CPO prices have soared more than 130% to the historic level of RM4,700/mt after hitting the low of RM2,022/mt a year ago. The unexpected strong rally was contributed by i) soybean oil price rally, ii) tighter CPO supplies in the market, iii) low carry-over and iv) the impact of quantitative easing measures. Despite the sharp rally in the CPO prices, there was little share price reaction for most plantation counters as we attribute this to poor liquidity and increasing concerns over ESG practices. In view of the better-than-expected CPO prices in 1H21, we revise up our 2021 CPO price forecast from RM2,500/mt to RM3,200/mt, raising our EPS forecast by 22%-63% across plantation companies under our coverage. We also reduce our PE multiple for Sime Darby Plantation and FGV Holdings by 2x (34x and 20x, respectively) to reflect their weaker ESG practices. Our top picks are Sarawak Plantation, Ta Ann and TSH given their more attractive valuations and stronger-than-average FFB production growth. Maintain Neutral on the sector as we think current CPO prices are toppish and we see downside risk in 2H 21.

• Not all players will fully benefit from the CPO price gains. Despite stronger CPO prices, not all players will enjoy the full benefit of CPO price rally as upstream plantation players in Indonesia are subject to hefty CPO export duty (USD144/mt) and CPO excise levy (USD255/mt), there would be huge income losses for them as they are only able to recognize a net CPO price of RM3,000/mt based on the current spot level of RM4,700/mt). This is significantly lower compared to Malaysia’s RM4,324/mt (after netting of 8% CPO export tax). Only players with refinery plants would be able to capture the full market price of CPO given the hedging nature. Some players, namely, Sime Darby Plantation, IOI Corp and TSH (refer to Figure 13) have locked in a big chunk of forward CPO sales earlier at lower selling prices.

• An unexpected bull-run. After hitting a low of RM2,033/mt a year ago, CPO spot prices made a strong comeback, soaring more than 134% to the historic level RM4,767/mt. The long rally has caught most industry players by surprise as current palm oil fundamentals could not warrant such price level. Despite the current bullish CPO price momentum, we think it is not sustainable and price correction would be inevitable once the inventory level sees a strong pick-up. We think CPO price could potentially drop below RM3,500/mt level after Sept when the ample supplies kick in.

• Rising ESG concerns put pressure on valuations. The increasing concerns over the environmental, social and governance (ESG) has put the plantation players in the spotlight due to the numerous pressure from the non governmental organizations. This can be seen when FGV and Sime Darby Plantations CPO exports were banned in the US recently. As of results, we reduce our PE valuations for both companies. Since end-2019, almost all plantation companies under our coverage have seen a decline in foreign shareholding, indicating that the foreign funds are gradually shifting away from the plantation sector that has weaker ESG practices. This also explains why there is little cheer for the plantation counters despite the record CPO prices as the poor ESG benchmark has put off investor interests in the sector.

• Feeling the pinch from labour shortage. Due to the Covid-19 government imposed border closures, the labor-intensive industry has suffered from acute shortage of manual labour especially during the peak production season. We gather that the Sarawak-based plantation players were hit the hardest as they were short of as much as 30% of harvesters. The main reasons are that most of their plantations are in the state and the close proximity to the border has made the various accessibilities for the foreign workers to return home. The severe labour shortage issue has resulted in significant loss of income for the plantation players amid the strong CPO prices. On the positive side, Sime Darby Plantation has recently started a pilot scheme by bringing back over 100 migrant workers from Bangladesh to overcome Covid-19 labour shortages. Some of the plantations have also engaged the contractors for more contract workers while some have trained up the local workers to be harvesters.

• Production seen picking up. Although CPO production in Malaysia has fallen 6% YoY to 5.1m mt for the first 4 months, the production has grown for two straight months and is expected to see sharper increase from June onwards when oil palm trees enter high production cycle. Meanwhile, Indonesia’s CPO production saw a slight increase of 1.4% to 11.1m mt for Jan-March. The Indonesian Palm Oil Association predicted that the production in Indonesia will reach 49m mt for 2021, an increase of 3.5% YoY. Malaysia’s commodities ministry forecast CPO at 19.7m mt, rising from 19.1m mt last year. The US Department of Agriculture expects Malaysia CPO production to rise 245k mt YoY to 19.5 mt in 2020/21.

• Stronger production seen in 1Q21. Almost all plantation companies (refer to Figure 10) except Genting Plantations, IOI Corp and Ta Ann registered stronger FFB production in 1Q21. A couple of factors contributed to the stronger production, i) moderate rainfall level, ii) no operation disruption during the movement control order 2.0 period and iii) labour issue was manageable during low crop season.

• Lacklustre palm oil demand. Malaysia’s palm oil exports fell 7.4% to 4.3m mt for the first 4 months, dragged by weaker demand by most consuming countries. India is the only key buyer that supports the demand this year mainly due to the steep discount of palm oil prices compared to other vegetable oils. Meanwhile, EU has reduced its palm oil imports since the EU Parliament and national governments passed the law in 2018 to cap the use of palm oil as biofuel at 2019 levels (50% of the palm oil imports are used for transportation) until 2023 and progressively reduced to zero by 2030. Lastly, the recovery of the China’s hog industry to 80% of the pre-African Swine Flu level has threatened China’s purchases of palm oil as its demand for soymeal increases. The China National Grain and Oils Information Centre forecasted the palm oil demand may drop 8.8% to 6.2m this year.

• Disparity between the CPO movement and plantation counters. Despite the rally in CPO prices, most plantation stock prices remain muted and we attribute this to market’s anticipation that the current high CPO prices are not sustainable and could weaken in the near-term. We also think environmental, social and government concern plays a role, resulting in lower interest and valuation for the plantation sector. Sarawak Plantation (TP: RM3.58, Outperform) is our best performer (rising more than 15% YTD) while Genting Plantations (TP: RM10.94, Neutral) was the biggest loser (down 13% YTD)

• What are the key drivers for CPO price rally? We attribute few key factors that drive the CPO price rally:-

i) Soybean oil price rally. Soybean oil, which is the closest substitute of CPO, has surged more than 130% to USD1,397/mt over the past one year. The steep gain also pushed the CPO price higher as wider premium also makes CPO demand more appealing.

ii) Tighter CPO supplies in the market. Following the drastic hike in export levy and export duty in Dec, there was a significant drop in CPO supplies from Indonesia as the high taxes imposed by the government has discouraged the Indonesian CPO producers from exporting directly, in its attempt to support the downstream products especially biodiesel. This makes Malaysian CPO an attractive choice for India, which prefers to import CPO instead of refined CPO given the presence of sizeable refining capacity in the country.

iii) Started on a low carry-over. Malaysian palm oil industry started the year of 2021 with a 23-year low inventory level of 1.26m mt. Although production has outpaced export growth in some months, inventory level only delivering small progress every month with an average growth of 5% to the current level of 1.54m mt.

iv) The impact of quantitative easing measures. In response to the covid-19 crisis that triggered a deep economic downturn of uncertain duration, majority of the countries rolled out quantitative easing programme or stimulus measures amid the low interest rate environment, boosting the money supply into various global investment products from cryptocurrency, commodity to stock markets. Institutional Investors especially the commodity traders and hedge funds used the cheap money to inflate most investment products from bitcoin (+403%), crude oil (+104%), soybean oil (+130%), copper (+90%), lithium (+270%), nickel (+44%), steel rebar (+92%) to technology stocks. CPO futures were not spared as well as it has soared more than 100% YoY.

• High prices will attract more new plantings. Compared to oil palm, which takes up to 3 years to mature, oil seeds such as soybean, rapeseed and sunflower requires much shorter duration for maturity. From seedlings to harvesting, it takes only three months or 110 days. Given the current attractive vegetable oil prices, we believe new planting would increase for the coming planting season. The influx of vegetable oil supplies should see apparent in 2H21, under a favourable weather condition.

• Raising CPO price forecast to RM3,200/mt for 2021. In view of the strong CPO price momentum in the 1H of 21, we revise up our 2021 CPO price forecast from RM2,500/mt to RM3,200/mt. For 2022, we raise our CPO price forecast from RM2,500/mt to RM2,700/mt as we think current CPO price is toppish and poised for correction in 2H21.

• Prefer small-cap plantation companies. Following our upward revision in our 2021 CPO price forecast from RM2,500/mt to RM3,200/mt, we raise our FY21 EPS forecast by 22%-63% for the respective plantation companies under our coverage except for FGV Holdings, which will see exceptionally stronger earnings growth of more than 100% after we resume the coverage. On the other hand, we have lowered our PE valuations attached for both FGV Holdings and Sime Darby Plantation (down by 2x) due to weaker ESG benchmark. The Outperform calls include Sarawak Plantation (TP: RM3.58), Ta Ann (TP: RM3.83) and TSH (TP: RM1.46). However, our Neutral call on the sector outlook remains. We suggest investors to look into small-mid cap plantation companies, which give more attractive upside compared to the big cap. We also introduce our new TP for FGV Holdings (TP: RM1.56, Neutral).

USDA expects global vegetable oils to grow by 4% in 2021/22, with gains for all nine major vegetable oils. The gains are primarily driven by palm, sunflowerseed and soybean oils. Global food consumption is forecast to expand by more than 3% or 4m mt while global industrial consumption is forecast to grow by over 2m mt or 4%, driven by expanding US biodiesel production. Continued strong demand for vegetable oil pressures global vegetable oil ending stocks to their lowest level since 2010/11.

Palm oil remains the largest vegetable oil consumed globally for food and industrial use. Meanwhile, global palm oil production in 2021/22 is forecast to rise with a strengthened pace compared to the prior year. Indonesia accounts for much of the production growth. Despite global production outpacing consumption, ending stocks continue to fall as stock levels recover from 2020/21 consumption exceeding production levels. The relentless rally in the soybean oil is increasing palm oil’s appeal as the cheapest edible oil as the palm oil-soybean oil spread has expanded to USD429/mt, the widest level in 12 years.

Palm oil’s closest substitute, soybean, is expected to see its production to reach 386m mt, up 6% from 2020/21. While it remains below this year, it is still above the long-term average for annual production growth. Nearly all production growth is limited to the US and Brazil, which account for roughly two-thirds of global production with similar expansion expected in area planted. Production increases are primarily a result of larger planted area, spurred by the highest prices since 2014. New plantings in Brazil are expected to be record high for the second year in a row as a FX rate enhances producer returns. Plantings in the US are currently forecast to be the largest since 2018 but face stronger price competition with corn as farmers allocate huge acreage for soybean plantings this spring.

With expanding production, global soybean supplies will reach record levels. Exports will continue to be driven by China demand, which is projected to account for 60% of global consumption.

India’s vegetable oil level currently stands at 1.6m mt level, which is relatively low compared to the 10-year average of 1.8m mt. India is also Malaysia’s largest palm oil importer, making up 20%.

Source: PublicInvest Research - 19 May 2021