DBS Regional Plantation: Beware of demand weakness

July production volume was slightly below forecast but exports beat expectations, growing 1.8% m-o-m
But demand could worsen on tight discount to soybean oil price ahead of Eid and Deepavali festivities
Top picks remain Sampoerna A., KLK, First R., IndoAgri and Wilmar

Higher volume, but still lower than expected. MPOB's July data pointed to a 7% m-o-m increase in production to 1.519m MT - in line with the seasonal trend. This was slightly below our forecast of 1.573m MT, largely due to what we believe is lingering tree stress due to drought earlier in the year. We expect production to continue its seasonal trend next month with softer growth of 3.8% m-o-m because of the Ramadan fasting month.

Strong export growth in July, but expect decline in August. July exports grew more than expected at +1.8% m-o-m vis-à-vis our expectation of -15.7% m-o-m. This was mainly led by exports to the EU, Pakistan, and India, which grew 22.8%, 21.3%, and 53.2%, respectively. Despite the strong data, we caution against over-optimism. We believe demand could shift to soybean oil, as CPO prices are expected to trade at meager discounts. We forecast August exports will decline by 11% m-o-m to 1.301m MT.

Pressure in 4Q10? We note that landed price of degummed soybean oil and palm olein differed by only Rs500/MT as at 6 Aug 2010, while palm oil refining margins have also lagged significantly behind soybean crushing margins, which indicate preference for soybean crushing. Our previous expectation of flat prices was overshadowed by unfavourable weather in Canada and Russia, which pushed prices of most soft commodities higher.

Nevertheless, at current prices, supply of soybean oil should continue to pick up on stronger margins and large soybean inventories. Soybean prices should ease further due to the still favourable outlook for US harvest this year.

Near term strength We believe palm oil prices will remain strong in the near term, as supply constraint arising from flat production volume over the next two months will persist due to the fasting month of Ramadan and Eid festival. However given the recent run, we believe plantation stock prices could have resistance near our TP's, on supply recovery in 4Q10. We also expect FY11F CPO to average RM2,470 on FFB yield recovery. Our top volume plays remain First Resources, IndoAgri, KL Kepong, Sampoerna Agro and Wilmar.