El Nino is typically negative for CPO (crude palm oil) production, but prices tend to rise sharply and overall it tends to be a net positive for plantation companies. For example, after the 1997-98 El Nino CPO production declined 2.7% YoY, but prices increased by 21%. Even if CPO production is not severely affected, there can also be indirect impacts on competingcrops – e.g. during the 2002/2003 El Nino, India experienced a severe drought and domestic oilseed crops failed, boosting CPO imports.
Typically, the negative impact on CPO production from drought only manifests 10-12 months later (although the impact on competing crops like soybeans is more immediate), but share prices and CPO prices react more quickly. For example, in 5 of the last 7 El Nino’s, plantation stocks out-performed the market by 5% - 93% during the event.
Even if El Nino has no significant impact on agriculture production, we remain bullish on CPO price fundamentals due to 1) Slowing CPO production growth (from yield stress and Malaysia’s replanting incentive); 2) Tight soybean supply; 3) Robust, inelastic global edible oil demand and 4) Increasing government mandates for bio-diesel, 5) Rising oil prices. Wilmar (Buy, Conviction List) remains our top pick in the sector, but we note that IFAR (Buy) has the highest earnings leverage to CPO (a 10% increase in CPO boosts 2010E EPS by 21%).
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