Market Outlook 2017: Plantations sector

Sizeable output to replenish stockpile

As recent damaging El Niño phenomenon has come to an end, we expect both palm oil production in Indonesia and Malaysia to gradually recover towards the end of this year before entering low-crop season in 1H16. We might see Indonesia’s palm oil output to increase to 33 mn ton next year, modestly higher compared to this year’s expectation of 31 mn ton as crop resumes its yearly growth momentum. With Malaysia’s output is also expected to improve further to well above 20 mn ton vs. 18.5 mn ton of this year’s forecast. Such strong pick up in production will likely to replenish the depleting inventories both in Indonesia and Malaysia; although we do not expect the stockpile to increase significantly, but we believe it will rationalize at its average historical levels.

Furthermore, latest El Niño-Southern Oscillation (ENSO) reading also suggests a neutral outlook on La Nina’s development. Even if La Nina exists, the model suggests that it will be weak and potentially short-lived, thus limiting the chance of output disruptions next year.

Higher acquisition activities as moratorium kicks in

The 5-year moratorium that limits planting permits on new land will urge companies to rejuvenate their existing concessions in order to boost output yield going forward. We believe companies’ growth strategy will shift towards replanting the less productive trees with new high-yielding seeds while at the same time promote higher efficiency in order to maintain margins. The moratorium is also expected to trigger higher acquisition activities during the 5-year period as part of planters’ inorganic growth strategy where big and well-capitalized companies with sizeable refinery capacity can benefit most. In this case, we prefer LSIP as they are sitting on a considerable cash pile which enables them to perform such strategic acquisitions.

India’s edible oil demand remains strong

On the export front, we believe India will continue to be a huge market for edible oil exports as its growing population and increasing income landscape help to drive up domestic consumption. India’s edible oil import is expected to grow by up to 7% YoY next year where palm oil will continue to cover for most of the imports volume. Note that imports from India are very price sensitive hence a relatively narrow gap would switch the country’s palm oil imports into other soft oil such as soybean and sunflower.

Biodiesel outlook looms, higher levy on the table

Given the low crude oil price environment, we suspect that the maximum subsidized biodiesel consumption can only be around 2 KL ton next year, or 20% lower than this year’s 2.5 KL ton target. That translates into 14.65% blending rate assuming gasoline usage of 13.65 mn KL (PSO only). Energy ministry has hinted that they might collect higher levy on exported palm products next year in order to secure higher revenue to subsidize the B-20 mandate. Based on our calculation, we found that for $10 increase in average levy, biodiesel consumption could only increase to 2.6 mn KL, which is still far below the targeted 3.5mn KL. The success of the biodiesel blending would continue to heavily dependent on the price gap between crude oil and palm methyl ester.

Expect price to range between USD 650 – 700/ton

We are not by any chance to forecast a bull market at this moment simply because output yield has started to improve while oil price remains low. However, the good news is that we believe the crude oil price has bottomed out and stockpiles still seen at its historic low levels which provides a good downside support for the overall edible oils market in the short run, including CPO. We expect CPO to trade slightly higher at USD700/ton in the 1H17 as we are entering low crop season and will start to rationalize to USD650/ton towards the year end next year.

Our top picks

We prefer companies with established refinery capabilities as they tend to outperform their peers given the likelihood of levy hike next year which could hamper the domestic raw CPO prices and squeeze the upstream industry players. Our top pick is TBLA as the company has tapped into numerous downstream products such as biodiesel and olein; let alone its high-margin sugar plantation and milling business. AALI is our second pick with 900,000 MT of refinery capacity, which roughly equals to 50% of its annual CPO production. Having the largest market cap and strong correlation with CPO price also provide an advantage to AALI.