EU ban on palm oil unlikely to change prospects for short term, Bumitama Agri a favourite

Malaysia has fought back. On Jan 23, the Malaysian Palm Oil Council said the EU’s Renewable Energy Directive of excluding palm oil-based biofuels is a potential violation of the World Trade Organization’s rules. Malaysia’s Minister of International Trade and Industry Mustapa Mohamed said: “The EU’s latest move is… a potential violation of the WTO rules as it is a deliberate attempt to block palm oil access into their market.” The Malaysian government is planning to collaborate with other palm oil-producing countries such as Indonesia to voice their concern on this issue, the minister said.

Malaysia is the world’s second-largest palm oil exporter after Indonesia. It exported 15.2% of its palm oil worth RM10.3 billion to the EU in 2016, according to the Malaysian Palm Oil Board (MPOB). Palm oil exports to the EU had decreased by 3.3% y-o-y to two million tonnes in 2017.

Currently, the EU is the largest biodiesel producer in the world, with an estimated output of 12.8 million tonnes in 2017. Apparently, 3.5 million tonnes of palm oil, or 27% of total feedstock, is being used as raw material. The EU is also a large consumer of palm oil, accounting for 11% of global palm oil demand, of which 46% is used for biofuels.

In a recent report, Credit Suisse estimates that around 5% of the global palm oil demand will be affected by the new EU legislation.

Separately, India is proposing to increase the import duty on refined, bleached and ­deodorised (RBD) palm olein from 40% to 45%. A higher tax would result in a duty difference of 15% between crude and refined palm oils, compared with 10% currently. The proposal will be submitted to the Indian government and then tabled for a vote in parliament on Feb 1. India accounted for about 14% of global palm oil consumption in 2017.

CPO prices eased in January

According to a weekly palm oil update by UOB Kay Hian, the three-month CPO futures price dropped to RM2,445 a tonne on Jan 19, down 3.6% w-o-w and 6.9% from its peak of RM2,625 a tonne on Jan 8. “Subdued demand, concerns about the EU palm oil ban and the potential of a third India import duty hike have caused negative CPO price movement,” UOB Kay Hian notes. This is despite seasonally weak CPO production in January, the broker adds.

In addition, weak demand is likely to leave inventories at a high level. Intertek Testing Services reported that exports fell 16.4% m-o-m for the Jan 1 to 20 period, while Société Générale de Surveillance reported that exports declined 2.8% m-o-m for the first 15 days of the year. This is in contrast to expectations of higher monthly export figures this year.

However, Malaysia has suspended CPO export duties for three months, from Jan 8 to April 7 to boost exports and reduce inventory levels. If this does not work, inventories could continue to build up, keeping CPO prices under pressure.

UOBKH is expecting CPO prices to average RM2,400 a tonne for 2018 and RM2,500 a tonne for 2019. “We are turning more bearish on CPO’s price outlook for 1Q2018. We reckon that CPO prices could trend lower to RM2,400 to RM2,700 a tonne in January to April this year, versus earlier expectations of RM2,500 to RM2,700 a tonne, owing to the weak demand and multiple negative news flow in the sector.” From May, UOBKH is even more bearish and is forecasting CPO prices of RM2,200 to RM2,400 a tonne because of a significant increase in production. Meanwhile, Credit Suisse is forecasting an average CPO price of RM2,500 a tonne for this year.

Global palm oil supply has been rising since 2000, with output at a record 67.5 million tonnes in 2017, representing a compound annual growth rate of 6.5% for 17 years. This year, Oil World estimates palm oil production will exceed 70 million tonnes.

“This growth in production should be supported by increasing output from the top two producing countries (Malaysia and Indonesia), albeit at a slower rate,” notes Credit Suisse in a Jan 23 report. “Yields have recovered post El Niño [in 2016] and young oil palms continue to come of age in these two countries.”

Wilmar and Bumitama Agri are favourites

Both UOBKH and Credit Suisse have “market weight” recommendations for companies in the sector. Credit Suisse’s top picks are Genting Plantations, Bumitama Agri and PP London Sumatra Indonesia. UOBKH also likes Bumitama Agri, along with Kim Loong Resources, Wilmar International and Tunas Baru Lampung.

Wilmar’s earnings are expected to grow by double digits this year. It will report its FY2017 results on Feb 22. UOBKH is expecting better q-o-q but flat y-o-y profit before tax for its tropical oil division, and better q-o-q but weaker y-o-y PBT for its sugar division. Overall, UOBKH has a net earnings estimate of US$360 million ($471 million) to US$380 million for 4Q2017, versus US$589.5 million in 4Q2016 and US$323.7 million in 3Q2017. Earnings for FY2017 are estimated at US$1.05 billion, up 8.4%. This is forecast to rise by 20.5% to US$1.27 billion this year, and by a further 14.5% to US$1.46 billion in 2019. Wilmar is an integrated agribusiness company encompassing the entire value chain of agricultural commodities, from the origin at the tree to the cooking oil in the kitchen.

Bumitama Agri is favoured by analysts because of its strong performance and its young plantations. RHB Securities also likes the palm oil producer. It is expected to post strong fresh fruit bunch growth of 23% in FY2017, rebounding from El Niño in 2016. “For FY2018 and FY2019, we expect FFB growth to continue in the double digits, at 16-18% y-o-y. This is on the back of 3,800ha of new land coming into maturity in 2018 and 6,700ha in 2019 (from 14,500ha in 2017), as well as an increase of 15,000ha in prime areas over the next four years,” RHB says.

Margins are likely to improve as these plantations mature and as more of the FFB processed is sourced from its “nucleus estates”. RHB is forecasting recurring net profit of IDR1.42 trillion ($140 million) for this year, up 27.1%, and a further 17.9% growth for next year to IDR1.68 trillion.