Bryan Wu Thu, Jul 07, 2022
RHB Group Research is maintaining its “neutral” position on agriculture plantations as it waits for the dust around geopolitical tensions to settle.
Analyst Hoe Lee Leng writes that as fundamentals begin to improve, crude palm oil (CPO) prices have fallen with a “vengeance”, adding that while valuations are starting to look attractive, 2H2022 could see CPO prices moderate further, making trading strategy suitable in this environment.
Hoe’s top picks within the sector include more integrated players like Kuala Lumpur Kepong (KLK) and Wilmar International which are able to withstand the current price pressures better.
RHB is beginning to see “a light at the end of the tunnel” with regards to supply of vegetable oils, noting that although the Russia-Ukraine war is still ongoing, there has been some progress with regards to food exports as Russia and Turkey have agreed to pursue talks on a potential safe sea corridor in the Black Sea to export seeds and grain from Ukraine.
In Malaysia, labour shortage remains critical due to the recurring delays on the timing of foreign workers entering the country. But Hoe notes that the first batch of Indonesian workers arrived on June 22 and another batch on June 24. The Malaysian government has also approved for more workers to come to work in plantations.
In Indonesia, since the lifting of the export ban and availability of the “flush out” export permits, the government has issued permits to export 2.4 million tonnes of palm oil products. But Hoe notes that this is still not enough to normalise the stock levels in Indonesia. In addition, despite the issuance of permits, shipments have not picked up as expected, given the current logistics backlog in the country. Domestic CPO prices in Indonesia have also remained weak, despite the lifting of the ban, due to the stock surplus in the country.
Hence, the analyst only expects a more normalised export volume and possibly domestic prices for Indonesia from July or August onwards, once the logistics backlog clears.
“CPO prices have fallen by more than 30% in the last three weeks — to current levels of RM4,000 ($1,268.88) per tonne — on the back of the lifting of the export ban as well as the issuance of the “flush out” export permits in Indonesia for those seeking an exemption from the Domestic Market Obligation (DMO) requirements,” says the analyst.
“Although we anticipated for prices to fall as quickly as they rose on the back of the lifting of the export ban, the quantum of decline was larger than expected, leading us to believe that speculative activities are also at play,” she adds.
RHB note that while other commodities have also fallen in the last few weeks, such as soybean prices falling by 10%, wheat prices decreasing by 14% and crude oil prices retreating 15%. CPO now trades at a significant discount to soybean oil (SBO) at US$419 ($588.46) per tonne and at discount to gas oil.
“With this, we should see demand coming back from consuming countries in the short term, particularly from price-sensitive countries like China, India, Pakistan and Bangladesh, given the extremely low stock levels currently,” Hoe writes.
Additionally, the palm oil-gasoil (POGO) spread has now turned positive — with gasoil now at US$5.30 per barrel (US$39 per tonne), more expensive than CPO (from -US$36 per barrel last month) — making it now financially feasible to produce biodiesel without subsidies, she adds.
“As such, stock levels should remain tight for the next two to three months, possibly until end-3Q, thus supporting CPO prices at current levels,” says the analyst. “However, as fundamentals improve thereafter — on the assumption that labour shortages are somewhat resolved and the Ukrainian oilseed output is able to be exported — CPO prices could fall to lower levels of RM4,000 to 4,500 per tonne for the rest of the year.”
RHB’s price assumptions of RM5,300 assume a price overage of RM4,300 for 2H2022 which could be surpassed on the downside based on current trajectory.
While regional planters’ P/E valuation has shrunk to an average 8x 2023F, with the big caps trading in the range of 11 to 14x, and the regional and mid-caps in the 4 to 6x range, RHB believes there could be more downside in 2H2022 as CPO prices moderate further.