KUALA LUMPUR: UOB Kay Hian Malaysia Research expects all companies under its coverage to register weaker on-quarter results on lower fresh fruit bunches (FFB) production and crude palm oil (CPO) average selling prices in the first quarter ended March 31, 2018.

The research house said year-on-year performances are likely to have been dragged down by the plunge in CPO average selling prices (ASP) despite the FFB production recovery.

“Companies with downstream operations could report weaker results due to smaller refining margins. The potentially weaker 1Q18 results and the bearish outlook could hamper share price performances in the medium term. Maintain underweight,” it said.

UOB Kay Hian Research expects refining margins in 1Q18 to have fallen on-quarter and on-year. Average refining margins were at -RM25 a tonne in 1Q18 vs RM22 a tonne in 4Q17 and RM19 a tonne in 1Q17. 

For 1Q18, Indonesia-based refiners are expected to see better refining margins as compared with Malaysia peers.

Malaysia-based refiners are facing difficulties in sourcing for CPO after the Malaysian government suspended the CPO export duty for three months (might need to pay a premium to source for feedstock), and they are also facing pressure from Indonesia peers who are getting cheaper CPO supplies. 

“Within our coverage, Sime Darby and Kuala Lumpur Kepong have exposure to downstream operations in Indonesia.

“We maintain our view that there will be significant CPO price weakness going into 2018 as palm oil is likely to see oversupply by mid-18. We have Sell calls on Sime Darby Plantation, IOI Corporation and TH Plantations,” it said.

The research house pointed out CPO production growth in 1Q18 moved in tandem with FFB production growth. This indicated that oil extraction rate (OER) has normalised. 

To recap, CPO production growth was lower than FFB production growth in 1Q17 due to lower OER due to high rainfall.

Assumption changes

• No change to the  CPO price assumptions of RM2,400 a tonne for 2018 and RM2,500 a tonne for 2019. For 1Q18, MPOB average CPO price was at RM2,462 a tonne.

• 2Q18: Volatile quarter. CPO prices could hover steadily in the range of RM2,350 to RM2,550 a tonne in 2Q18 as a production recovery is expected to be uneven and vary by region, while exports are likely to be stable on the back of Hari 

Raya festive demand. Thus, inventory could stay at current levels or the build-up would be slow.

• 3Q-4Q18: Downward pressure on prices as production picks up. CPO prices could trend lower to RM2,200-RM2,400 a tonne in 3Q-4Q18 on a significant increase in production assuming no increased palm oil demand from China due to the US and China trade war.

Risks

Factors that will lead UOB Kay Hian Malaysia Research to reverse its Underweight call are:

a) Weather disruption would affect soybean production badly and draw down inventories. This will lead to higher soybean prices, which is positive to CPO prices.

b) The Indonesian government has proposed to extend subsidies to the non-PSO segment. If the incremental biodiesel production volume is sufficient to absorb the additional supply in 2018, it could be a catalyst to CPO prices.

c) Severe labour shortage that could affect CPO production.

d) US and China trade war that proposes a 25% import tariff on soybean could lead to demand shifting from soybean to soymeal. If fewer soybeans are crushed, there will be less soyoil produced and this will give an opportunity for palm oil to fill up the supply gap.

e) Meaningful increase in palm-oil biodiesel consumption globally.