Sarawak Oil Palm Berhad http://klse.i3investor.com/servlets/stk/nb/5126.jsp  is involved primarily in the cultivation of oil palms and operation of palm oil mills. It was listed in Bursa Malaysia since 1991 with a partial public ownership under the entity Pelita Holdings Sdn. Bhd.. For the past decade or so, the company has been very active in its capital investment namely with the addition of three extra palm oil mills totalling 210 TPH capacity excluding the palm oil mill included in its recent purchase of Shin Yang Oil Palm Berhad. Nonetheless, a major concern among investors on the growth of its revenue is its profit margin deterioration coupled with its position from a net cash company to a net debt company. As recent as 2014, the company also incorporated SOP Green Energy Biodiesel Plant which unfortunately happened at a time when the oil price crashed. 

Historical Performance

Referring to historical financial figures below, one can understand why the stock price has been on a declining trend for the past half of the decade. 

Industry Analysis

On the industry level, crude palm oil price trend has been analogous to SOP's price trend up until 2016 where despite an uptrend in crude palm oil price, SOP is penalized by the market due to the fall in output. 

Concurrently, the market is expecting global palm oil output to increase significantly (approximately 10%) as the weather is expected to be favourable around palm oil-producing nations. To make things worse, global markets are forecasting soybean output (a common substitute of palm oil) in USA, Brazil and Argentina to increase significantly despite unfavourable weather forecast in 2017 (I don't know why such paradox appear). Additionally, Malaysian palm oil export share has been declining from 46% in 2011 to 37% in 2016 while Indonesia's palm oil export share has been increasing. (Data from MPOC) In other words, the market's outlook towards palm oil industry especially Malaysian palm oil industry is currently very pessimistic. However, one can interpret differently given the data below. 

Due to ElNino, production of crude palm oil fell significantly and the constant demand for it shrank inventory stockpile very significantly. Thus, the expected increase in output this year in my opinion only compensates not even all but a major part of past year production decline. It is up to the market on how it wants to price CPO but I personally believe CPO price will rebound in the mid-future. Similarly, the market may have penalized the industry's valuation due to its beliefs about the dependence of CPO demand on China yet there may be another more important customer in this business. 

Sure enough, China is indeed still a significant customer but India is currently playing the most important role. If one believes that the Indian consumption power will increase over time given its ongoing structural reform, the quantity of palm oil demanded shall increase. On the other hand, some people are concerned about European Union's decision to continue its import of palm oil products given its high standards of environmental protectionism and etc. but that has been factored into the current price already (IOI Group dispute). From another side of the market, an increase in crude oil price can also be a catalyst for CPO due to the return to biodiesel standard in several countries. 

Company Output Performance

As mentioned above that SOP valuation was penalized by output decline, their recent increase in output due to acquisition of ShinYang Oil may be a potential catalyst for the stock in the mid-term. 

As shown above, SOP's output (industry output too probably) is seasonal with September to February showing declining output while March to August showing increasing output. One can also note that in 2016, annual output is indeed lower due to weather issues but an important point to observe is its output since December 2016. Despite September to February being a declining period, SOP output increased from January due to the incorporation of ShinYang Oil and this can be deemed the "New Low". In coming quarters, output is very likely to be above those achieved during the peak years of 2014 and 2015. Similarly, yield per hectare (in terms of FFB / Mature Palms) in 2017 should be able to outperform last year's yield per hectare given favourable weather condition and probably less tree stress. Based on historical precedence, it is quite likely to happen. 

Infact, the age profile of SOP's plantation is very favourable so investors are rest assured that growth in the incoming years will be significant unless weather disruption becomes a disasterous phenomena. 

The incorporation of ShinYang Oil's plantation since 2016 December made the proportion of ages change as it consist mainly young plantations (which is a good thing). For clarification purpose, I have also provided the numerical figures of the plantation. 

Company Free Cash Flow

Looking through the company's financial performance, it is probable that the market is valuing the company appropriately due to its high capex requirement (whether a huge proportion of capex all these while is considered maintenance capex or growth capex is an important question here). Boiling down tho, capital expenditure as a proportion of sales has been declining so free cash flow may soon be well positive again. 

The latest capex for 2016 includes RM284432417 for the acquisition of ShinYang Oil and I believe the company will tread with more caution now in terms of their capital expenditure given that their debt as a proportion of asset is currently at 43% (quite high which may explain why they conducted rights issue to raise funding although equity cost of capital is higher than debt cost of capital) and is unlikely to conduct additional equity fundraising which may upset shareholders (a little more on this later). Hence, I believe capital expenditure requirement will revert back to the average of 2013 to 2015 which gives approximately RM140 mil. For precautionary purposes, I decide to escalate capital expenditure requirement by 15% which gives RM161 mil. Free cash flow is projected under the assumption that 

i) Net cash flow from operations grow at 15% while CAPEX grows at 5% for the first 5 years.

ii) Terminal growth is assumed to be 3% to reflect inflation rate

iii) Cost of Capital of 10% (refer to below) 

Cost of Capital

As an equity holder, i demand 15% returns as I am very risk-averse and the company has higher financial distress risk. Conclusively, this gives an intrinsic value per share of RM4.50. Based on current price, this provide approximately 20% margin-of-safety.

Valuation Ratios

The peers are chosen based on their relative closeness of market capitalization. Despite being the biggest plantation company in terms of plantation size with one of the most favourable age profile, the company is valued at almost the lowest multiples (PE ratio employs EBIT as earnings while all numbers are based on 2016 Annual report and not TTM). Since almost all of them have negative free cash flow due to high capital expenditure (excluding BousteadP and HapsengP with 2% FCF yield), cash flow from operation yield is more appropriate for comparison. 

Acquisition of ShinYang Oil Plantation

ShinYang Oil Plantation was acquired for a cash consideration of RM284423417 (raised from rights issued) coupled with an inheritance of RM588573458 of debt. Total land acquired is 47000 hectares in which 23798 are planted with oil palms while the balance went to reserves. Out of 23798 hectares, 8161 contains immature plantation while 16066 contains mature plantation. This translates to a price of RM18575 per hectare for the land. As far as concerned, 1 hectare of palm plantation land in Sarawak should be approximately RM25000 (average price seen from land listing sites) so this purchase is a bargain. (No idea how it became such a bargain)

Conclusion
 

Despite uncertain crude palm oil price outlook, the company's valuation must reflect its incoming increase in output. Assuming capital expenditure starts to normalize again, the company's valuation should incorporate the positive free cash flow. At current valuation, it is undervalued and present a considerable margin-of-safety. No doubt now is not the best entry point but should the outlook rotate, its amount of floating share at approximately 11.75% will create a decent tailwind.

P.S. This is not an investment advice and purely reflects my personal beliefs. Please feel free to provide feedback in order for me to improve my work.