Integrated Palm Oil Producers Expected to Remain Firm When CPO Rally Fizzles Out


Integrated palm oil producers with upstream and downstream operations are expected to withstand lower crude palm oil (CPO) prices better than pure upstream players once the current rally tapers off.


Integrated palm oil companies are those that operate along the entire, or major parts of the, value chain — from upstream in the plantations to milling, refining, biodiesel production, R&D and consumer goods.


Over the past year, CPO futures contracts have traded as high as RM6, 873 per ton (April 29). Having closed at RM6, 468 last Thursday, the commodity has risen 72.4% in the last 12 months.


“When faced with weaker prices, plantation companies can deploy certain strategies. It all depends on the size of their production and their exposure to the overall supply chain of the market,” says David Ng, senior proprietary trader at derivatives trading firm IcebergX Sdn Bhd.


“An integrated plantation company could withstand price pressure fairly well compared with smaller companies or those that focus on upstream segments, which tend to bear the brunt of falling prices.”


He adds that oil palm companies that have large exposure along the palm oil value chain could potentially deflate some of the price pressure. “Plantation companies can embark on cost-cutting measures like reducing fertilizer application, lowering labor usage by decreasing the harvesting cycle, and mechanization.”


Palm oil producers that enjoyed the higher CPO prices are likely to face compressed margins when prices start to decline, given rising labor and fertilizer costs.


“Producers would have to absorb the increasing cost pressure to produce palm oil. As a result, their bottom lines will be affected,” says Ng.


CPO to stabilize at RM5, 000 to RM6, 000 per ton

CPO prices are likely to stay at elevated levels this year, trading above the RM5, 000 per ton mark in the medium term.


“This is because prices are buoyed by strong fundamentals, especially with weak supply and rising global demand. However, ongoing labor shortages and a lack of yield in key estates are causing pressure on oil palm production,” Ng tells The Edge.

However, smaller planters would fall to price pressure once CPO prices deteriorate, he adds. “Smaller plantation companies with smaller land bank tend to succumb to price pressure. Therefore, the gyration in market prices will cause uncertainty in their respective profits.

“In addition, smaller companies do not have much bargaining power and are not able to pass on the higher input costs to their end-consumer, thus eroding their overall profit margins. Some companies may opt to hedge the price risk using futures contracts to mitigate the price impact.”


Furthermore, the persistent conflict between Ukraine and Russia is causing imbalances in the global vegetable oil market. The region is a major producer of sunflower oil, thus palm oil benefits from the gaps left by other vegetable oil complexes.

Dr Sathia Varqa, founder of Palm Oil Analytics, tells The Edge that CPO prices are likely to move lower from the second half of this year as Indonesia reintegrates into the global export supply and heads into a higher production season.


“Active month will likely move to below RM6, 000 per ton in the June/July period as stocks rise. Protectionist policies are the main factor to watch in edible oil complex prices in 2022 and 2023,” he says.


Going forward, MIDF Research maintains a positive stance on CPO production levels, which will slightly improve following the high season months, better weather conditions and the expected return of 32,000 foreign workers this month.


A better demand outlook on the back of improved economic activity locally and globally is expected to bode well for CPO prices. A drought in South America, which will affect soybean production and tighten supply of sunflower oil on the back of the Russia-Ukraine crisis, could positively impact CPO prices.



CPO production inefficiencies hidden by high prices

Despite the myriad issues of severe labor shortages, rising wage costs, and oil palm product ban risks due to various environmental violations faced by the industry, plantation companies in Malaysia have posted stronger quarterly earnings, beating analysts’ expectations.


The manpower shortage has affected the performance of most plantation companies. Sime Darby Plantation Bhd, for one, said in its press release on its first quarter ended March 31 that it expects lower overall fresh fruit bunch (FFB) production for its current financial year compared with FY2021, as the new intake of foreign workers for the plantation industry is only expected to start in the second half of the year.


According to an AmInvestment Bank strategy report released last week, the FBM KLCI’s 2022F average earnings per share has turned around to a growth of 1.1% from an earlier contraction of 5.6% due to higher earnings revisions, mainly in the plantation and oil and gas sectors.


Meanwhile, plantation companies under MIDF Research’s coverage registered the highest percentage of positive surprises at 71%. “The general improvement in earnings was in line with the higher CPO price, which hovered at around RM6, 000 per ton levels during the period. The average selling price (ASP) of CPO in 1QCY2022 was RM6, 050 per ton (+55.3% y-o-y), representing a huge improvement from RM3, 895 per ton in 1QCY2021,” the research house says in a June 2 report.


Among those that fell short of MIDF’s expectations were PPB Group Bhd and MSM Malaysia Holdings Bhd. PPB’s earnings were dragged by a fair value loss on derivatives, while MSM’s performance was affected by higher production costs, mainly attributed to a weakening ringgit against the US dollar, higher freight charges and higher refining cost from a lower utilization rate factor.


Meanwhile, Sime Darby Plantation, FGV Holdings Bhd, Ta Ann Holdings Bhd, Kuala Lumpur Kepong Bhd (KLK), IOI Corp Bhd, Genting Plantation Bhd and TSH Resources Bhd recorded stellar performances, mainly driven by higher margins owing to the higher average CPO prices realized.


“Nevertheless, the majority of planters were having lower FFB production due to unusually heavy rainfall in January and early February, compounded by harvester shortage,” MIDF says in the report.


AmInvestment Bank’s 1Q2022 report card was mixed as 25% of the stocks under its coverage were outperformers, 48% were in line with expectations and 27% fell short. Of all the sectors, plantation stood out as six out of seven stocks under its coverage outperformed, due to higher-than-expected CPO prices.


The outperformers included IOI Corp, Sime Darby Plantation, KLK, TSH Resources, Hap Seng Plantations Holdings Bhd and FGV Holdings, while the underperformers were PPB and MSM.


Source: www.theedgemarkets.com