Looming challenges for plantation stocks
Stephanie Jacob 
A strengthening ringgit keeps downward pressure on CPO prices, according to Pong

THE plantation sector has failed to excite given the presence of several notable headwinds that are expected to affect export growth and impact crude palm oil (CPO) prices.

The unexciting outlook on export growth and CPO prices will also likely impact investor enthusiasm for plantation-related stocks, says Inter-Pacific Research Sdn Bhd head of research Pong Teng Siew. He believes that “plantation sector stocks will not see the return of favourable investor appeal before H2FY18.”

Late last year saw a move by India to increase its customs duty on CPO and refined palm oil imports by almost double. The Indian market is the largest importer of Malaysian palm oil.

Then in mid-January, the European Union Parliament’s environment committee announced that it would endorse a legislative campaign to remove palm oil from its list of designated renewable fuels by 2020 due to environmental considerations.

This basically means that palm oil biofuel will be phased out from usage as vehicle fuel by that period. The EU market accounts for about 12% of local palm oil exports, making it the second largest destination for Malaysian palm oil.

OCBC Bank maintains its bearish outlook for the palm oil sector this year although production has recovered significantly last year and is poised to continue its uptrend in the near future.

“Export outlook does appear rather soft given India’s and Europe’s weaker demand, especially the latter’s decision to ban the use of palm oil in motor fuels from 2021,” the bank’s economist Barnabas Gan tells FocusM.

According to the Malaysian Palm Oil Board (MPOB), CPO production in Malaysia increased by 15% last year due to the recovery from the El Nino phenomenon. Inventories rose close to two-year highs in November which in turn prompted benchmark prices to hit a 16-month low in mid-December.

MPOB expects production to continue rising this year as do most research houses.


Surging ringgit a bane

The weakening demand environment comes at a bad time given the steady build-up in palm oil stockpiles. Analysts believe that the higher inventory could be a drag on CPO prices.

A JF Apex Securities report notes that the CPO price “accelerated its downtrend in December 2017” and that it was down 10.5% month-on-month versus November. The research house pointed to high inventories as the main culprit for the softening prices. It further expects inventory to be among the “bearish factors” to weigh on prices this year.

Concerns over high inventory and its effects on CPO prices has motivated the federal government to take measures to reduce the large stockpiles. On Jan 5, the government announced that it would suspend export taxes on CPO for three months.

The rationale behind the tax suspension will boost palm oil prices and help to draw down the large stockpiles, according to Minister of Plantation Industries and Commodities Datuk Seri Mah Siew Keong.

Moreover, the move is intended as a short-term pre-emptive measure to manage the fall in CPO prices so as to prevent the income of smallholder farmers from being harshly impacted in the quest to keep the country’s palm oil industry competitive.

While the move was welcomed, there are concerns that it might be nullified by other factors, particularly the stronger ringgit. The local note strengthened 9.5% last year (after having tumbled 4.5% in 2016) and has continued to firm against the greenback in the early days of this year (3.7% as of end-January).

“A stronger ringgit of late is also to blame for the weaker palm oil price,” OCBC’s Gan points out. “The ringgit has appreciated to below 4.00 per US dollar in the past weeks.”


La Nina phenomenon

In percentage terms, Gan observes that while the ringgit has appreciated 2.7% in the first three weeks of this year, palm oil futures had fallen in tandem by 2.3% over the same period.

Inter-Pacific Research’s Pong also emphasises the impact of the ringgit’s recent strength on prices.

“A strengthening ringgit also keeps downward pressure on CPO prices,” he argues. “Its price [CPO] when quoted in US dollars is only 15.5% lower than its peak in early February 2017 compared to 26.3% lower when quoted in ringgit.”

Meanwhile, even traditional price boosting factors like the La Nina weather phenomenon might have a lesser impact in driving CPO prices this year.

“La Nina conditions seen of late has failed to support palm oil prices,” suggests Pong. “As predicted by weather experts, 2018’s early La Nina severity proved to be a weak one and is likely to be short-lived.”

Moreover, the La Nina weather pattern historically tends to affect prices less versus the hotter and drier El Nino phenomenon. In Pong’s reckoning, the real pressure would likely stem from expectation of the ringgit further strengthening this year.

Hong Leong Investment Bank Research Chye Wen Fei is also neutral on the broad plantation sector given the lack of strong demand catalysts.

“While La Nina and the government’s recent move to suspend CPO export taxes will lend support to near-term CPO prices, these are just short-term catalysts,” Chye opines. HLIB forecasts CPO prices to average at RM2,500 per tonne this year.


Global economic outlook

Similarly, TA Securities Research has a neutral recommendation on the sector, while its CPO price estimate is RM2,800 per tonne. “We expect CPO prices to trade higher in the first half of 2018 and gradually tapering off in the second half,” noted analyst Angeline Chin.

Chin said re-rating catalysts would be the extreme weather change which would affect both production and CPO prices. Elsewhere, downward revisions in soybean production estimates and better-than-expected demand from China and India could also improve the outlook.

Interestingly, Inter-Pacific’s Pong also holds the view that weaknesses in the plantation sector might hamper the overall recovery of the bourse this year. He has projected the FBM KLCI to rally in tandem with higher CPO prices but that did not happen.

“Among the various sectors, the view we hold is that any boost to the domestic economy will be most palpable and broad-based if it comes from the palm oil sector as price increases flow straight into incomes of a broad swatch of the rural heartland of the country,” he maintains.

Meanwhile, MIDF Research stands apart from many of its peers with its positive outlook on the sector. Taking a contrarian view to growth, it forecasts CPO prices to rise to an average RM2,900 per tonne this year in tandem to a better global economic outlook.

This article first appeared in Focus Malaysia Issue 270.