According to a recent Reuters report, some refineries are overflowing and need to stop operations as there is no real additional demand to take away this surplus. Malaysia’s June palm oil stocks surged 9.8 per cent to 2.10 million tonnes, the highest in at least 25 years, as the production cycle shifted to a higher gear amid a slowdown in shipments.
Palm oil output in Malaysia, the world’s second-largest producer, rose 4.9% to 1.53 million tonnes in June, according to a median estimate of five plantation houses. Overseas demand for palm oil, used mainly in soaps and chocolates to biofuels, dropped 3.4% in June to 1.15 million tonnes.
June’s palm oil reserves would be the highest in the past 25 years, or since 1983, historical data from industry regulator Malaysian Palm Oil Board (MPOB) showed.
Although palm oil prices have eased roughly 22% to RM3,489 (US$1,060) from a record high of RM4,486 in March, demand from traditional consumers India and China remained lacklustre.
A decline in exports usually occur in the second quarter of the year as there are no festivals to lock in supplies.
Traders in Malaysia and Indonesia generally expect overseas demand for palm oil to pick up in July, as buyers tend to stock up at least two months before the Asian festival season that begins in early September.
But demand will have to really strengthen in the coming months to cut into reserves significantly, which have swelled due to healthy output growth on the back of good weather and strong yields.
SWFs on a binge
Sovereign wealth funds and to a large extent, the linked government corporations, have been big buyers of banking assets in the past. Energy related companies have been targeted as well.
Some US pensions and endowments have followed in the highly successful Yale’s endowment strategy, which has invested in real assets like timberland, oil and gas for some time now.
This is a model for other institutional investors and sovereign funds.
Since many sovereign funds are explicitly modelling themselves on endowments, they could have a similar exposure, particularly in their allocation to absolute return strategies and alternative investments.
We have seen China’s sovereign wealth funds and government linked companies launching themselves aggressively to buy energy and banking assets.
In recent times, these companies have ventured to lock in supplies of critical commodities.
The recent 97% hike in iron ore prices affirms that their strategy is correct and it will be reflected in other commodities critical to the domestic economy.
Hence it is surprising that no China company has bought a significant stake in any palm oil company.
That does not mean it is not going to happen but rather palm oil has to wait its turn.
Reliable sources confirmed that there have been a number of company visits by Chinese executives to palm oil companies.
Chinese interest in palm oil
The recent experience of blaming oil price spikes on speculators should have brought about the reality that the futures markets is probably not a good place to try and secure future supply.
The example of iron ore prices being jacked up by 97% owing to the fact that it does not have a futures market, but is open to contractual negotiations, also lends weight to owning real assets.
I would expect a surge in the top few plantation companies in the near future, owing to the likely passive investment by the said Chinese companies.
Any investment is likely to be sizable in the 5%-15% range. This will soak up an enormous amount of free float.
The other factor is that they will likely stick with the top few established companies, and refrain from investing in government linked counters.
To China, palm is becoming a strategic asset to have in order to ensure supply. It’s still a relatively cheap vegetable oil, plus palm oil is critical to manufacture other essential products. China cannot grow palm oil.
The trans-fat issue has also improved demand for the healthier palm oil. Besides cooking oil, palm oil and fats are critical for production of cosmetics and detergent, chemicals (paint, grease) and food products (biscuits, cakes, chips, ice cream, margarine, mayo, to name a few).
The viability of biofuel also adds to the long term sustainability of demand for palm oil, considering the future outlook for fuel price.
Plantation stocks
None of the top plantation companies need cash infusion.
Probably none of them even need to sell down any of their holdings - hence there would probably be no new share issue, which would mean having to mop up from the open market.
I doubt very much that any of the smaller substantial shareholders would be thinking of selling their stakes at this point in time.
The more intrusive government intervention by Indonesia to palm oil exports may cause the Chinese strategic buyers to shy away from Indonesian centric plantation companies.
Sime Darby RM9.00 / Mkt cap US$17bil / Free float 40%
IOI Corp RM7.30 / Mkt cap US$14bil / Free float 41.2%
KLK Berhad RM17.00 / Mkt cap US$5.7bil / 28%
Wilmar S$5.00 / Mkt cap US$24bil / 18%
Golden Agri S$0.90 / Mkt cap US$6.8bil / 51.5%
That being the case, all the above stocks are expected to trade at a higher premium than previously. Particularly, KL Kepong, which has a tight free float. Wilmar’s free float may be even tighter but may be at a prohibitive level to attract the passive Chinese investors.
The investment into even one of the four is likely to result in a ratings upgrade for all the top tier companies.
photos: Nancy Wu Ting Yan
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