Firm CPO price likely to be sustained into next year
The recent upsurge in the CPO price validates our previous argument made in the early part of the year. This is that CPO production has only been marginally higher due to the impact from bad weather and partly due to poor yields amid unexpected production declines from substitutes. This weaker supply growth - and stronger global demand - has resulted in higher CPO prices. While CPO production may improve in 2H on seasonality, the severity of heavy rainfall will cap production at 46.9mn tons this year – a mere 1.6mn tons increase, or lower than 2009’s 2.0mn tons increase. For now, we maintain our benchmark CPO price estimates at US$850-860/mt CIF for FY10-11E respectively. Our production estimates for Indonesian plantations, however, are cut by 24-16%, as poor yields prevail, slashing the FY10-11E EPS by 39-28% respectively. At the same time, we cut our recommendation on AALI to HOLD, while keeping the rest intact. Our top pick remains on BWPT, mainly due to its robust production and profitability. We also initiate coverage on LSIP with a BUY and a TP of Rp11,250.
Demand supply imbalances to persist
Consumption of global vegetable oil is likely to increase by 3.9% over the course of one year, a touch below its production growth of 4.0%. The risk shall still be on the supply side, we believe. Heat and dryness in West Europe, Russia, Kazakhstan and some parts of South America have affected the grain and oilseed crops. Canada and Eastern Europe, on the other hand, have been too wet. As a consequence, over 3mn tons of rapeseed is expected to be lost over the next season, capping global vegetable oil supply growth. Note that oil yields on rapeseed have been around 39-43%, and therefore making a significant contribution to vegetable oil supply. Soybean, however, may see higher production in the US on larger than expected plantings, albeit much of them shall likely be offset by a sharp decline in South America’s production, largely due to a shift in plantings towards wheat and sunflower seed aside from smaller average yields. On a net basis, soybean production is likely to drop by as much as 3.4mn tons next season. Soybean-crushing activities, however, may have picked up, but much of the resulting soya oil will be absorbed for bio-fuel purposes, hence the sustained robust demand for palm oil and positive price outlook.
Strained by bio-fuel consumption
As much as we hate to admit it, the rising consumption of vegetable oil for bio-fuel purposes is likely to result in food and energy tussles. Almost half of the increase in global vegetable oil consumption is used for bio-fuel feedstock. The EU, which uses 60% of rapeseed oil consumption in the EU for bio-fuel purposes, may see a shortage of feedstock supply over the next season, pushing the price above US$465/ton, as alternatives are limited due to technical requirements. Even if there is stock availability, it will have to compete with China’s requirement for food purposes. The significant price premium of rapeseed, however, will lead to greater demand for cheaper alternatives such as palm oil. Meanwhile, the largest exporters of soya oil, Brazil and Argentina, will see their exports dwindle next year. Indeed, soya oil is the major feedstock for Argentina’s (90%) and Brazil’s (83%) bio-diesel production. Argentina’s government has raised the mandatory admixture of bio-diesel to 7% starting next month from currently 5% and will raise it further to 10% starting next year. As for Brazil, the government has kept its 5% mandatory admixture of bio-diesel.
Short term CPO production setback
While we expect CPO yields to improve over the course of one year, the short-term (about 6 months) production increase will still be marginal. Heavy rainfall has limited pollination from taking place and led to slower production growth. The next 18 months will be crucial for palm oil production, we believe, as the effects from heavy rainfall will lead to smaller bunches being produced, aside from lower quality and a lower OER. At least for Indonesian plantations, production is expected to grow by about 1.2mn tons this year, or lower than 2009’s increase of 1.9mn tons. Some 5.7mn ha are expected to be mature this year, just an additional 380,000ha from 2009’s 5.4mn ha. By next year, the production increase will basically emerge from newly mature areas from plantings done in 2006-2007, some additional 400,000ha. And as for Malaysia’s plantations, maturing areas will stay the same. Over the longer term, production may also be hampered by a lack of new plantings as erratic rainfall continues. This is aside from the government’s role of limiting new land bank issued to planters.
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