Kenanga Research in their Sector Update report today (March 24) states that fragile supply recovery for calendar year 2023 may now extend into calendar year 2024 on a subdued inventory outlook following smaller-than-expected soybean surplus in South America.
Fortunately, palm oil supply should recover in calendar year 2023 with crude palm oil prices likely to stay relatively firm over calendar year 2023 and into calendar year 2024 unless palm, soy or rapeseed harvests prove exceptionally good later in calendar year 2023.
“We are keeping our calendar year 2023 future crude palm oil price of RM3,800 per metric ton intact but revising up calendar year 2024 future crude palm oil price from RM3,500 to RM3,800 per metric ton,” said Kenanga Research.
Positive factors for the sector include palm oil being an essential food and fuel for markets in emerging economies such as China, India and Indonesia, players’ asset-rich net tangible asset, and share valuation at 1.1x price by volume with a lot of the bad news already priced in.
“It is also Shariah compliance (9.6% of FBM Shariah Index, 9.4% of FBMKLCI) but we are keeping our neutral weight intact in the absence of a strong upside catalyst. Our crude palm oil price upgrade for calendar year 2024 is a positive but not enough to justify an upgrade. Our sector pick is KLK (OP; transfer price: RM27.00) and PPB (OP, RM19.30),” said Kenanga Research.
Recovery of edible oil supply in calendar year 2023 is underway but less robust than expected. Record outlook for a Brazilian soybean harvest is likely but so is for a very poor Argentinean harvest.
While Brazil is the top producer, Argentina is actually more important for international trade, often ranking as the 3rd or 4th largest edible oil exporter in the world after Indonesia, Malaysia and sometimes Russia.
Fortunately for the edible oil supply market, palm oil supply should also improve. However, even as supply recovers, demand is also expected to recover, potentially at a faster pace.
Note that Asia Pacific is the world’s biggest market for edible oil. Prominent users such as China (the world’s no. 1 market) are already consuming almost as much as the EU and US combined while India should surpass the US soon with Indonesia close behind.
Demand from the region is also expected to get higher on demographic growth and rising affluence. Among the most widely used edible oils in the region is palm oil.
Before it overtook soybean oil to become the leading edible oil by volume around the turn of this century, palm oil used to enjoy premium prices. Commanding around 35% of market share currently and half of all edible oil traded internationally, palm oil is often more affordable than many other alternatives.
Much like the EU, Indonesia’s biofuel policy aims to improve energy security and preserve the environment but also to support the rural economy. Today, US and Indonesia are near equal as the second and third biggest biofuel users after the EU.
Biofuels such as bioethanol are derived from sugar/starch-rich crops (sugarcane or corn) while biodiesel is from edible oils. The main palm-based biodiesel market is Indonesia which just raised its B30 blend to B35 in Feb this year. Brazil also recently raised its soy-based biodiesel B10 blend to B12 last week with B15 as the target by 2026.
“With robust demand recovery, we maintain a fragile calendar year 2023 supply-demand outlook with firm crude palm oil prices likely. Our present concern is that the tight balance may extend into calendar year 2024 on likely smaller-than-expected South American soybean surplus. Higher palm oil production of 3-5% year-over-year in calendar year 2023 should ease oil supply, even if on a limited scale,” said Kenanga Research.
Nevertheless, easing the labour shortfall in Malaysia should help nudge fresh fruit bunches up by 1-2 million metric tons year-over-year. Longer term, the growth of palm oil looks less rosy. Expansion in the form of new oil palm planting is slowing due to tighter regulations.
Indonesia, which has 15 million hectares of oil palm trees, has only 3-4 million hectares left for the crop while Malaysian oil palm area has been contracting even before reaching a voluntary cap of 6.5 million hectares.
This implies fewer young and prime palms over the coming years while palms planted in the 1990s and 2000s are growing older and taller, slowing down harvest, lowering fresh fruit bunches yield and pushing up costs. Replanting will eventually be necessary leading to a production pause for 3-5 years.
Cost is easing but still elevated and sticky. Fertiliser cost has eased by around 20% from the peak in quarter two calendar year 2022 but wage increase will need time to be absorbed, mainly by improving productivity through better planting material, mechanisation and/or field operations.
Meanwhile for calendar year 2023, cost inflation will be negated in part by recovering fresh fruit bunches yields among some Malaysian planters as the workers shortage eases. Overall, crude palm oil production cost is estimated to have risen from RM2,000 (or less) in calendar year 2021 to RM2,000-2,500 per metric ton for calendar year 2023.
The plantation sector is currently already trading close to book value which is often understated as many players hold estates which are worth more than their reported value.
Gearing is not excessive either with some holding net cash. Although costs have risen resulting in tighter margins, they are still decent overall and palm oil is also an essential consumable (as food and fuel), popular with emerging economies.
The sector is also Shariah-compliant (9.6% of FBM Shariah Index, 9.4% of FBMKLCI). However, there is no strong upside catalyst even though the sector is highly defensive and ratings are far from demanding. Sector consolidation is a possible upside but is best evaluated on a case-by-case basis.
“Maintain neutral with KLK (OP, transfer price RM27.00) as our sector pick given its track record, efficient upstream operations and strong regional presence. Thanks to non-oil palm agribusiness, consumer and FMCG contributions, PPB (OP, RM 19.30) should see earnings bottoming out earlier than peers,” said Kenanga Research.
TSH (OP; transfer price: RM 1.35) is set to expand its planted area from 40k hectares to 60k-65k hectares after paring net debt from RM 816 million in financial year 2021 to RM 179 million for financial year 2022 (9% net gearing). HSPLANT (OP; transfer price: RM 2.30) offers pure upstream exposure with strong net cash holdings and decent dividend yield prospects.
