At this stage of the market cycle, the Predictive Ocean Atmosphere Model for Australia (POAMA) projects a high El Niño probability. However, we expect the real impact of El Niño on companies'€™ oil palm fresh fruit bunch (FFB) production to only be felt in the first quarter, 2016, suggesting higher crude palm oil (CPO) prices ahead based on historical records. Note that every 10 percent increase in the CPO price will result in 23 percent higher overall sector earning price per share (EPS) growth, based on our study.

Another positive aspect for CPO prices on the ground stem from the government'€™s plan to increase biodiesel consumption to 6.14 million kiloliters or 5.3 million tons of CPO next year, from 1.5 million kiloliters or 1.3 million tons of CPO in 2015. Note that we have seen higher domestic CPO consumption starting July (see table), mainly supported by the implementation of the government'€™s policy to increase mandatory blending of 15 percent of biofuel into diesel (government'€™s B15 program), and the Idul Fitri celebration.

On the recent forest fires in Kalimantan and Sumatra, while there could be some distribution channel disruption, overall impact on production growth is limited as the fires have only ravaged 1,000 hectares of planted CPO areas, or 0.1 percent of Indonesia'€™s total. Currently, the number of hot spots is on the rise due to the occurrence of El Niño with 1,465 hot spots in Sumatra (1,025 in South Sumatra) and 350 hot spots in Kalimantan (188 in the west) with the officials aiming to put out the fires by November.

On a more negative note, according to cargo surveyor Intertek Testing Services (ITS), Malaysian exports increased 7.6 percent month-on-month (mom) for Sept. 1-20, helped by the weaker Malaysian ringgit against the US dollar by 25.4 percent year-to-date (ytd), the rupiah/US dollar rate is -19 percent ytd, leading to cheaper CPO for offshore buyers. However, Indonesia'€™s August exports remained flat at 1.9 million tons on the back of new taxes, which created confusion on product delivery at customs points.

Based on the Oil World, India will keep importing vegetable oils at around record levels next season as the dry weather is causing oilseed crop failures for the second year. However, to protect local farmers, India has raised import duties on vegetable oils from 7.5 percent to 12.5 percent, likely to cause lower CPO demand.

Downside risks for the sector include slow demand from India and China because of their economic slowdown. For example, the Asian Development Bank'€™s recent cut in India'€™s 2016 GDP growth forecast to 7.8 percent from 8.2 percent would suggest limited expansion in CPO demand next year. Hence, we forecast limited average CPO price growth to US$690/ton next year, up just 6 percent year-on-year, particularly given the current low oil prices.

At this stage of the market cycle, our 2015 CPO price assumption of $650/ton is still in line with ytd average price of 654/ton. Thus, while we retain our neutral stance on the Indonesian CPO industry, protracted rupiah weakness may raise the sector'€™s attractiveness as we calculate that every 1 percent rupiah depreciation will result in overall net profit growth of 3.5 percent for stocks under our coverage.
______________________________

The writer is a research analyst at Bahana Securities.

Popular

Is Indonesia really ready to embrace dual citizenship?

Tens of thousands seek better lives in Jakarta. But is the city losing its draw?

Elon Musk's Starlink granted licences to operate in Indonesia