Opinion On CPO

CS view: The 1985 recession in Malaysia led to a 23% and 37% drop in new planting in 1986 and 1987. The 1998 recession and the sharp drop in palm oil prices in 1999 led to a 73% drop in new planting in 2000. Historical cycles for palm oil prices (trough-to-trough) lasted from 37 to 46 months. If history repeats itself, we should be close to the trough for palm oil prices, as the current cycle is in its 44th month. CS assumed that palm oil prices will average RM1,400 for the rest of the year (FY2008 - RM2000) while FY09 forecast RM2,250 and RM2500 for FY10.

Macq view: Our expectations of improvement in the stock-to-usage ratio of edible oils as well as strong CPO production growth in Indonesia in the coming years, we believe that CPO prices will continue to decline over the next two years, as the market increasingly factors in the strong supply outlook. Long term price for palm oil at about US$400/t or RM1,400/ton

JPM view: CPO prices traded at a trough level of M$660/t (US$190/t) historically since 1996 to mid-2006. However, higher cost of production currently we believe will likely help keep CPO prices above the historical trough level. we see a floor in CPO prices at the M$1,500/t level (US$440/t). This is close to the long-term 10-year average CPO price stripping out the bio-diesel impact of the past two years, and is also close we believe to the production cost per ton for the marginal CPO player.

UBS view: CPO price assumption for 2009 US$450/t, 2010 US$480, 2011 US$510, long-term CPO price assumption lower from US$740/t to US$570/t.

Production

CS view: Slower production growth due to cutback in expansion plans, tree stress due to higher fertilizer cost.

Macq view: We expect Malaysian production to stagnate at 17.6m tonnes next year due to a decline in the yield cycle. For Indonesia, we expect a jump of 2mt; we also expect world production to increase by ~2.4mt. Further, if we assume consumption growth will slow to 2.5mt (vs 3.8mt previously) due mainly to the slowdown in biodiesel and oleochemical usage, we expect the stocks-to-usage ratio to potentially rise from last year's level. Post 2008, we expect CPO production growth to slow in 2008–09 to 2.4mt from 4.9mt in 2007–08 due to expected biological stress cycle on the trees after a record production year. Other industry sources such as Oil World expects palm oil production growth to slow to as little as 2mt next year.

JPM view: Oil World is forecasting global supply growth to moderate from 13% in 2008E to 6% in 2009E, just slightly below demand growth of 7% estimated for next year.

UBS view: Inventory remains persistently high because of weaker demand—we think demand will continue weak and therefore it will take longer for inventory to clear.

Demand

CS view: Global edible oils consumption has never contracted, even during global recessions, but the growth rate is normally lower than during boom times. Demand for edible oils increased by 2 mn to 4 mn tonnes per annum (t.p.a.) between 1980 and 2004. Between 2005 and 2008, edible oil demand grew 6 mn to 8 mn t.p.a., boosted by rising demand for biodiesel.

Macq view: The USDA data for the past 30 years indicate that on average, there is fairly stable consumption in food items such as coffee and palm oil in volume terms. Consumption of palm oil has grown on average by 9%, soy oil by 5% and produce such as coffee by 2% pa for the past 30 years. Even during periods of weak economic conditions, contraction in volumes, if any, is small.

JPM view: Based on Oil World''s forecast, global palm oil demand growth is forecast to moderate from 10% in 2008E to 7% in 2009E, During the previous Asian crisis in 1998, global demand growth for palm oil still rose, but at a much slower rate of 3%.

UBS view: The significant cut in our assumptions is based on new lower global GDP growth and crude oil forecasts made by UBS on 30 October 2008. UBS's crude oil forecast for 2009 was lowered from US$105/barrel to US$60/barrel, a cut of 43% compared with our CPO price assumption cut of 31%. UBS also lowered global GDP growth from 2.2% to 1.3%.

Comments: If you look at too many indicators, you would end up being confused. Best to isolate a few that really matters. Predicting a price for CPO for the next 12 months is difficult and largely a moving target. On the way up, CPO price had a high correlation to oil price jumps - there is a strong involvement by hedge funds and commodity funds in ramping up long positions in all soft and hard commodities. On the way down, it looks like a positive correlation as well but that isn't really true because its a de-leveraging process. I believe oil price and CPO have decoupled and now trades on purer fundamentals of supply and demand. CPO price may see some volatility as producing nations try to bolster the supply-demand equation with new regulations.

To spot good entry levels, we need to monitor the monthly inventory levels. As at end Sep 08 the inventory was at a historic high of 2m tonnes, with a similar situation in Indonesia. Octo and Nov should see inventory rising further to 2.2m tonnes. Hence there is NO HURRY to go long on CPO stocks, you can and should trade them but not buy and hold yet. CPO should only start a genuine recovery trend when inventory reaches around 1.6m tonnes. As it gets closer to that level, you can start buying. Hence we may very well see RM1,300-1,400 for CPO as the bottom of the barrel.

The present discount gap between soy oil and CPO was at a staggering US$300, far from the average US$100 per tonne. Watch the spread closely, if it starts going below US$200, that is a sure sign that genuine buying has resumed. Right now end users are keeping a low buying inventory as they expect demand to be uncertain and CPO prices volatile with a downside bias. They can only keep a low inventory for so long.

The measure to blend 5% of palm biodiesel with diesel is a good move but MUST be properly thought out. The move is good because it takes 500,000 tonnes of CPO a year. It would be bad if its not a permanent strategy as that would hurt the biodiesel industry again. Has the government given sufficient consideration if CPO price were to be at RM3,000 again, would the 5% still make sense. Theoretically it should as with CPO at RM3,000, the price of oil should also be higher, maybe at US$110. But, what IF CPO price were to hit RM3,000 and oil stays at US$70... does it still make sense. If its to be a good long term strategy, I would make the ruling permanent. Stress test it with various combinations of both prices, and stick to it through thick and thin. Only then can investors and entrepreneurs invest properly into a viable and sustainable biodiesel industry, and valuations be properly accorded. Implement and then take away is not sound for business. Having said that, the policy will only take effect in 1Q2010, which will not play any part in the demand supply equation for the next 12 months.

I expect a high low of RM1,900-1,300 for the next 12 months, with a higher bias further down the road, and a bias towards the low end in the short term. That being the case, its pointless to look at P/BV or ROE. Just look at CAGR, PER and dividend yield going forward. Under those measures, the Malaysian CPO firms are not attractive compared to regional players in Singapore and Indonesia. Astra Agro and Golden Agri both looked much more attractive. Best among the locals are IOI Corp and Hap Seng Plantations.

p/s photo: Elanne Kong