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Saturday, June 13, 2009

Here comes the El Niño?

Plantation Overweight

Here comes the El Niño?
Feeling a little hot of late?

El Niño and La Niña are officially defined as sustained sea surface temperature anomalies of magnitude greater than 0.5°C across thecentral tropical Pacific Ocean. The severity of this temperature change is classified by the NOAA in three categories; MILD, MODERATE and STRONG. Direct effects of the El Niño result in drier conditions occurring in parts of Southeast Asia and Northern Australia, increasing bush fires and worsening haze and decreasing air quality dramatically. In the NOAA’s latest report released 8th June, they noted that “conditions were currently favourable for a transition from ENSO neutral conditions to ElNino conditions during June-August 2009”.

Years 1997-8, 2002-3, 2004-5, 2006-7

    The years above represent the previous 4 dry spells we have experienced. 1997-1998 and 2002-3 categorised as STRONG, 2006-7 as MODERATE and 2004-5 as MILD.

Only when Moderate to Strong do CPO prices react

    Based on our observations of data on Malaysia’s stock, production (stock to production ratio) as well as the corresponding CPO price average of the month, we note that the STRONG and MODERATE El Niño events tend to affect prices rather significantly. This was seen in 1998, 2003 and 2007.

    This could possibly bring CPO prices to the next level Hence, should this weather phenomenon occur in a severe manner, we believe it would create more legroom for CPO prices to run. We note that for now, it is only the very early stages of this weather development hence the outcome is highly uncertain. But if the current weather is any indication and that a couple of planters we have spoken to have also noted dryness in estates, this may be a sign of things to come. Needless to say, we will be monitoring weekly reports from the NOAA on further developments.

Maintain Overweight.

    Your browser may not support display of this image.We maintain overweight on the sector for now in view that this development as well as soybean shortages and rising oil prices which will keep CPO prices buoyant for the time being. We are also acutely aware that production trends are beginning to turn up into the high season and if exports turn out flattish, stocks could be on the rise again and put downward pressure on CPO prices. If these positive factors really come into play and if valuations reverted to the upper range of these companies PE Bands, it would appear that there is much room to go for the sector.

Figure 1 : Financial summary of stocks under coverage

Price

(RM) @ Company 10 June

Asiatic 5.75

IOI Corp 4.70

Kim Loong 2.20

TSH 1.92

Sime Darby 7.05

KL Kepong 12.00

Boustead 4.22


EPS (sen)

2008 2009F 2010F

52.2 37.1 43.5

35.7 27.3 30.3

21.5 30.9 24.3

27.0 18.4 19.6

58.4 31.1 49.7

97.5 66.5 74.4

88.9 60.5 73.8


EPS Growth (%)

2009F 2010F

-28.9 17.3

-23.5 11.0

43.7 -21.4

-31.9 6.5

-46.8 59.8

-31.8 11.9

-31.9 22.0


P/E (x)

2008 2009F 2010F

11.0 15.5 13.2

13.2 17.2 15.5

10.2 7.1 9.1

7.1 10.4 9.8

12.1 22.7 14.2

12.3 18.0 16.1

4.7 7.0 5.7


    ROE (%)

2009F 2010F

    11.3 12.1

    17.0 16.0

    21.0 12.1

    14.3 12.1

    12.0 14.0

    12.0 12.8

    11.0 13.0

Dividend

Yield (%)

2009F 2010F

1.7 1.7

2.1 2.1

4.5 4.5

3.4 3.9

2.1 3.5

2.9 4.2

2.4 2.4


The El Niño Explained

Feeling a little hot of late?

El Niño and La Niña are officially defined as sustained sea surface temperature anomalies of magnitude greater than 0.5°C across the central tropical Pacific Ocean. When the condition is met for a period of less than five months, it is classified as El Niño or La Niña conditions; if the anomaly persists for five months or longer, it is classified as an El Niño or La Niña episode. Historically, it has occurred at irregular intervals of 2-7 years and has usually lasted one or two years.

ENSO (El Niño Southern Oscillation) is associated with floods, droughts, and other disturbances in a range of locations around the world. These effects, and the irregularity of the ENSO phenomenon, make predicting it of high interest. Direct effects of El Niño resulting in drier conditions occur in parts of Southeast Asia and Northern Australia, increasing bush fires and worsening haze and decreasing air quality dramatically. Drier than normal conditions are also generally observed in Queensland, inland Victoria, inland New South Wales and eastern Tasmania from June to August. (Sources from Wikipedia)

The first signs of an El Niño are:-

    Rise in surface pressure over the Indian Ocean, Indonesia, and Australia

    Fall in air pressure over Tahiti and the rest of the central and eastern Pacific Ocean

    Trade winds in the south Pacific weaken or head east

    Warm air rises near Peru, causing rain in the northern Peruvian deserts

Your browser may not support display of this image.Warm water spreads from the west Pacific and the Indian Ocean to the east Pacific. It takes the rain with it, causing extensive drought in the western Pacific and rainfall in the normally dry eastern Pacific.

El Niño in recent times

1997-8, 2002-3, and 2006-7

As the chart above and table below indicates, there have been some 3 very significant El Niño events since 1950 (highlighted in grey in figure 3). According to the NOAA (National Oceanic and Atmospheric Administration), the 2002-2003 El Niño barely ranks 10th place over the past half century. The 2006-2007 occurrences reached a similar peak as the 2002-2003 event but lacked staying power and collapsed in 2007 leading into a LaNina event Your browser may not support display of this image.which we recall as heavy flooding seen early 2008 in Malaysia. 1997-1998 was one of the strongest El Niño events of the century.

Your browser may not support display of this image.Figure 2 : ENSO occurrence since 1950 in table format

El Niño ONI Value La Niña ONI Value
JAS 1951 -NDJ 1951/52
    0.8
ASO 1949 –FMA 1951
    -1.7
MAM 1957 –MJJ 1958
    1.7
MAM 1954 –DJF 1956/57
    -2.1
JJA 1963 –DJF 1963/64
    1.0
ASO 1962 −DJF 1962/63
    -0.8
MJJ 1965 –MAM 1966
    1.6
MAM 1964 –DJF 1964/65
    -1.1
OND 1968 –MJJ 1969
    1.0
NDJ 1967/68 –MAM 1968
    -0.9
ASO 1969 –DJF 1969/70
    0.8
JJA 1970 –DJF 1971/72
    -1.3
AMJ 1972 –FMA 1973
    2.1
AMJ 1973 –MAM 1976
    -2.0
ASO 1976 –JFM 1977
    0.8
SON 1984 –ASO 1985
    -1.0
ASO 1977 -DJF 1977/78
    0.8
AMJ 1988 –AMJ 1989
    -1.9
AMJ 1982 –MJJ 1983
    2.3
ASO 1995 –FMA 1996
    -0.7
JAS 1986 –JFM 1988
    1.6
JJA 1998 –MJJ 2000
    -1.6
AMJ 1991 –JJA 1992
    1.8
SON 2000 –JFM 2001
    -0.7
AMJ 1994 –FMA 1995
    1.3
ASO 2007 –AMJ 2008
    -1.4
AMJ 1997 –AMJ 1998
    2.5


AMJ 2002 –FMA 2003
    1.5


MJJ 2004 –JFM 2005
    0.9


JAS 2006 -DJF 2006/07
    1.1



Source: NOAA,

Oceanic Niño Index (ONI) – the defacto standard that the NOAA uses to identify El Niño (warm) and La Niña (cool) events in the tropical pacific. Events are defined as 5 consecutive months at or above the +0.5o anomaly for warm (El Niño) events and at or below the -0.5

anomaly for cold (La Nina) events. These are further broken down into Weak (with a 0.5 to

0.9 SST anomaly), Moderate (1.0 to 1.4) and Strong ( 1.5) events. (www.ggweather.com)

And the next one could possibly be soon…

The latest report on the El Niño development was released on 8th June by the NOAA (http://www.cpc.ncep.noaa.gov/products/analysis_monitoring/enso_advisory/).

In the summary of the report, it was noted that conditions were currently favourable for a transition from ENSO neutral conditions to El Niño conditions during June- August 2009.

However it is pertinent to note that the length and severity of a potential El Niño cannot be measured in these early stages.

El Niño and Palm Oil

Lower stock/production ratio – supply concerns – Higher CPO Prices

We had Asiatic over for a luncheon yesterday during which we received some clarity on the impact of dry weather on plantations. From their observations, should severe dry weather prolong for periods of >6 months, then they will, after a few months into the dry season, start to see dropping yields. However, if the dry period is short and severe, then it could have adverse impact on yields in the coming 12 months. Below we have a chart on Malaysia’s stock to production ratio dating back to 1999 against average CPO prices for the respective months. Ideally we would want to have pre 1998 data to asses the last major drought, but it is unfortunately unavailable from MPOB.

Your browser may not support display of this image.Your browser may not support display of this image.Figure 4 : Stock to production ratio vs. average CPO prices since 1999 .Our observations from the chart above are as follows:-

The last 2 major dips in stock to production ratio were in 2003 and 2007 coinciding with the 2 El Niño events which had an ONI value of >1, indicating a MODERATE drought. We can see that the 2003 stock/production ratio was lower than the low in

2007 corresponding with the higher ONI value of 1.5. The El Niño event in 2004-5 did not have major impact as the ONI value was <1,>

Next we look at how prices reacted during the time. In 2003 there was a definite reaction as prices hit a RM2000 high (this was also seen in 1998 when prices went past RM2400, ONI reading was 2.5, in the STRONG category). Then the 2007-

2008 period of low stock/production caused by the drought also brought prices upwards.

    Simple correlation tests on this data from Jan-99 to May-09 reveal an irrelevant -

0.06 correlation result. However if we tested data from Jan-08 to May-09, correlation improves to a stronger 0.26. Correlation was also stronger if data included the 2003 period. We further deduce from here that when there are El Niño (drought) effects and stock/production ratio is behaving out of the norm, there will be some impact to CPO prices. We also don’t doubt that data from 1997-1998 will yield similar results.

Your browser may not support display of this image.Figure 5 : Correlation results of stock/production ratio vs. CPO average monthly price

      Time Period Correlation

      Jan-99 to May-09 -0.06

      Jan-00 to May-09 -0.06

      Jan-01 to May-09 0.02

      Your browser may not support display of this image.Jan-02 to May-09 0.13

      Jan-03 to May-09 0.18

      Jan-04 to May-09 0.11

      Jan-05 to May-09 0.03

      Jan-06 to May-09 -0.02

      Your browser may not support display of this image.Jan-07 to May-09 0.08

      Jan-08 to May-09 0.26

Source: Bloomberg,

Our better question is if this will happen again? From the appearance of the chart, we would need a MODERATE to STRONG El Niño to take CPO prices to the next level. Needless to say, stock prices will follow. But as said, for now, it waits to be seen.


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