KUALA LUMPUR: Many factors, ranging from weather and declining inventory level to tight supply of other edible oil and expected good demand, are pointing to stronger crude palm oil (CPO) prices.

Given the expectation of the buoyant CPO prices, many analysts maintain an overweight recommendation on the plantation companies.  

“There is still room for plantation stocks to climb further simply because of the strong CPO prices. Most of the share prices have yet to factor in the current rally on the CPO prices despite the rise last year,” said a plantation analyst who anticipates an average CPO price of RM3,200 this year.

For every 10% of increase in the CPO price, major plantation stocks could achieve 7% to 15% of increase in their earnings per share. IOI Corp Bhd is the least sensitive to the change of CPO price at 7.4% sensitivity, followed by Sime at 8.3%, KLK at 9.5% and the most sensitive being GENP at 14.5%, according to the analyst who declined to be named.

The CPO prices have been on a steady climb since the middle of last year. The three-month futures contracts rebounded from the RM2,250 level last year to the peak of RM3,860 on Jan 4. The futures contracts closed at RM3,751 yesterday.

Hong Leong Investment Bank (HLIB), which rates the plantation sector as overweight, anticipates a strong earnings outlook on the sector amidst a bullish view on CPO prices and demand.

“We note that there is still plenty of upside to plantation stocks, as the five plantation stocks under HLIB coverage are still trading at below two-year historical forward P/E mean at the current share price level,” it wrote in a research note.

The five stocks under HLIB coverage are Genting Plantation Bhd, IOI Corp Bhd, Kuala Lumpur Kepong Bhd, Sime Darby Bhd and Tradewinds Plantation Bhd.

Genting Plantation share price surged 37.5% in 2010 to RM8.80 from RM6.24. The stock finished at RM8.63 yesterday. Kuala Lumpur Kepong also jumped 34% last year to a record high of RM22.10. It closed at RM21.88 yesterday

However, IOI Corp and Sime Darby appeared to be laggards judging by the share price performance. IOI Corp only gained 6.2% while Sime Darby bucked the bullish trend dropping nearly 2% last year.

Sime Darby is catching up with its peers and soared to RM9.46 at the start of the year. The conglomerate closed at RM9.31, up nearly 6% so far this year. IOI Corp closed at RM5.85 yesterday.

According to ECM Libra Investment Research, the CPO futures are likely to continue their climb, largely driven by further news on poor Argentinean soyabean prospects. The Buenos Aires exchange reported that production is forecast to fall by 15% to 47 million tonnes this year due to a shortage of water supply in the main growing regions.

The good demand shown by major markets such as China and India and the rainy season in most plantation areas in Malaysia and Indonesia were the main factors for the rally in CPO prices.

“We view that CPO prices will continue to hold up over the first quarter this year given the existing supply crunch in the oilseed (soyabeans and CPO) industry,” said ECM Libra which is recommending a trading buy on plantation stocks under its coverage.

An analyst told The Edge Financial Daily that the rally in CPO prices could have been due to the substitute effect of the recent hike in soya oil price.

Soya oil, the main substitute to palm oil, has been on an upward trend due to the dry weather in most of Argentina’s growing area. Argentina is the third largest producer of soya oil, after Brazil and the US. Soya oil futures traded on the Chicago Board of Trade (CBOT) reached a high of US$58.37 (RM178.61) per pound on Dec 31, 2010. The futures contract was at US$57.27 last Friday.

Plantation veteran Datuk Yeo How, who is now the president of Asian Agri Group, anticipates an average CPO price of RM3,600 per tone in 2011. He believes there is potential for the soft commodity rallying beyond RM4,000 in the near term, albeit with greater volatility relative to 2010.

According to HLIB, Yeo expects the high CPO price to extend beyond 1H11, supported by the record-low inventory levels for several major oilseeds, including soyabean, sunflower oil and CPO.

He is of the view that CPO output will recover which potentially would put pressure on the price beyond 1H11. However, the quantum of the crop recovery remains uncertain and this will not soften CPO prices should crop recovery is weak.

This article appeared in The Edge Financial Daily, January 25, 2011.