The Star Online (06/01/2019) - PETALING JAYA: The plantation sector is off to a good start in 2020 as crude palm oil (CPO) continues to extend its rally from 2019 to trade above RM3,100 per tonne on strong fundamentals.

According to analysts, the bullish sentiment is expected to last till the second quarter of 2020, buoyed by supply tightness and declining stocks amidst the biodiesel mandates in Indonesia and Malaysia.

Last Friday, the third-month benchmark CPO futures for March delivery closed firm at RM3,116 per tonne while the CPO spot price for January South ended strong at RM3,120 per tonne.

This is a sharp turnaround for the sector, which suffered from an oversupply situation, record stockpile at 3.34 million tonnes and a dismal CPO price at the start of 2019.

Many plantation analysts were also seen revising upward their CPO average price forecasts between RM2,300 and RM2,700 per tonne for 2020.

More significantly, local plantation companies are also expected to post steep earnings recovery in 2020.

This is in contrast with the profitability of the sector, which has eroded to the lowest in 18 years at the start of 2019.

Kenanga Research said: “After a weak fourth quarter 2019, planters are expected to register significant earnings improvement in the first quarter of 2020, on the back of higher CPO prices.

“We think that most planters deserve to trade at similar valuations when CPO prices were traded at RM2,700-RM2,900 per tonne in 2017 given that CPO is currently trading an average of RM2,900 per tonne.

“Additionally, we expect improvement on planters’ return on equity (ROE), which justifies the higher valuations, ” said the research unit in its latest first quarter (1Q) 2020 investment strategy report.

Year-to-date, CPO prices have increased by over 50%, while the KL Plantation Index on Bursa Malaysia chalked up a mere 10%, which suggest that planters are likely to play catch-up to the CPO prices, added the research unit.

Should the CPO average price fell below RM2,700 per tonne, it noted that “Our earnings forecast assumes that CPO prices to average RM2,700 per tonne in 2020.

“We think that we have provided sufficient downside buffer given that it is currently trading at about RM3,000 per tonne.

The first half (year) prices are seasonally stronger compared with the second half (year) mainly on higher supply coming in the later part of the year.

“Hence, we forecast first half price to average at RM2,900 and second half at RM2,500 per tonne.

“Our sensitivity analysis shows that a RM100 CPO price difference would impact the FBM KLCI 2020 growth by around 0.4%, ” explained Kenanga Research.

MIDF Research meanwhile pointed out that the sudden spike in CPO prices could serve as “a double-edged sword” for the plantation sector.

“While the current elevated CPO prices will provide a breather and helps to possibly uplift the plantation companies earnings, but the impressive surge might also dampen demand.

“This is predicted on the diminishing pricing advantage of CPO to the soybean oil and the brent crude oil, ” it pointed out.

MIDF Research said the price spread between palm oil and soybean oil has narrowed significantly to a new high in two years.

Furthermore, the premium of palm oil over gas oil currently stands at US$84 per tonne compared with the average discount of US$61 per tonne in the past year.

Moving into 2020, the research unit expects the outlook for the plantation sector to improve considerably supported by CPO price will remain elevated.

“We are upgrading the sector to Neutral from Negative previously with a CPO price target of RM2,400 per tonne in 2020 and RM2,600 per tonne in 2021 respectively, ” it noted.

CGS-CIMB Securities in its latest strategy report expect oil palm planters to report significantly better earnings in 2020 with their quarterly earnings may have bottomed in the second quarter of 2019.

It noted that “The upstream planters should report better earnings, driven by higher output (from improvement in yields from younger estates) and CPO prices.

“However, this could be partially offset by higher fertiliser costs, higher CPO export tax, as well as the return of windfall tax at the current CPO price of RM2,797 per tonne.

“We expect CPO prices in Malaysia to average RM2,300 per tonne in 2020, which is higher than RM2,041 per tonne in the first 11 months of 2019, ” it added.

On the other hand, the research unit has raised its concerns over CPO supply shortfall that will outweigh demand risks.

CGS-CIMB Securities pointed out that demand for palm oil will be driven mainly by the mandated biodiesel programmes in Indonesia and Malaysia.

These programmes are estimated to raise palm oil demand by 2.5 million tonnes in 2020.

“However, this could be partially offset by weaker discretionary biodiesel demand as palm oil is currently not competitive relative to gasoil.

“On top of this, food demand from price-sensitive countries such as India may be negatively impacted by the higher CPO price.”

The research unit, which has a neutral rating on the sector feels that “ The robust earnings outlook for 2020 has been priced in. Furthermore, the share prices of some of the large cap planters did not correct during the period of low CPO prices.

“We prefer companies with younger estates profiles, lower CPO costs of production relative to the industry, good earnings leverage and attractive valuations.”

Maybank IB Research in its 2020 Outlook and Lookouts Report expects that CPO price will continue to stay strong going into the first quarter of this year.

This will help to ration the demand amid low brought forward stockpile and low production expectation.

However, the high CPO prices may not be sustainable when the output recovers from the second quarter of 2020 as CPO price at current levels has lost its price competitiveness vis-a-vis other edible substitutes.

The recent CPO rally has narrowed its price discount to the US soy oil to just US$7 per tonne (Dec 10,2019) compared with the historical average discount of US$150 per tonne, it pointed out.

“Even the discretionary demand for palm biodiesel has likely disappeared as palm oil now trades at US$167 per tonne premium to diesel (versus US$50 per tonne discount for the first 11 months of 2019.

“This will likely to cap further upside to CPO price, ” said the research unit.

It is also neutral on the sector as the valuation of large caps have reflected CPO average selling price of RM2,300 per tonne, which is its estimate for this year.

It also prefer small and medium-sized caps during the current up-cycle as “their earnings are more leveraged to CPO price recovery.”

However, it warned investors to consider selectively taking some profits if the CPO prices breaches above RM3,000 per tonne.

Read more at https://www.thestar.com.my/business/business-news/2020/01/06/good-start-for-malaysian-plantation-sector