Regional plantations - Inventories rising faster than expected - Macquarie Research

Event
§ Our channel checks suggest that production growth is above our expectations, while customers have shied away from purchases in recent months due to high CPO prices and a narrow price discount to soy oil. This means that CPO inventories are likely to rise faster than our and market expectations, putting downward pressure on prices in the near term.

Impact
§ Indonesian production rebounds strongly, Malaysia recovering as well:
Production growth for some Indonesian companies (large and small) in the first two months of the year has been north of 25% (see Fig 2). Production in Indonesia had already started recovering in 4Q10 as can been seen in Fig 3, but the growth this year has so far exceeded our expectations. We are assuming a 7% YoY growth in Indonesian production for 2011. Our discussions with Malaysian companies also suggest that production continues to recover in March after easing of heavy rains. Recent press reports suggest that mills in Johor (which produce 30% of Malaysian CPO output) have reported a 20+% MoM increase in March output.

§ Export demand continues to be weak: Latest data from cargo surveyors suggests that Malaysian exports for March so far have fallen 10% MoM. This would imply a 20% YoY fall in export demand for 1Q11. Indonesian exports for the month of January also fell 2.4% YoY despite an increase in output. We believe that high CPO prices and a relatively narrow discount to soy oil have caused customers to postpone/shift their purchases.

§ Inventories to rise sooner than expected: Rising production and falling export demand mean that inventories are likely to rise sooner than expected, causing pressure on prices in the near term. We now see downside risk to our 2Q11 CPO price forecast of RM3,683/t unless soy fundamentals turn significantly supportive.

§ Soybeans – tight supply but also slower demand: Soybeans are the supportive factor for CPO prices for 2011, in our view, as our agri-economist, Alex Bos, expects a tight US soy balance sheet this year and no growth in US soy acreage. On the other hand, Chinese imports of soybeans in recent months have been weak (see Figs 8 and 9), with Feb 2011 imports falling to a three-year low and crush margins weakening further. USDA’s 31 March planting intentions report should be a key factor to watch.

Outlook
§ We are Neutral on the plantations sector for 2011. We believe that stocks are currently factoring in a CPO price of RM3,150/t vs the current three-month forward of RM3,330/t. We see higher production pressure prices in the coming months, while a tight soy complex and rising crude oil prices should provide support. Our preference, therefore, is to own stocks that are still likely to grow their earnings in 2012, despite our assumption of an 11% decline in CPO prices next year. Based on this, our top picks are KL Kepong in Malaysia, London Sumatra in Indonesia and New Britain Palm Oil in London.