We are taking the market’s conservative approach and maintain MARKET WEIGHT. However, we see good value in our preferred picks - FR and BAL - even without the El Nino.
• Edible oil prices finding support from recent changes in biodiesel policies. Crude palm oil (+10% from recent low on 29 Apr 15) and soybean oil prices (+7% from recent low on 31 Mar 15) recovered thanks to the recent biodiesel policies changes in Indonesia, Malaysia and US. All three countries announced higher usage of biodiesel for domestic diesel mixes. Palm oil and soybean oil are major feedstock for these markets.
• But market is not convinced. Despite the recovery of edible oil prices, share prices of plantation companies hardly performed, with the exception of First Resources after the sharp sell down and Eagle High Plantation after the high valuation stakes disposal news.
• What needs to be done for the market to be convinced? In our view, the following events need to happen before the market regains investor confidence on tighter supply in the coming years.
- El Nino – Staying cool before the heat comes. Actual dryness needs to happen to see a rush into the market. Actual dryness is the best evidence as it marks the coming of an El Nino and this is likely to happen only in Sep/Oct 15.
- Biodiesel – Show me the volume! The market is waiting for the execution of biodiesel purchases from Pertamina. With the current policy structure, biodiesel producers are more than happy to supply, but without the purchase from Pertamina nothing will translate into dollars and cents. Malaysia is too small to influence the balance of global supply and demand.
• Crude oil prices. Non-mandated biodiesel demand will return if crude oil prices recover above US$80/bbl. Biodiesel usage is now at about 16% of total palm oil consumption (9.5m tonnes). Out of this, discretionary demand (subject to crude oil price) took up about 3m-4m tonnes.
• Possibility of El Nino. El Nino conditions will lead to severe drought in Southeast Asia. Although the El Nino phenomenon has been confirmed, its severity has yet to be determined. If it is strong, CPO prices could rally above our expectation.
• CPO price assumptions of RM2,200/tonne for 2015 and RM2,300/tonne for 2016.
• Maintain MARKET WEIGHT. CPO prices are likely to stabilise at the current level of RM2,100-2,300/tonne pending the implementation of Indonesia’s new export levy, biodiesel blending and development of El Nino.
• Sector to be re-rated in the event of a strong El Nino. If the El Nino turns out to be strong, the sector will be re-rated to 1SD above valuations. In the event of an El Nino, all plantation stocks will move but the following might see greater returns:
• Pullback of biodiesel policy. A pullback in terms of reduction in biodiesel blending volume will dent CPO prices as the extra supply will need to find new homes within a short period of time and this might not be easy. (Read Report)