Small holders have to deal with higher production costs; > Severe Production Risk in 2027F
Most palm oil associations in both Indonesia and Malaysia are now concerned about smallholder farmers, since a rising price of oil, exacerbated by a weaker currency and high fertilizer & associated operational costs, is making it difficult to sustain output from their palm oil estates. Steep fertilizer prices could discourage them from applying a sufficient spread onto crops, with an impact hard to measure until it becomes too late. Historical El Niño impact indicates that this could be happening within the next 8-12 months; we could start to see negative results in 2027F. Indonesian smallholder yields are currently stuck at only around 2-3t of CPO per hectare, a figure some 50% lower compared to an ideal level of 4-6t per hectare. This matters, since 41% of Indonesian palm oil production derives from smallholder estates. Moreover, next year’s planned full implementation of B50 mandates in Indonesia will drastically heighten additional CPO demand, from around 4.2Mt to 18.7Mt, which could result in an acute deficit for the sector, unless we curb our export allocation, instead of prioritizing domestic demand: over the past 5 years we already note a consistent annual deficit of 0.4-0.6Mt. Looking at the current CPO industry setup, if El Niño depresses both Indonesian and Malaysian production, we predict a very tight market supply, draining the inventory to a critical level, unless there is a correction in demand next year. In the most severe scenario, coinciding with a La Niña next year, major soybean producers like the U.S. and Argentina could be facing an acute and persistent drought.
The Malaysia Palm Oil Council (MPOC) expects that we might witness deteriorating yields after 9-12 months, following this El Niño event, as drier conditions and a lack of rainfall will hit the Southeast Asian, Australian and Indian regions. Meanwhile, Malaysia’s Economic Minister has declared they expect an 8-10% lower CPO by yield this year, owing to a projected strong El Niño, as some states are suffering 40-60% less rainfall. 6M26 Malaysia CPO production remains flattish at 9.02Mt (+0.64% YoY), with exports at 7.71Mt (+10.8% YoY), and consumption at 1.82Mt (+7.8% YoY), despite a combination of flat production, stronger exports and a consumption inventory surged to 2.54Mt (+25.3% YoY). This high inventory was mainly driven by carryover from a cycle of unusually higher production from October 2025-Mar 2026. However, the palm trees are now entering a resting phase, following their previously unusual production.
For Indonesia, 4M26 CPO production grew by 13.4% YoY to 20.46Mt, with exports at 11.32Mt (+20.2% YoY) and consumption at 8.66Mt (+ 6.1% YoY), despite a sharp 16.0% YoY production inventory decline to 2.6Mt, owing to strong domestic consumption and busy exports. As of this writing, BMKG expects a peak dry season to run from June-September; however, the El Niño phenomenon will persist until early next year, with a 98% probability of it staying at a moderate level, and a 62% probability of a strong El Niño.

It is still too early to expect any disruption in soybean yields
The arrival of El Niño signified a growing risk of delayed grain planting, and narrowed the second crop planting window (west central Brazil), pointing to lowered crop quality in 2H26F, with a probability of a strong El Niño rising to 81% according to the U.S. National Oceanic and Atmospheric Administration (NOAA). However, a report from Itaú BBA predicts the El Niño effect is expected to vary across Brazil, with drought expected in the north and northeast, irregular rainfall in the central west and southeast, and excessive rainfall and even a high probability of flooding in south Brazil. Despite a potential El Niño disruption, the USDA expects Brazil to reach its third consecutive year of record soybean yields, resulting in 2026-27F marketing year exports bumping up to 184Mt (+2.2% YoY). Crush is estimated at 62.5Mt (2.4% YoY), supported by available supply and domestic demand for meal and oil. Meal is expected to reach 47.7Mt, spiked by strong livestock demand. Around 12.8Mt of soybean harvest is forecasted, the result of a steady increase in biodiesel blending mandates driving domestic demand.
The same story for U.S. soybean production: USDA expects yields to reach 4.47bn bushels (+0.07% YoY), with predicted exports reaching 1.66 (+1.8% YoY), responding to strong demand. Most production increases will be coming from increased acreage.
However, any risk of variable soybean production is usually less severe than it is during episodes of La Niña, since both U.S. and Argentine production will feel minimal impact, with most of the risk In Brazil. However, if we do see a La Niña next year, it might be coupled with a serious persistent rise in both CPO and soybean oil prices, as La Niña will exert a huge impact on U.S., Argentine and some Brazilian farmers. Apart from the weather, rising fertilizer costs and interest rates could cut into their profitability; lighter fertilizer application could impair yields.

Move from NEUTRAL to OVERWEIGHT
We change our sector rating from NEUTRAL to OVERWEIGHT, and we shuffle our pecking order for the sector to DSNG>LSIP>AALI (was LSIP>AALI>DSNG). Since most CPO firms under our coverage have already corrected from their peak, we perceive an opportunity to reenter the sector and position ourselves for a potential rising CPO price next year. We therefore maintain our 2027F TP: DSNG at IDR1,940/sh, and LSIP at IDR2,000/sh, AALI at IDR9,410/sh.

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22 February 2024 - 10.06am

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