Driven by tight palm oil supplies and slow production growth in both the top two producing countries, CPO prices unexpectedly surpassed RM5,000/mt, the highest level since June 2022. The sector's supply woes have been exacerbated by slow replanting progress with additional demand from Indonesia's expanded biodiesel mandate. Nevertheless, we think the current CPO price is toppish and is expected to retrace in the next couple of months. In view of the stronger-than-expected CPO price movement, we raise our CPO price forecast from RM3,800/mt to RM4,100-RM4,200/mt for 2024 and 2025, respectively. However, our Neutral call on the sector outlook remains. Top picks are Sarawak Plantation and Ta Ann.

• Higher biodiesel mandate in Indonesia. The Indonesian government plans to increase the current mandatory 35% blend of palm oil in biodiesel to 40% in early 2025 in a bid to reduce its energy imports. If implemented, the move could lead to an increase in biodiesel consumption to 16m kilolitres next year, creating an additional demand of 1.5m-1.7m mt and hence, reducing global export of palm oil. According to estimates by Indonesia's biofuel producers' association, APROBI, the revised B40 mandate will boost the country's CPO use for biodiesel to 14m mt from the estimated 11.6m mt needed this year for the B35 blend. However, to increase biodiesel blending, the country would need to increase the production capacity of its biodiesel industry and ensure availability of biodiesel incentives and improve the distribution infrastructure. The export levy collection, which is mainly used to provide biodiesel subsidy and replanting aid, is estimated to total 32 tln rupiah by the end of this year, and it may need 47 tln rupiah in the fund to run the B40 next year.
• EU considers delaying deforestation-free imports regulation. The EU may delay the enforcement of its Deforestation-Free Product Regulation by 12 months, providing additional time to address environmental concerns related to commodities. Initially set for 30th Dec 2024, the regulation's implementation could now be pushed to Dec 2025 for large companies and Dec 2026 for small and medium-sized enterprises. The proposal, which has been approved by the European Council, awaits a final decision from the European Parliament.
• Short-term joy for planters. CPO prices normally trade lower in the second half due to the upward pressure on palm oil inventory as production is seasonally higher towards the year-end. However, it is exceptional for this year, as production reached its peak earlier while exports have been doing well for the last 7 months, with YTD registering 13% growth. The decline in YoY palm oil inventories from Malaysia coupled with strong export performance have pushed the CPO prices to above RM5,000/mt. Other key factors include India's low palm oil inventory levels, Indonesia's shift of biodiesel mandate from B35 to B40 in 2025 and the global palm oil deficit outlook given by USDA forecast. Nevertheless, we believe the current strong CPO price momentum may not be sustainable, as the current steep premium over the soybean oil price could discourage buyers from taking palm oil amid the upcoming winter period. It is also worth noting that palm oil will solidify/freeze during winter, making it a less attractive option for consumption. In our view, the frenzy run-up in CPO prices could taper off. We believe plantation companies would lock in the high prices by selling forward, though demand could be limited at the prevailing prices.
• Global demand and supply of vegetable oils. Industry expert Dorab Mistry estimated that demand growth could outpace supply growth in 2024-2025 with an increase of 6.5m mt and 3m mt, respectively. For palm oil production, he expects production to grow by 2.5m mt, led by improved production in Malaysia despite flattish growth in Indonesia. Meanwhile, the Malaysian Palm Oil Board forecasted that palm oil production is on track to exceed 19m mt in 2024 and is likely to remain around 19m mt in 2025 as there are no new plantations while replanting progress has been slow. It also further guided that it may need a few years before it can reach 20m mt level. Meanwhile, the Indonesian Palm Oil Association, GAPKI, sees production of 54.5m mt next year, up from an estimated production of 52.5m mt this year. Global vegetable oils are forecasted to rise from 222.4m mt to 227.12m mt in 2024/2025, led by an increase in soybean oil and palm oil production. Inventory is expected to ease from 30.2m mt to 28.8m due to lower palm oil inventory as Indonesia plans to divert more supply to biofuel, which is set to further tighten the market. Despite the tight palm oil supply condition, we expect to see a more rebalanced demand and supply as current high CPO prices may divert demand from price-sensitive countries like China, India, and Pakistan. The current high vegetable oil prices may not bode well for biofuel as it is relatively cheap to consume diesel. In addition, current high prices will attract more new plantings from soybean farmers in Argentina, Brazil, and the US. A ceasefire in the Russia-Ukraine war might also spark a resurgence of sunflower seed supply and soybean production.
• POGO spread at the widest level in 29 months. The current price of palm-based biodiesel is significantly higher than gasoil, making it non-commercially viable for the biodiesel consumption. Palm oil-gasoil spread has expanded to USD423/mt, the widest spread since June 2022. At current wide spread, we believe it will negatively affect European palm oil demand as more than 50% of its palm oil imports are meant for biofuel consumption. (Refer to Figure 9)
• Slow replanting progress in Indonesia and Malaysia. The ageing palm oil trees are the key factor in declining production growth in the world's top two producing countries, as the replanting programme have fallen behind schedule. In Indonesia, the replanting target was 180,000 ha each year. However, since 2017, Indonesia has only allocated funds to replant 360,000ha, according to Indonesia's economic affairs minister. Meanwhile, Malaysia's Palm Oil Association estimated that 664,000ha or approximately 12% of the nation's planted area, falls within the age group of 25 years and older and they are subject to replanting. It is projected that over a third of the planted area could be classified as old by 2027 and may not reach the national long-term average FFB yield of 18m mt if prompt action is not taken in the near-term. Currently, about 1.5m ha of oil palm plantations are managed by smallholders, making up 26.4% of Malaysia's total planted area. Based on the estimated replanting cost of RM20,000 per ha, the total cost for replanting the entire ageing oil palm area is projected to be around RM13bn. Assuming 175,296ha (26.4% of 664,000ha) of the nation's ageing oil palm area belongs to the smallholders, at least RM3.5bn would be needed for full replanting.
• Production cost likely to remain elevated. Despite a significant reduction in fertilizer costs, down 21% YoY, and a decline in borrowing costs, we expect production costs to remain elevated in 2025 due to increased minimum wage rate and the introduction of the Employee Pension Fund for foreign workers in Malaysia. Additionally, planters must contend with higher export taxes following the revisions in the recent Budget 2025. In Indonesia, there is pressure on the government to increase the provincial minimum wage by 10% in 2025, and a plan is underway to standardise wage hikes across regions.
• More capex spending needed on mechanisation. To address the labour shortages and rising labour costs in the long-term, planters may need to increase digitalisation and mechanisation efforts to optimise the workforce and improve operational efficiency. This shift could reduce high dependency on manual labour by increasing the land-to-worker ratio. With automation, the land-to-worker ratio could increase from 8-10ha to 17ha per worker. Mechanised tools and equipment could be deployed for non-harvesting tasks such as infield FFB collection, and field maintenance, including spraying pesticides and monitoring fruits and yields.
• Production likely to start pick up earlier in 2025. According to the Malaysia Palm Oil Council, Malaysia's palm oil production peaked in Aug, two months earlier than usual, with production typically peaking in Oct or Nov. We believe the lagged effects of El Nino have contributed to biological stress on oil palm trees. Nevertheless, we foresee FFB production starting to increase earlier next year, following this year's earlier-than-expected production pause. Given favourable weather conditions this year, FFB production in 2025 is likely to show improved performance.
• Soybean may become a bargaining tool under the new US President. To reduce the US-China trade deficit, we anticipate that the new US President, Donald Trump could pressure China to increase its soybean purchases from the US. As of 31st Oct, China accounted for only 44% of total US soybean sales, the lowest level in 18 years. We believe China will be compelled to respond to these pressures to mitigate the impact of rising trade sanctions. This potential shift in demand from palm oil to soybean oil may lead to weaker palm oil imports from China in 2025.
• Shift in India's palm oil demand. India, the world's largest vegetable oil importer, is expected to see lower vegetable oil imports in the 2024-2025 season as favourable weather boosts domestic crop production. The country is estimated to import 15 m mt compared to 16m mt in the 2023-2024 season. Weather has been favourable for India this year, resulting in higher production of soybean, ground nuts, and rapeseed. India's palm oil imports, which accounted for 60% of India's vegetable oil imports, saw a decline from 9.8m mt in the previous year to 9.2 m mt in the 2023-2024 period. Palm oil is expected to lose 2-3% market share while soft oils will gain as high palm oil prices this year have made buyers shift to sunflower oil.
• Eyeing a beautiful report card in 2H. In light of stronger CPO prices during the high production season, we expect most plantation companies under our coverage to report better results in the remaining quarters. Amongst six plantation companies we cover, we believe Sarawak Plantation and Ta Ann will outperform their peers with only IOI Corp, Sarawak Plantation and Ta Ann achieving higher production growth. However, IOI Corp's downstream could remain in the doldrums due to stiff competition in refining and weak demand for oleochemical in China.
• Raising CPO price forecasts. Given stronger-than-expected CPO prices in the first ten months this year, we raise our CPO price forecasts from RM3,800/mt to RM4,100/mt for 2024 and RM4,200/mt for 2025, respectively. YTD, the average stands at RM4,090/mt, which is 6% higher compared to 2023's RM3,852/mt.
• Prefer small-cap pure upstream plantation players. With our upward revision of the 2024-2025 CPO price forecast from RM3,800 to RM4,100/mt-RM4,200/mt, we raise our FY24-26F EPS by 10%-20% for the plantation companies under our coverage. Also, we upgrade Genting Plantations to Outperform due to its attractive valuations. Additionally, we also introduce a new TP for IOI Corp after rolling over our valuations to FY26. However, our Neutral call on the sector outlook remains as we expect a sharp pull back in CPO prices. We suggest that investors consider small-mid cap plantation companies, which offers more attractive upside compared to the big-cap. We favour Sarawak Plantation and Ta Ann given their i) attractive valuations, ii) pure upstream focus, iii) young age profile, and iv) lack of hedging policy, allowing them to fully benefit from the current CPO price upcycle.

Source: PublicInvest Research - 15 Nov 2024