Artemis FA

Why Sarawak Oil Palm is an attractive investment proposition

Artemis
Publish date: Sat, 01 Jul 2017, 08:46 PM

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. 

  2008 2009 2010 2011 2012 2013 2014 2015 2016
Revenue 683250 533304 728158 1166949 1314943 1711402 2874718 3670787 4416122
Growth YoY%   -21.95% 36.54% 60.26% 12.68% 30.15% 67.97% 27.69% 20.30%
EBIT 217078 140694 219732 357648 214606 156420 183548 149239 218816
Growth YoY%   -35.19% 56.18% 62.77% -40.00% -27.11% 17.34% -18.69% 46.62%
EBIT Margin 31.77% 26.38% 30.18% 30.65% 16.32% 9.14% 6.38% 4.07% 4.95%
Net debt (Debt - Cash) -27237 -28928 -63247 -91991 74719 342965 443495 661113 452220

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. 

Production (tonnes) 2010 2011 2012 2013 2014 2015 2016
Crude Palm Oil 16993717 18911520 18785030 19216459 19666953 19961581 17319177
Growth YoY%   0.11285365 -0.0066885 0.02296664 0.02344313 0.01498087 -0.1323745
Crude Palm Kernel Oil 2014943 2144699 2164024 2269822 2277382 2276466 1959423
Growth YoY%   6.44% 0.90% 4.89% 0.33% -0.04% -13.93%
Closing Stocks (tonnes) 2010 2011 2012 2013 2014 2015 2016
Palm Oil 1616237 2058400 2627419 1987111 1902306 2633940 1666673
Growth YoY%   27.36% 27.64% -24.37% -4.27% 38.46% -36.72%
Palm Kernel Oil 245184 285592 374102 343705 299033 336328 222615
Growth YoY%   16.48% 30.99% -8.13% -13.00% 12.47% -33.81%

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. 

Malaysia Palm Oil Exports to Selected Destinations (tonnes) 2010 2011 2012 2013 2014 2015 2016
China 3484779 3982128 3513908 3714517 2856873 2391369 1889566
EU 2064208 2005863 2226848 2336759 2539869 2614295 2116650
Pakistan 2134604 1821099 1343254 1435217 815618 706935 880455
India 1169998 1667908 2639930 2325386 3251564 3686315 2825840
US 1028048 1054997 1029443 1012135 783105 703482 590030
Others (Others, Philipines, Japan, Vietnam, Turkey) 4783431 7461360 6822103 7322809 7787281 8107431 8401125
Total 9881637 10531995 10753383 10824014 18034310 18209827 16703666
Growth YoY%   6.58% 2.10% 0.66% 66.61% 0.97% -8.27%

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. 

Yield Per Hectare 2008 2009 2010 2011 2012 2013 2014 2015 2016
Tonnes FFB / Mature Palms 23.11 21.25 19.87 20.37 18.21 17.09 17.5 18.55 16.79
Crude Palm Oil / FFB 0.2091 0.2157 0.2123 0.209 0.2067 0.2014 0.2026 0.1988 0.1997
Palm Kernels / FFB 0.0436 0.0437 0.0438 0.0429 0.0439 0.0435 0.0439 0.0427 0.042

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. 

Age Profile 2008 2009 2010 2011 2012 2013 2014 2015 2016
Immature 33.34% 41.45% 42.52% 30.94% 28.70% 12.70% 5.30% 3.89% 12.11%
Young (4 - 10 years) 46.45% 38.25% 33.94% 36.99% 39.70% 50.90% 53.10% 54.02% 51.38%
Prime (11 - 20 years) 14.13% 15.32% 16.67% 24.17% 23.80% 26.80% 31.90% 33.48% 31.90%
Old (21 & Above) 6.08% 4.98% 6.87% 7.91% 7.80% 9.60% 9.70% 8.62% 4.61%

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. 

Detailed Age Profile (hectares) 2008 2009 2010 2011 2012 2013 2014 2015 2016
Immature 14837.97 22487.45 25061.29 18236.04 18155.91 8068.31 3358.981 2470.811 10625.8
Young (4 - 10 Years) 13779.39 12150.5 11497.85 12531.1 17907.48 28211.83 31858.41 32978.67 39621.69
Prime (11 - 20 years) 4191.665 4866.551 5647.296 8188.071 10735.47 14854.17 19139.04 20439.21 24599.69
Old (21 & Above) 1803.632 1581.947 2327.35 2679.671 3518.346 5320.896 5819.709 5262.424 3555.002

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. 

  2008 2009 2010 2011 2012 2013 2014 2015 2016
CAPEX -164749 -146248 -138650 -234847 -221253 -157276 -162349 -108894 -344750
% of Sales 24.11% 27.42% 19.04% 20.12% 16.83% 9.19% 5.65% 2.97% 7.81%
Net Cash Flow from Operations 199605 167797 211183 293761 99223 168640 89636 -90793 255855
Free Cash Flow 34856 21549 72533 58914 -122030 11364 -72713 -199687 -88895

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) 

  2017 2018 2019 2020 2021 Terminal
Net Cash Flow from Operations 294233.3 338368.2 389123.5 447492 514615.8 7351654
CAPEX -161228 -169289 -177753 -186641 -195973 -2799615
FCFF 133005.8 169079.4 211370.2 260851 318642.8 4552039
Discount rate 1.1 1.21 1.331 1.4641 1.61051 1.771561
NPV 120914.3 139735 158805.5 178164.7 197852.1 2569508
Net debt -782795
IV per share 4.500053

Cost of Capital

 

Market Capitalization 2030000
Debt 1521218
Cost of Equity 0.15
Cost of Debt 0.05
Tax rate 0.25
Debt-to-asset 0.428365
Equity-to-asset 0.571635
WACC 0.1

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

 

Company SOP Boustead IJMPlant TSHResources HapSengP
Total Planted Area (Hectares) 87744 64500 59595 42103 36145
Entreprise Value 2916460 3115631 3144100 3929451 1915405
Earnings Yield 7.50% 4.59% 2.28% 3.10% 8.73%
Price-to-book ratio 0.991139 1.17833 1.663874 1.57533192 1.018068
Price-to-earning ratio 9.277201 18.25481 37.21663 19.4880888 12.42626
CFFO / Price 12.60% 5.34% 2.13% 5.54% 7.41%
ROE 7.01% 10.40% 13.06% 4.20% 6.80%

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.

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Discussions
3 people like this. Showing 16 of 16 comments

Hafid

Shin Yang is selling to sop because the land is a trouble land. So let sop bear the consequence of it. Own co and way.

2017-07-02 07:38

Jason Lim

Well said Hafid. With Shin Yang in the way, there is no way SOP can spread her wings and soar high. Shin Yang's management is very poor.

2017-07-02 15:28

enning22

what trouble land? all farm lands initially are trouble land ,need to be clear ,get trees planted , and put in sufficient fertiliser,and then land becomes good and productive.ShinYang is operating with insufficient capital, incured debt, need to merge with well funded entity.

2017-07-23 17:46

enning22

the real worry in general,I think is this, people worry about high production in Indonesia,with high supply that may cause CPO price to fall to unprofitable level.This i think is not going to happen.Current Cpo price in world market is around 2500-2600 ringgit per tonnes, and cost of production for CPO ranged from 1500-1700 per tonnes in malaysia.

2017-07-23 18:04

enning22

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).
-----------
the answer to this is quite simple ,the planted acreage this season is report as 7% enlarged as compare to last year, so unfavourable weather may reduce production some what , but still the end result still could be bigger then last year figure.
ON the demand side , you should see China import of soyabean is also increasing with sizeable %. (please refer to USDA world supply and demand report)

2017-07-23 18:22

Good_buy

Q1 EPS 12 sen. Q2 2017 FFB output still up 10% QOQ.

2017-07-23 18:36

Artemis

thank you @enning22 for the extra information. I totally agree about the Indonesian production fear plus Indonesia has been seizing bigger market share over the years. In my own opinion, SOP is highly undervalued and found a bottom already

2017-08-01 20:03

enning22

100% agree

2017-08-07 17:04

joetay

@enning22,

u obviously do not know how things work in sarawak.

the big issue facing plantation companies in sarawak is native land rites issues, which can dragged on for yrs and may not be resolved easily.

even if a company works with the state govt via pelita, the company will still get into legal issues. and furthermore, there is the rspo and csr with major mnc to deal with.

thats why u dont see klk or up venturing into sarawak or even ioi expanding its footprint in sarawak since 2006.

2017-08-08 11:59

enning22

i did see many MATERIAL LITIGATIONs between THPLANT vs respective parties, and not so with SOP, further your accessment of production cost is bias and not correct (refer your post in calvin column).

2017-08-08 16:10

Jaack1

Artemis/Enning22 - thanks for sharing

2017-08-10 14:46

tkt66

Artemis, good evening!

Noticed that you did not add in the following items in your year 2016 capex calculation.

a. Increase in land held for property development
b. Acquisition of additional shares in an associate
c. Additions to land use rights

and added Acquisition of subsidiaries, net of cash into the capex figure.

However, Acquisition of subsidiaries – net of cash was not included in capex for 2010 & 2009.

I am not a financial person, could you please explain?

Thanks & regards

2017-10-12 21:27

tkt66

Another item is (Decrease)/Increase in trade and other payables (516,091) is the culprit of -ve CFFO for Q1 2017 - may I know why this can happen?

$ used to pay Sin Yang for the estates? it is only around 284,432, how to derive to the huge amount of (516,091)?

Hope can receive your reply soon.

Thanks & regards

2017-10-12 21:40

Artemis

@tkt66

a) I took a focused approach whereby I only want to look at their palm oil plantation business since their property business as of 2016 was really small although it is expected to be bigger due to completion of their various Property Development projects. Simply speaking, I personally have no grasp of their future direction with their property segment which is why I try not to put a hard figure for it.
b) Acquisition of additional shares in an associate is 0 in 2016
c) I must have left out this figure by accident as it was a very small figure
d) Same mistake with (c) I apologize for these mistakes

Acquisition net of cash should generally be included in capital expenditure requirement because some companies grow through acquisition instead of investing into new property, plant and equipment. The reason it should be net of cash is because you are acquiring the enterprise (i.e. you acquire the counter-company's debt and cash too so the total price paid is actually market cap + total debt - total cash).

The decrease in trade payables (516091) is just the result of SOP's management of their working capital. It can be because the late payment interest charges are about to be commence that motivate them to pay off the account payable or it can be of other reasons too. I can't confidently say I will know "WHY" they decided to pay off those payables.

If you read page 20 of 2016 annual report, you can see that the company acquired ShinYang with a combination of different financing strategies. I may not be 100% right but these are my takes on this company.

2017-10-14 12:15

tkt66

Artemis,

good evening!

Noted with thanks - the purchase price is not only 284,432 but also inheritance debt of 588,573.

Best regards

2017-10-18 21:27

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