DBS Plantation

Plantation Counting the cost of drought

We upgrade our sector call to Neutral and raised our 09F, 10F, and 11F CPO prices by 25%, 17% and 12% to RM1,900, RM2,000, and RM2,200, respectively, as La Nina’s effects in South America have offset a good part of the anticipated jump in US soybean output this year. At current prices, most stocks have more than priced this in and we see downside potential in the near term. When that happens, we recommend investors to pick up on dips. Others have already shown real bargains. We upgraded Wilmar to Hold but recommend waiting for more attractive levels. Our top buys are First Resources and Indofood Agri (please see our initiation report issued separately). Our top Sell/Fully Valued calls are Sime Darby and IOI Corporation on valuation concerns.

Moving into supply deficit this year. The phenomenal 4.3m MT jump in palm oil consumption last year ended up substituting the drop in soybean output and meeting biofuel demand. With drought this year, implied soybean oil supply should rise by 0.3m MT, while palm oil is to add 2.1m MT – against combined demand growth of 2.8m MT (a drop from 5.3m MT last year). Given the slower increase in palm oil supply this year, there should not be much leeway for prices to drop to November low, in our view.

Inelastic demand. There has been a significant reduction in global trade this year, hit by demand drop in manufactured goods and trade finance issues. Despite this, palm oil restocking in major consuming countries since end December proves that demand from the food sector remains largely inelastic. The sector is one of few steady USD earners, amidst the anticipated prolonged weakness in MYR, IDR and SGD.

Take advantage on near term weakness. Having jumped by 20% since end of last year, palm oil prices should pullback over near term recovery in production, while restocking subsides. We expect prices to gradually rebound thereafter with a test case during peak harvest season (September – November), which may yet run the risk of slower than expected production.