This article first appeared in The Edge Financial Daily, on March 21, 2016.

KUALA LUMPUR: After being overlooked for the past couple of years as crude oil prices stayed in the doldrums, plantation stocks seem to be gaining interest now as the commodity’s price stages a recovery,

The interest, ironically, is being driven by the scorching El Nino heat, which is threatening crop yield. Still, sunny days, in more ways than one, are ahead for plantation companies, according to KAF Investment Funds Bhd chief investment officer Gan Kong Yik.

“If you talk about plantation stocks, over the past few years, nobody have even bothered to look at them because the CPO (crude palm oil) price was trading at about RM1,900 per tonne.

“Some of the stocks have been laggard compared to [stocks in] all the other sectors. But sentiments have changed and you can see there are increasingly more people talking about plantations. Interest has been coming in very strongly,” he told The Edge Financial Daily.

CPO prices declined sharply in the middle of 2014 due to larger-than-expected global vegetable oil supplies, weaker demand for biodiesel usage in Indonesia, and low crude oil prices. On Sept 2, 2014, CPO futures fell to RM1,914, the lowest since March 2009.

The Malaysian government stepped in to temporarily waive the export levy in May 2015, which helped to support CPO prices. After almost a year, it announced last week that the export levy on palm oil will be reinstated next month at a 5% rate.

The export duty kicks in when CPO prices touch above RM2,250 per tonne at 4.5%, and can go up to 8.5% when prices exceed RM3,450 per tonne.

For exposure to the sector, Gan prefers palm oil companies with estates that boast trees with a young age profile, such as Sarawak Oil Palms Bhd and IJM Plantations Bhd, as well as those with cheap valuations like TH Plantations Bhd, which is trading around its five-year low.

“We also favour Sarawak Oil Palms and IJM Plantations. They are all good picks because they have exposure in Kalimantan, so their trees are all very young, which means the yields will be better than those companies with old trees,” he added.

Data from the Malaysian Palm Oil Board show that production has been declining since November last year, and stockpiles have been slipping since December last year.

Inventories, comprising CPO and processed palm oil, stood at 2.17 million tonnes at the end of February, down 6.05% from a month earlier. This follows a 7.7% decline in CPO output last month to 1.04 million tonnes, compared with 1.13 million tonnes in January.

As a result, CPO prices have rebounded to above RM2,500 per tonne. The third month futures contract for CPO closed RM29 higher at RM2,622 per tonne last Friday, buoyed by prospects of a sharper decline in inventories expected in the months ahead.

Some, like MIDF Research, think it could touch RM3,000 per tonne in the second quarter of 2016. Its analyst Alan Lim expects the palm oil inventory level to decline to 2.02 million tonnes in March and fall to the “critical” level of around 1.5 million tonnes in the second quarter of 2016 as production declines further due to El Nino.

“During the period of critical level of inventory, we expect [the] CPO discount against soybean oil to diminish and hence, our short-term CPO price target of RM3,000 per tonne in the second quarter of 2016,” he said in a note issued last Friday.

MIDF Research’s top pick is IOI Corp Bhd, due to its rerating potential after it regained its syariah status on Nov 30, 2015, and strong year-on-year earnings growth of 22% to RM778 million in the first half of financial year 2016.

Public Investment Bank analyst Chong Hoe Leong noted that concerns about palm oil supply could spike if stocks decline past the psychological level of two million tonnes.

His full-year average CPO price estimate is RM2,500 per tonne. If inventory drops below two million tonnes, it could hit RM2,800 per tonne.

Besides young tree profiles and those with cheap valuations, investors should consider picking stocks with a pure upstream focus, he said. “Our top pick is Ta Ann Holdings Bhd, followed by TDM Bhd, Genting Plantations Bhd and TSH Resources Bhd.”

Meanwhile, CIMB Investment Bank Bhd remains “neutral” on the sector despite its positive earnings potential, as this is offset by the risk of lower-than-expected production.

“The sector at this moment is positive in the sense that prices are rising. But the concern is that the rise in prices is coming due to a weaker supply situation. So, we are ‘neutral’ on the sector. Our preferred stock in Malaysia is Genting Plantations Bhd,” she said. She likes Genting due to its young estates, solid balance sheet and strong management.

Downstream players, such as Singapore-listed Mewah Group and Wilmar International Ltd, would also reap benefits from the 5% export duty on CPO to kick in next month, she said, as they are likely to enjoy higher processing margins due to the difference between the higher export tax on CPO against refined palm products, which have zero export tax.