Contrarian view on plantation sector


  • Business
  • Saturday, 01 Mar 2003

BY ERROL OH

IT IS not every day that an investment analyst borrows from the work of rock music icon Bob Dylan. So, when a local stockbroking house recently came out with a research report called The Times They Are A-Changing, it is noteworthy. 

But the use of a Dylan song title – hardcore fans would point out that it ought to be The Times They Are A-Changin' – is not the only thing atypical about the report. What is more significant is that it offers a contrarian view on the plantation sector. 

In the report, the research outfit downgraded its call on the sector from overweight to underweight. It also downgraded its recommendations on the plantation stocks it covers. 

The analyst, who requested anonymity, argues that fundamental shifts in supply and demand in the global edible oils market will block crude palm oil (CPO) prices from rising further. In particular, he cites the possibility of higher production of oilseeds and of CPO itself in a matter of months. 

He points out that the prices dropped below RM1,600 per tonne in mid-February, the first time since last December. “As palm oil prices tend to move in cycles of three to four years, we think the dip since the beginning of 2003 heralds the commencement of a new bearish phase,” he says. 

CPO has rebounded impressively since sinking to a 10-year low of under RM700 per tonne in February 2001. It hit a high of RM1,704 in late December last year. 

Being in a commodity business, plantation players are more than familiar with platitudes like “All good things must come to an end” and “What goes up must come down”, but is it really time to brace for a fall? 

 

Too soon to fall 

 

Other industry watchers think it is too early for the CPO party to end. They believe that the prices will continue to stay strong until at least the middle of the year, although only the ultra-optimists are talking about the prices reaching the RM2,000 mark. 

A veteran planter with a listed company agrees: “The prices will remain firm over the next six months. Beyond that, it's hard to tell. For us, it's already a bonus that the prices are hovering at the RM1,600 level right now.” 

He is referring to the fact that plantation companies are currently enjoying a boom in earnings, thanks to the buoyant CPO prices.  

Considering that their production cost per tonne is generally between RM500 and RM900, it is no surprise that recent results of listed plantation players show exciting leaps in net profits. 

Other analysts tracking plantation stocks say the various factors that have been pushing up CPO prices will continue to be in place. For one thing, the global supply of oilseeds will probably still fall short of demand although there have been forecasts of bumper soybean harvests soon. 

An analyst with a foreign research house rejects the possibility of increased soybean production hammering CPO prices within the next few months. 

She explains: “There have been expectations of record soybean harvests from South America every year. This has always been part of the equation. But industry experts say this will not be enough to compensate for the fall in the production of other oilseed products, such as rapeseed.” 

Another plantation analyst shares this opinion. “Typically, the CPO bull run ends when a substantial supply of edible oils comes into the global market. But I don't see this happening anytime soon. There's still some upside to the CPO prices,” she says. 

In fact, some observers are convinced that this year's average CPO price will top that of last year, which was RM1,353 per tonne. They anticipate some softening of the prices due to certain developments (such as an outbreak of war on Iraq) but they think that the effects will be short-term. 

 

The war effect? 

 

There is the perception that if the US attacks Iraq, CPO prices will suffer. The analysts do not dispute this but they say the impact may not be as bad or as lasting as widely believed. 

They point out that palm oil is pretty much a necessity because consumers use it to cook and food manufacturers need it to make their products. “Even in times of war, people need to eat. That is why plantation stocks are among the best defensive stocks,” says an analyst. 

In addition, plantation companies usually sell forward their CPO stocks, thus locking in their earnings. This adds another dimension to their status as defensive stocks. 

It is equally significant that demand for CPO is expected to stay strong, particularly in the two largest export markets, India and China.  

It has been reported that China had raised its palm oil import quota for 2003 by 4.2 per cent to 2.5 million tonnes. China (including Hong Kong) was the largest import destination for Malaysia's CPO last year. It accounted for about 20 per cent of our total palm oil exports. 

Meanwhile, on account of poor rapeseed harvest, India is expected to raise its imports of palm oil and soybean oil to meet local demand for edible oils. Industry players are waiting to see if the country's budget announcement will include a cut in tariffs on oilseeds. 

However, the analyst who downgraded his call on the plantation sector says the chances of this happening are slim because the Indian government is more inclined to protect its domestic edible oil industry. “Even if the tariffs are lowered, I don't see it having a major impact on our CPO prices,” the analyst adds. 

Another crucial factor is our CPO output. Fresh fruit bunch yields have been on the low side since the last quarter of 2003 and this will persist until March, due to the production cycle of the palm trees. 

The contrarian view of what happens from April onwards is that the higher production will impose downward pressure on the CPO prices. But this is based on the assumption that the demand for the commodity will be flat. 

However, others think that this will not be the case. Because the supply of other edible oils is likely to fall or, at least, will not grow fast enough, the demand for CPO will keep up with the rising supply. 

It is true, of course, that the dynamics influencing CPO prices are more complex than this. An analyst points out that high prices may drive down demand and weaken the commodity's competitiveness as compared with other edible oils. 

There is no doubt that the prices will eventually fall. Most analysts think this will happen in third quarter of the year. But they also reckon that it will not be a sharp drop as that of the previous downhill ride. Back then, the peak was higher and the sour economic conditions compounded the misery.  

Traditionally, the prices of plantation stocks will slide a few months ahead of the drop in CPO prices. 

“The changes in the palm oil prices will affect the plantation stocks in varying degrees, depending on the extent of the exposure to downstream operations,” says the analyst who made the underweight call. 

Companies that have substantial oleochemical and refining operations (such as IOI Corp Bhd and Kuala Lumpur Kepong Bhd) will have the blow cushioned by their resource-based manufacturing activities. 

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