Indonesian Plantation Sector: Helpless

Leonardo Henry Gavaza, CFA
Senior Research Manager
Research Department

On the back of plunging oil prices, we believe Crude Palm Oil (CPO) prices would be helpless, unable to decouple from petroleum price downtrend.  This is particularly true given the country’s recent decision to move away from fuel subsidies, which would spell bad news for the Indonesian government’s biodiesel program.  

Looking ahead, we believe there would be an adverse impact on CPO demand in 2015, as Indonesia’s biodiesel program was expected to absorb around 3mn tons, or around 10% of total Indonesia’s CPO production next year.  In addition, biodiesel demand from other countries could also decline on the back of current depressed levels of oil prices.

Thus, going forward, despite limited production growth of 2.4% y-y to 169mn tons based on USDA forecast, vegetable oils inventories could spike on possible lower demand from world-wide biodiesel programs, which currently account for around 14% of total global demand of vegetable oils. Note that CPO price is currently trading at lower discount to soy oil price, compared to historical level of discount (exhibit 2), suggesting downside for CPO price ahead.

On the CPO supply disruption potential, we see risks continuing to fade as shown by SOI with value unsustainable at below -8, suggesting a low probability of weather disruptions ahead. Furthermore, the Predictive Ocean Atmosphere Model for Australia (POAMA) indicates a low El Nino probability. Despite dry 4Q14 weather, we believe that CPO production in major areas of Malaysia and Indonesia would remain solid.    

Factoring in the recent CPO price weakness, we cut our 2014 Rotterdam price estimate from USD831/ton to USD821/ton, down 3% y-y (Malaysia: MYR2,400/ton). In 2015, we lower from USD866/ton (up 4% y-y) to USD725/ton, down 12% y-y (Malaysia: MYR2,150/ton). However, the net impact on domestic CPO players should be less as export tax is currently zero for Rotterdam CPO prices at below USD750/ton. We also raise our local currency expectation to IDR11,500/USD for 2015 and to IDR11,200/USD for 2016 on improving current account deficits. As such, we lower our 2015F-16F earnings by around 17%-37%.

Given the significant impact of weak crude oil price outlook on CPO price expectations (exhibit 3), we now have an UNDERWEIGHT recommendation for investors with no BUY rating on all the stocks under our coverage.  Risks to our call are  a stronger USD, higher CPO prices and lower fertilizer costs, which would help the performance of the sector.