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Plantation companies are going through some challenging times in the face of falling crude palm oil (CPO) prices. After a good run in the first few times few months of the year, the commodity has fallen to a five-year low.
In January, the spot price was around RM 2,598 per tonne, before climbing to a peak of RM 2,917 in March. Since then, prices have headed south, losing more than 33% to close at RM 2,051 on Sept 8.
The world's most consumed edible oil started the year with optimism and positive prospects owing to increased demand for biodiesel from Indonesia and expectations of the El Nino weather phenomenon which cases droughts and floods that disrupt CPO supply.
When CPO prices started falling in May and June, industry players were unfazed, as prices traditionally weaken towards the middle of the year. This is in anticipation of larger production in the second half of the year. However, prices continued to fall mainly due to the ample supply of soybean oil.
On Sept 2, the spot price for CPO closed at five-year low of RM 1,933.50 having fallen 17% since August. Demand for palm oil exports fell about 5% month-on-month in August on concerns of weaker demand from China and increasing competition from other vegetable oils.
Most research houses reacted to the news by adjusting their ratings for plantation stocks to "neutral" from "overweight". Public Investment Bank, for one, revised its forecast of average CPO prices to RM 2,450 and RM 2,550 per tonne for 2014 and 2015 respectively, from RM 2,750 per tonne.
If the price slump stretches into fourth quarter of this year, the planters' profit margins will be badly impacted, analysts say. Each plantation company has a different sensitivity to the price trend, depending on its upstream business exposure. Integrated companies that operate in both upstream and downstream business segments are less sensitive to CPO price fluctuations. Such players include IOI Corp Bhd and Kuala Lumpur Kepong Bhd.
Bursa Malaysia's Plantation Index hit a high of 9,383 points in May before sliding to 8,534.78 points on Sept 2, recording a year-to-date (YTD) decline 4.6%. The sector under performed the FBM KLCI, which saw a YTD drop of 0.1%.
Ivy Ng Lee Fang, an analyst at CIMB Investment Bank, says the current valuation of plantation stocks is reflective of CPO prices at more than RM 2,400 which is higher than current CPO spot prices. This is because the market is hoping for a rebound by year-end.
"Besides, liquidity in the market remains high as investors have no compelling reason to sell their stocks to invest elsewhere even though the sector is facing some headwinds. However, if CPO prices remain sluggish over the next three to six months, the market could be disappointed and there might be a correction," she adds,
Analysts are watching soybean oil prices closely as it is main vegetable oil substitute for CPO. Soybean oil futures tumbled to a four-year low in August on expectations of a bumper harvest.
The November futures contract fell to a low of US$ 10.125 a bushel on Sept 4, a level not seen since September 2010. The US Department of Agriculture on Aug 12 estimated that the country's soybean harvest this year would reach an all-time high of 3.82 billion bushels.
Industry observers believe soybean oil prices will rebound and stabilize as bumper crops in the US are expected to end by November. Nevertheless, some argue that soybean supply will continue to rise as South American Countries, such as Brazil and Argentina, are increasing their soybean planting. As a result, supply in the first half of next year will increase when the harvest period begins.
The global supply of vegetable oil could increase further if El Nino does not happen. In August, Australia's Bureau of Meteorology reduced the probability of an El Nino to 50% from 70% previously. The US National Oceanic and Atmospheric Administration (NOAA), meanwhile, lowered the likelihood of the lowered the likelihood of the phenomenon happening between October and January to ^0% from 65% in its latest weather forecast. If El Nino does not occur or occurs at a level that is less severe than anticipated, CPO prices could be further impacted as the crop harvest will be larger than expected.
Additionally, there is a growing fear of China's crackdown on commodity financing, as investors are trying to get rid of excess palm oil stocks that have arrived at the ports. Importers in China have difficulty raising financing as banks have suspended funding for commodities, following the Qingdao port metal financing scandal.
Despite the poor performance and negative sentiment, the consensus is that CPO prices should rebound by year-end. CIMB Investment Bank has maintained a "neutral" rating on the plantation sector with a view that prices are likely to stay weak until market players have priced in all the factors.
Alan Lim Seong Chun, plantation sector analyst at Kenaga Investment Bank, believes that CPO prices will increase to an average of RM 2,400 per tonne by year-end, in tandem with higher soybean oil prices. " In 2015, we are expecting prices maintain at an average RM 2,500 per tonne. We believe the demand for palm oil from the food sector will be sustainable as the world population continues to grow.
"Some 85% of palm oil production is used to manufacture food products, followed by 10% for industrial use and 3% to %% for biodiesel. Demand from top palm oil consumers, such as China and India, should continue as their per capita consumption should increase in line with better economic growth," he says.
Lim opines that the downside risk is limited because of the demand for biodiesel. "CPO prices should bottom out at RM 2,00 per tonne owing to the support from the biodiesel sector. At that price, and with Brent crude oil prices remaining at US$ 103 per barrel, it is economically feasible for biodiesel producers to run their facility without any subsidies."
In response to the weaker CPO prices, in early September, the government exempted the commodity from export tax for September and October. In June, the tax was lowered to 4.5%. The rates are subject to review every month.
Market observers believe the move should provide some respite for plantation companies as it would enable them to withstand the fall in CPO prices. Eventually, the country will want to expand the downstream business as exemption of export tax on CPO will not benefit the local refineries.Moreover, if the Indonesian government follows suit and adjust its export tax structure, it will no longer be an advantage for Malaysia as Indonesia is the world's largest exporter of palm oil.
In the long-term though, industry players will have to be cost-efficient. Tan Siok Choo, chairperson of United Malacca Bhd, believes that CPO has entered the bear market since prices have dropped more than 30% within the short period of time. She points out that planters are currently in a challenging position and they have to be cost-efficient to maintain margins.
One of the bigger concern is labour shortage. Planters usually hire Indonesia to work on oil palm estates because they are more experienced and have better skills. However, they are plenty of working opportunities in their home country.
"They prefer to work in places like Sulawesi and Kalimantan as the minimum wage in Malaysia and Indonesia is almost the same and they are able to bring their families along. To resolve this issue, United Malacca is hiring workers from Nepal and Bangladesh. " Due to the language barrier and cultural differences, more training is needed to ensure safety and increase efficiency. The faster a fresh fruit bunch is sent to the mill, the better the quality of CPO produced. she says.
Meanwhile, scarcity of land is another challenge local planters face, which has led many of them to expand abroad. Expansion into Indonesia, however, may become more difficult. In mid-August, it was reported that its lawmakers have drawn up a new draft bill to restrict foreign ownership of plantation assets to 30% from 95% currently. The move is intended to give the smaller local players more opportunities .The affected companies will be given five years to comply with the rules, or face a fine, temporary suspension or revocation of permit.
If the draft bill is approved, it will impact Malaysia planters with exposure in Indonesia. According to Affin Investment Bank, Malaysian companies with significant plantation landbank in the country include Sime Darby Bhd, IOI Corp Bhd, Kuala Lumpur Kepong Berhad, Genting Plantations Bhd and Felda Global Ventures Holdings Bhd.
However, this may not come to pass such a move will slow down new plantings in Indonesia and limit its supply growth.
Sources from personal money magazine, October 2014 edition
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