Palm oil's tasty buying opportunity

A recent price fall could set up an interesting opportunity, as trees may not mature fast enough to meet future demand

May 22, 2012

Commodity prices generally have been hit hard by the renewed bout of market volatility, and crude palm oil (CPO) is no exception - it's fallen to a five-month low. But the impact of extreme weather conditions on the edible-oil market means prices may well start firming in the third quarter, and beyond 2013 palm oil fundamentals look strong due to a hiatus in planting caused by the credit crunch. All in all, the recent slump could prove to be a buying opportunity.

Last week, New Britain Palm Oil reported that first-quarter revenues had slipped by 26 per cent to $147m (£92.5m), as its plantations took a battering from the freak rainfall that swept across the province of West New Britain. The volume of fresh palm fruit processed fell by 8.3 per cent as the region received more than half the rainfall recorded for the whole of 2011 in just three months.

But weather-related disruption is an inherent feature of agricultural stocks, and the deluge that hit Papua New Guinea may have been linked to the La Niña weather system that was also responsible for drought conditions that constrained agricultural production in parts of South America, including Argentina, one of the world’s principal producers of soybeans. Soyabeans are a key substitutable input, along with palm oil, in the food processing and household goods industries, so supply issues could have a upside for CPO prices later this year.

Palm oil’s centrality to the food processing industries can be gauged by the recent decision of processing giant Unilever to build a $100m palm oil processing plant in Sumatra. The decision followed changes to Indonesia’s export duty regime whereby lower duties will be levied on refined palm products than on CPO shipments. A danger now exists that the decision - designed to boost domestic refining - could conceivably lead to structural overcapacity, as refiners either enter the Indonesian market or expand existing operations.

Singapore - the palm oil capital

There's a handful of palm oil producers trading on the London Stock Exchange, including REA Holdings, New Britain, Anglo-Eastern Plantations, MP Evans, Asian Plantations and Equatorial Palm Oil. However, there are some bigger players close to the source.

Some of the oldest plantations in the region are run by Malaysia’s Felda Global Ventures Holdings Bhd, the country’s largest palm-oil producer, which is pressing ahead with a planned $3bn flotation on the Bursa Malaysia in June, making it the second largest flotation in the world this year after Facebook. About a fifth of the offering's 2.19bn shares are being allocated to ethnic Malays and other indigenous minorities under affirmative-action rules. Anyone wishing to view a prospectus can contact Morgan Stanley, the joint coordinator of the listing, or either JPMorgan or Deutsche Bank which are acting as joint bookrunners.

Malaysia’s Prime Minister Najib Razak is intent on turning Felda into a “global conglomerate”. But his ambitions for the state-owned group would have been further fuelled by the performance of Indonesian palm oil producer Bumitama Agri (SGX: P8Z), which is trading 25 per cent ahead its April float price on the Singapore Stock Exchange. Most of Bumitama's palm trees are either immature or young, with only around 30 per cent having reached peak production age. The company still has well over a third of its land bank unplanted - leaving plenty of room for expansion. Two other Singapore entities – Indofood Agri Resources (SGX: 5JS) and Golden Agri-Resources (SGX: E5H) - are both likely to deliver enhanced yields over Felda due to the relative age of their plantations, according to Citigroup analysts.

However, if you’re after scale advantage within the sector, the most obvious target is Wilmar International (SGX: F34), the world’s largest listed processor and trader of CPO and Asia’s leading agri-business group. With a market capitalisation equating to around £12bn, it’s also one of the biggest companies trading in Singapore, so you can dispel any worries over liquidity. Like Unilever, Wilmar is also forking out in excess of $100m to expand its refining capacity in Indonesia. It’s an obvious pointer to long-term confidence, despite the fact that the group’s first-quarter net profits fell by a third, as margins in its oilseeds and grains business were squeezed by excess capacity in China. Wilmar is an edible oils powerhouse in the region, but price volatility in CPO and demand fluctuations can have a pronounced effect on group performance.

THE ETHICS OF PALM OIL

Most of us sluice, scour or ingest palm oil on a daily basis through familiar products like Flora margarine, Bisto gravy granules, or Britain’s other major contribution to haute cuisine – the Pot Noodle. But the rapid growth in its production has not gone unnoticed by the environmental lobby, which maintains that vast amounts of rainforest have been cleared for palm cultivation.

Unilever knows all about this. The Anglo-Dutch group, under intense pressure from the environmentalists, is committed to securing an ever greater proportion of the palm oil it utilises from sustainable sources. To this end, it recently terminated commercial links with two Indonesian producers – Duta Palma and PT Smart – that were accused of clearing virgin rainforest for palm oil plantations.

Both Duta Palma and PT Smart were members of the Roundtable on Sustainable Palm oil (RSPO); a body set up by Unilever and other stakeholders to promote best practice throughout the industry. Theoretically, the formation of the RSPO should have made it far more difficult to pursue commercial relationships with the likes of Unilever unless you could prove that your palm oil was not produced at the expense of South-East Asia’s dwindling rainforests.

But there’s an anomaly. As part of its function, the RSPO issues GreenPalm certificates that can be purchased by end-users, in much the same way as carbon credits, so there’s no real guarantee that the actual CPO purchased by an end-user is genuine. The certificate only represents a tonne of palm oil produced in acceptable environmental conditions somewhere in the tropics.

For that reason, the certification system has attracted criticism from companies such as New Britain, whose output is fully traceable to source. Part of New Britain’s attractions for shareholders is that they can invest safe in the knowledge that their capital won’t be put to use clearing rainforests, and as consumer awareness grows, the ethical credentials increasingly look like they could feed through to commercial success.

SHOP IN SINGAPORE – THE CPO HUB

Orangutans aside, what is the current pricing outlook for palm oil as part of the greater edible oils market? The first thing to note is that prices for Malaysian CPO futures are being partly governed by worries over Greece's potential exit from the single currency. Last Friday, CPO prices hit a five-month low after posting a 5.5 per cent weekly loss, the worst performance since early December. Analysts at Macquarie Capital take the view that CPO prices had “run ahead of fundamentals” during the second quarter; so a correction would have been likely regardless of the Hellenic impasse, particularly given China’s high current CPO inventories.

Nevertheless, it’s thought that the global supply of soybeans will be at its tightest from June through to September, due to the poor growing conditions in Argentina, which suggests that CPO prices could rebound during the third-quarter. Prices for next year are likely to be kept in check due to production from new plantings that were undertaken in Indonesia from 2007-09. However, the reverse scenario is likely to play out beyond 2013. Economists from Standard Chartered recently pointed out that a shortfall in plantings brought about by tight farm credit in the wake of the last banking crisis would continue to tighten the supply dynamic well into the current decade. It takes around six years to bring new plantings to fruition, so it’s impossible to simply ramp-up production overnight in response to increased demand. It’s also worth remembering that statistics from the US Department of Agriculture indicate that supplies of the main substitutable edible oils – rapeseed (canola) and sunflower – are at their lowest ebb since 1977.