Fitch Ratings expects average crude palm oil (CPO) prices to be significantly lower in 2024, based on its expectations of a higher output of palm and other vegetable oils, due mainly to favourable weather conditions amidst a transition in global weather patterns.
The ratings house assumes Malaysian benchmark CPO prices to average USD650/tonne (t) next year, compared with USD830/t in 2023. Lower prices should weaken producers’ margins and EBITDA, and raise leverage. However, EBITDA should be supported by higher fruit yields, oil output, and lower unit production cost. Free cash flow (FCF) profiles should also benefit from a release of working capital, on lower inventories and trade receivables. Several Fitch-rated issuers have limited rating headroom in terms of credit metrics, but Fitch expects them to support their financial profiles by cutting discretionary capex and dividends.
Higher Yields and Lower Costs to Limit Price Impact
Industry data indicates that yields in Malaysia have started to rise from 2H23, following a pick-up in Indonesia since the start of the year. Output growth in Malaysia lagged behind in 1H23 due to inadequate availability of skilled foreign workers, but the issue now appears to have been resolved. This bodes well for producers with large operations in Malaysia, including Sime Darby Plantation Berhad (SDP, BBB/Stable) which reported a 5% drop in total CPO production in 1H23.
Producers in the region should also benefit from lower unit production costs, on softer fertiliser prices and a thinner spreading of costs across a larger output base. Companies such as SDP are also targeting a significant reduction in their workforce, through increased mechanisation mostly in nonharvesting activities, which should result in a structurally better cost base.
We forecast significantly Weaker average lower CPO prices in 2024- akesh gupta,Director
Weaker prices should also result in lower inventories and trade receivables for producers, freeing up a portion of working capital. For example, Golden-Agri Resources Ltd., whose consolidated credit profile forms the basis for the ratings of subsidiaries PT Ivo Mas Tunggal and PT Sawit Mas Sejahtera’s ratings (both A+(idn)/Stable), reported an 11% drop in short-term trade receivables and inventories in 1H23, reflecting a similar fall in benchmark CPO prices. We think producers also have some flexibility in reducing capex and dividends, which is likely to be exercised next year
Lower Prices, Higher Output Likely
The Malaysian benchmark CPO spot price is currently trading below USD800/t, and is likely to average around USD830/t in 2023, down almost 30% yoy. Higher output of palm oil as well as other vegetable oils globally has led to weaker prices, which we expect to trend lower in 1H24 on further improvement in output, and average USD650/t for the year.
The global weather patterns, which affect rainfall in key plantation regions, transitioned in 2023, creating favourable conditions for output growth which we think will continue until at least 1H24. Global vegetable oil production is forecast to increase by 6 million tonnes next year, or 3%, by the United States Department of Agriculture, driven by growth in soybean oil and palm oil output.
Output and Inventories on the Uptrend
Latest data from Malaysia and Indonesia indicates a material improvement in palm oil output and expects further growth in 2024 on conducive soil conditions. CPO output in Malaysia has picked up since July 2023, due to a recovery in the availability of foreign workers following the relaxation of Covid-19-related restrictions, and production in October was up 7% yoy.
Fitch expects unit costs for CPO production to decline in 2024, based on our expectations of lower fertiliser prices and improved oil palm yields. The cost benefit would be partly offset by the steady inflation in labour wages. Fertilisers constitute one of the largest cost components for producers, and Fitch’s price assumptions for 2024 suggest a fall of 20%-40% across various categories. Lower production costs – apart from a cut in working-capital needs, discretionary capex and dividends –
should support cash flow for the industry and allow producers to focus on maximising their output.
During the last strong El-Nino event in 2015-2016, Malaysian benchmark CPO prices fell below USD600/t before recovering. Fitch thinks the pattern could repeat in 2024, with prices falling below USD650/t in 1H24 before improving towards the end of the year. The Ratings agency sees higher upside risk to our price assumption for 2025 and 2026 from a strong El-Nino weather pattern. On the other hand, milder weather conditions are likely to boost supply and pressure prices.