°C in the first quarter of 2016 as the El Nino effect reaches its peak. Most parts of Malaysia (except southern Pahang and Johor) are expected to receive lower-than-average rainfall. This could reduce palm oil supplies in 2016 and 2017.
The areas predicted to experience below-average rainfall in 1Q account for around 70% of the palm oil producing region in Malaysia. This could impact palm oil supplies in 2016. Approx. 8-20 weeks of lower than required rainfall could lead to multiple lagged effects on palm oil production in the form of: 1) bunch failure (4-6 months later); 2) floral abortion (10-12 months); and 3) sex differentiation (22-24 months).
This news is near-term supportive for CPO prices. Our 2016 average CPO price of RM2,450 per tonne assumes a moderate El Nino. We could raise our CPO price forecasts if El Nino turns out to be more severe, but this will come at the expense of lower production.
Investors should remain vigilant of the potential impact of the on-going El Nino in 2016. Our view is the El Nino impact on palm oil supplies from Indonesia will be more severe compared to Malaysia in 2016, based on 2015’s rainfall data.
2. Apart from the effect of El Nino, what other catalysts will drive growth for plantation players this year?
Conrad Werner, Macquarie:
The bigger swing factor on the demand side remains the Indonesian biodiesel mandate. Most notably, a biodiesel fund has been set up to disburse the proceeds from export levies to support the market via subsidies.
Under the new system, Pertamina [Indonesia’s state-owned oil and natural gas corporation] will pay a market diesel reference price (MOPS) to the biodiesel refiners. It is the refiners who must now collect a US$125 per ton biodiesel subsidy from the biodiesel fund. On the one hand, this can be seen as a positive, in that it simplifies the purchasing process. On the other hand, shifting the onus of subsidy collection to the producers creates a different layer of potential complexity for them. We have sensed a mixed reaction to this change from market participants we spoke to.
There remains the risk that having a fixed subsidy of US$125 per ton potentially squeezes biodiesel refiner margins in the event that CPO prices rise (an input cost for the refiners) or MOPS declines (the price they receive from Pertamina). Of course, the reverse is also true in both cases. In any event, the subsidy is up for review every six months. On current prices, there is a theoretical US$5-10 per ton margin for refiners with a US$100 per ton conversion cost (most listed companies are at or below that cost).
Patrick Yau, Citi:
After introduction of Indonesia's B10 policy in late 2013, implementation has been disappointing. In 2014, only less than 50% of the blending target is realized. Efforts have been made to increase blending in the forms of subsidy and new biodiesel tender price, but implementation is yet to be seen.
In the latest development, the government announced that it will impose a US$20-50 levy/ton on CPO and derivatives exports, partly to help fund the biodiesel subsidy. The collected levies will be pooled into a 'CPO Fund', an agency that will be formed to manage the fund usage.
In our view, if properly executed, implementation of the levy will be positive in the long term as it could make biodiesel sustainable and thus provide price support to CPO. To put this into context, the biodiesel target of 3bn liters will translate to significant increase in demand at around 3mn tons for CPO. This is equal to ~10% of the Indonesian annual CPO production and is more than the average CPO inventory in Malaysia.
However, in the short term, if Pertamina is not able to accelerate its biodiesel tender and blending process, the levy will likely have negative impact to planters.
UOB Kay Hian Regional Research:
With the implementation of a blending of 10% palm biodiesel (B10), utilisation could double to 1.2m tonnes of palm oil per year (0.8m tonnes for the transport sector and 0.4m tonnes for the industrial sector). The additional volume will use up 24% of the current inventory of 2.63m tonnes and act as support to CPO prices.
Malaysia is targeting to launch B10 in Apr 16. We understand there are no major technical issues in the implementation which involves stakeholders such as petroleum companies, automobile manufacturers, palm oil suppliers and relevant government agencies and this could delay the implementation. We have not factored this increase in demand in our earnings projections, thus if the implementation really takes effect in Apr 16, this is slightly positive to CPO prices.
3. What are the key risks to plantation players this year?
Conrad Werner, Macquarie:
Soybean oil (SBO) remains well supplied and could cap the price performance of vegetable oils overall. The fall US soybean harvest has been good and Latin America’s spring harvest is also shaping up well, though some weather risks are present in the current planting stage. But taking a step back, we would note that SBO accounts for only 26% of world vegetable oil production and 16% of exports, with palm oil at 39% and 66%, respectively.
Low oil prices not only reduce discretionary biodiesel blending demand, they also raise the cost of mandated biodiesel programs like Indonesia’s. Indonesia’s program is being funded by CPO export taxes. We would note that over half of the tax receipts are currently earmarked for an oil palm replanting program with the rest going into the biodiesel subsidies. We see room for replanting funds to shift to the biodiesel side if necessary.
Patrick Yau, Citi:
We believe that the upside for CPO prices would be subdued due to high stockpile of competing oilseeds as well as weak oil prices, which damage biodiesel demand.
Our commodities analysts are of the view that oilseeds supplies should remain in a large overhang in 2015/16, given the bumper crop sowed in the US, expanding Brazil acreage in 2015/16 on the likelihood of a weaker BRL and recent cycles showing more corn planting allocation to its second crop.
Global soybean ending stock as of October 15 stands at ~78mt based on USDA data. As soybean prices remain depressed, we expect plantings for subsequent seasons to decline as the crop becomes less profitable for farmers.
Planters with high gearing or those with large exposures to USD debt also present risks given the sharp volatility in ASEAN currencies.
In the fourth quarter of 2015, major agribusiness players including Bumitama Agri, First Resources, and Wilmar reported lower profits due to low palm oil prices. Others, such as Golden Agri and Olam, booked losses for the full year.
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