What Goes Up Must Come Down
CPO prices have corrected 28% since Indonesia announced the lifting of the export ban.
After this CPO price correction, we are seeing some positives emerge to prevent further
price deterioration: a) it is commercially viable to increase biodiesel mandate or nonmandatory biodiesel blending, and b) demand recovery is in sight in India and China.
But Indonesia’s palm oil industry has clearly not benefitted from the high CPO prices
over the last six months. Maintain MARKET WEIGHT.
WHAT’S NEW
• Sharp CPO price correction came earlier than expected. CPO prices corrected 28%
since Indonesia uplifted the exports ban. CPO 3-month futures hit a low of RM4,493/tonne
yesterday. The sharp correction came earlier than expected. We attribute the sell-down on
CPO to: a) the expectation of more exports from Indonesia (which we are yet to see happen)
to reduce the high stocks doemstically, b) rising recession risk also triggers the fear that
demand may weaken futther, and c) crops production output in Ukraine and Russia are
better than expected. In addition, the sell-down on CPO futures also may be due to the
concern of liquidity withdrawal as the Fed tightened the monetary policy.
• Indonesia’s CPO prices corrected more sharply. Indonesia’s domestic CPO net selling
prices are estimated to have weakened by 35% since the exports ban was lifted on 23 May 22.This correction is slightly sharper than Malaysia’s spot and future prices which declined
by 21% and 28% for the same period of time. We attribute this to the oversupply of palm oil
domestically in Indonesia as the export is not fast enough to ease the high inventory
pressure. Lower ASP and higher taxes have depressed the profit margin for Indonesian-based plantation companies especially the upstream players.
• Wilmar’s food product margins should recover in 2H22 with the correction in
feedstock prices. Wilmar’s weak 1Q22 performance was partly affected by the margins
compression for its food products due to high feedstock prices despite selling price
adjustments. The recent 20-30% agri-commodity price correction should be a big relief to
this division and should show good improvement in 2H22. On top of that, China’s soybean
crushing and soymeal sales have improved in tandem with the recovery in pig farming
margin. The recovery in these two segments will be partly offset by the weaker earnings
contributions from its upstream. Although the upstream earnings may not be as good as
1H22, it is still much better as compared with 2019 and 2020.
ACTION
• Maintain MARKET WEIGHT. CPO prices have weakened as expected and this has a larger
negative impact to Indonesian-based plantation companies due to the significantly higher
taxes imposed vs its Malaysian peers. In addition, the frequent changes in Indonesia’s palm
oil policies have significantly affected sales as well. This may have caused low investor
interest given the uncertainties in the sector as well as companies’ potentially disappointing
earnings.
• Adjusted our valuation. We have rolled over our valuation to 2023 to better reflect the CPO
price downtrend; we expect a lower average CPO price of RM4,000/tonne for 2023 vs
RM5,200/tonne for 2022. With this, we have downgraded Bumitama Agri to HOLD with a
lower target price of S$0.65, while maintaining HOLD for First Resources at a lower target
price at S$1.70. We pegged both of the valuation at -2SD from its five-year mean. For
Wilmar, we maintain BUY with a target price of S$5.50 after rolling over our valuation to
2023 and factoring in a lower PE (from 12x to 10x) for its non-China operation while
maintaining 26x valuation for the China operation.
ESSENTIALS
• Supportive factors are emerging. We reckon the current price range is more reflective of
fundamental factors, which is a reflection of the easing of supply tightness. CPO prices
should be stabilising as current prices induce demand from the biodiesel segment, China
and India.
a) Potentially more demand from biofuel segment. Palm oil-gasoil (POGO) prices spread
is turning negative, which means it is commercially viable to start non-mandated biodiesel
blending. This is also encouraging amid the fuel shortage due to Black Sea Tensions.
Just a week ago, Argentina has raised the biodiesel blending mandate on the backdrop of
supply scarcity together with high diesel prices.
b) Demand recovery is seen in China after the palm olein price premium to soybean oil
narrowed significantly. The price premium has dropped from around Rmb4,000/tonne in
late-April to around Rmb1,900/tonne currently. After the sharp price decline, demand for
palm olein in China has been improving over the past weeks. China’s palm oil inventory is
at its historical low of 203,300 tonnes as at 17 Jun 22 vs the usual level of 400,000-
600,000 tonnes. If the demand recovery sustains, China may need to increase the import
of palm oil to meet the demand.
c) India may increase palm oil imports as margins turn positive. The positive import
margins should encourage higher palm oil imports by India. This price correction comes at
a time when India usually increases import of vegoil to meet the high festive demand.
Similar to the situation in China, palm oil inventory in India was also at a low level of
240,865 as at end-Apr 22 vs its usual 600,000–700,000 tonnes of inventory. Negative
import margin has stopped India from importing palm oil.
ASSUMPTION CHANGES
• CPO ASP assumptions. We maintain our CPO price assumptions at RM5,200/tonne and
RM4,000/tonne for 2022-23 respectively.
SECTOR CATALYSTS
• Higher-than-expected US green diesel demand.
• Stronger-than-expected commodity cycle.