Published March 5, 2009

Don't write off palm oil and related plays yet

By OH BOON PING

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INTERNATIONAL crude palm oil (CPO) prices have plunged from their record high of US$1,400 a tonne last year to below US$600 now, and the Q4 results of listed stocks such as Golden Agri and Indo Agri have not been encouraging either.

Golden Agri reported a 76.8 per cent plunge in Q4 net profit to US$133.28 million, while Indo Agri turned in a net loss of 757.6 billion rupiah (S$97.4 million), hit by writedowns of their biological assets.

However, it may be premature to dismiss the palm oil plays as several trends in the sector remain intact, which will continue to benefit the CPO plays on the Singapore stock market.

For example, the CPO price cycle is largely supply-driven and there are signs of a price recovery ahead.

These include a biological yield stress where yields naturally decline as the oil palms conserve energy; and a scheme in Malaysia to replant old trees, which could reduce CPO production by as much as 2 per cent this year and next, according to some analysts.

Also, sharply lower soyabean production in South America is expected due to adverse dry weather, and this could translate into higher demand for crude palm oil since both are seen as edible oil substitutes.

On the demand side, orders growth should stay resilient, stemming from higher world demand for edible oil, which is not surprising given the growing population. Also, CPO is continuing to gain market share from its price competitiveness against soyabean oil - all of which means that demand may well outstrip supply this year and next.

On the renewable energy front, bio- diesel policies in several markets have not slowed or reversed despite the slump in the crude oil price from its US$147 a barrel peak last July to under US$37 a barrel now.

Indeed, industry observers believe that governments will push ahead with biofuel policies to reduce carbon emissions and improve fuel security and rural development.

'While developed nations like the EU and the US were, up until relatively recently, the frontrunners in biofuel policy, lately we note that developing countries are also accelerating their policies,' said Goldman Sachs in a report.

For example, Brazil has raised its mandatory blend to 4 per cent - up from 3 per cent previously - starting from April, and Oil World estimates this could add 400,000 tonnes per year of new biodiesel demand. Meanwhile, the US has started mandatory biodiesel blending this year of 500 billion gallons per annum.

Apart from those factors, it helps that CPO is the cheapest edible oil, and this lowest-cost position is important in a downturn.

This comes as the price-substitution effect should trigger demand to switch out of alternative commodities into CPO.

In terms of valuation, Indo Agri looks attractive with its forward price- earnings estimated at 6.73 - below the mean of 7.55 among similar stocks here.

Plus, the company is a major player in the cooking oil segment in Indonesia, thus giving it a buffer in any economic downturn. A successful refinancing of its short-term liabilities and potential synergies from its merger with London Sumatra could also benefit the stock.

Attractive prospects are also in store for Wilmar, which has a 25 per cent share of the world's CPO refining market. As the largest soyabean crusher and the most popular cooking brand in China, it is also set to ride on the Chinese consumer story.

So beyond the present bearishness, there is fuel yet in the tank for palm oil and palm oil-related plays going forward.