SINGAPORE (Dec 20): The palm oil industry this past year endured its fair share of turbulent times on the back of weak commodity prices, bad weather and dry spells in key markets such as Indonesia. The industry also faced headwinds from unfavourable new regulations such as the European Union’s biodiesel levies on Indonesia’s produce.
Naturally, plantation stocks did not do well. In June, analysts noted that the counters had corrected on the back of escalating US-China trade tensions that had dampened soybean prices and diminished prospects of a crude palm oil (CPO) price recovery.
As the year draws to a close, however, plantation stocks seem to have been lifted out of the doldrums, as they appear to be staging a comeback. In particular, Singapore-listed ones are poised to thrive on higher CPO prices, which has resulted in renewed investor interest in the local plantation counters.
Analysts at DBS Group Research expect average CPO prices to rebound 19% to US$596 a tonne in 2020, in tandem with a plateauing global palm oil supply. Analysts also anticipate that demand will remain steady in the upcoming year.
“The market typically requires six months to correct the supply-demand imbalance and this suggests prices are expected to remain elevated through 1QFY2020, before correcting from 2QFY2020,” says OCBC economist Howie Lee.
“The correction might prove especially deep if China agrees to substantially increase its purchases of US soybeans, which may initially lift palm oil prices but then ultimately deflate when soy oil returns to normal levels in Chinese inventories.”
Indonesia a key determinant
DBS analyst Yeo Kee Yan says Indonesia’s B30 biodiesel programme is “a wild card”. The world’s top palm oil producer’s plan for biodiesel to contain some 30% of bio-content, up from the current 20%, is slated to begin in January 2020. This is part of President Joko Widodo’s push to reduce energy imports, and utilise more of the country’s output of vegetable oil.
Market watchers highlight how the move could well increase domestic consumption of palm oil, causing the commodity’s price to increase.
“Top palm oil industry analysts revised up their price outlook for the edible oil, pointing to reduced production and optimism that Indonesia’s so-called B30 biodiesel programme will help bolster demand,” notes UOB Kay Hian analyst Leow Huey Chuen.
Leow highlights how CPO prices are likely to recover in the near term on the back of lower production, stronger demand for biodiesel and lower production of alternatives such as rapeseed and canola.
OCBC analysts are fairly confident of the B30 mandate taking shape as planned.
“There are concerns that the high prices would stop the B30 mandate implementation from going ahead, but we think that is unlikely,” says OCBC’s Lee.
“What may happen is a pushback of the B40 and B50 implementations if economics are unfavourable, although it does appear that President Jokowi is determined to see through at least up till the B50 mandate, if not B100.”
The analysts also highlight, however, another area that has brought about some concern — droughts in Indonesia, which have resulted in “worse-than-expected yields” of palm oil, which in turn affected production.
“The drop in yields is not expected to last, but growers are under pressure from both authorities and environmentalists [and, increasingly, ESG (Environmental, Social, and Governance)-conscious buyers] to produce sustainable palm. Yields might suffer in the near term,” cautions Lee.
A mixed bag
Leow goes on to note that local companies such as Wilmar International, GoldenAgri Resources and First Resources have biodiesel operations in Indonesia and are poised to thrive on the implementation of the B30 programme.
“The companies’ biodiesel plant utilisation rates might increase and benefit from the potential stronger biodiesel demand in Indonesia,” says Leow. “With the increment of palm oil usage in biodiesel, there would be a positive contribution to companies’ earnings in their downstream segment.”
On the whole, local stocks are poised to thrive on the higher CPO prices, which would in turn speed up the “slow recovery” that analysts had initially forecast.
Yet, DBS analyst William Simadiputra attests that it is imperative to remain cautious on the industry, saying that the industry is “currently a mixed bag”, although the worst is clearly over.
“We still favour planters with younger tree-age profiles for their higher volume growth. We also like planters with strong balance sheets, which would allow them to take advantage of any opportunistic brownfield acquisitions, expand their value chains downstream and/or diversify their businesses to other crops,” says Simadiputra in a recent report.
For 3QFY2019 ended September, the benefits had not yet set in, as most stocks reported a decline in earnings. The companies had attributed the decline to weaker oil prices, among other contributing factors.
Bumitama Agri saw its earnings slide 30% to IDR189.6 billion ($18.3 million) despite a 1.4% increase in revenue. According to the group, the higher sales volume for the quarter was offset by the decrease in average selling prices in its CPO and palm kernel segments. Shares in Bumitama slipped 28% since 2015 to close at 74.5 cents on Dec 16, which indicates that the stock is trading at 21.35 times historical value, and has a market capitalisation of $1.31 billion.
Singapore agribusiness Wilmar International hopes to attain regulatory approval in early 2020 for the IPO of its China business, Yihai Kerry Arawana Holdings. The group’s earnings slid 10.2%, however, to US$389.3 million ($528.2 million). Similarly, First Resources reported a 44% decline in earnings to US$57.1 million, along with a 43% decline in operating profit. The higher sales volumes booked by the group was insufficient to offset the effects of weaker palm oil prices, says the group in its latest earnings call.
Uncertainties ahead
On the one hand, things are looking up for the plantation sector, in view of limited room for supply expansion and a simultaneous growing demand. In addition, the recent US-China trade developments have seen improvements between the
two economic powerhouses, paving the way for a gradual demand recovery in China as well as improvements in import appetite.
Yet, DBS urges investors to remain selective on the industry’s stocks amid uncertainties. The brokerage notes that a critical factor to consider includes a stock’s potential for yield expansion, which means that companies are able to keep operational costs low in anticipation of price fluctuations. “It is good to be selective despite the hype surrounding the CPO price rally,” says Simadiputra.
In addition to a stock’s fundamentals, weather factors such as natural disasters are significantly correlated to the performance of plantation stocks, which invokes a certain level of risk in investments.
In addition, the low prices of palm oil substitutes could well limit the upside potential of the stocks, which has resulted in analysts’ maintaining a fairly cautious stand on the industry. “We do not want to speculate on a steep recovery on the price despite the ongoing inventory drawdown on palm oil,” says Simadiputra.
