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Introduction
Commodities have done well this year, and it’s not limited to crude oil. Just look at the base metals (copper, zinc, tin, aluminum), agriculture (corn, wheat, soy beans, rubber, sugar, lumber) and even livestock (lean hogs and cattle), and you will realize that most are at multi-year highs.
As a result, commodity-related stocks have also boomed in unison.
We do note one exception – Palm Oil Stocks. Despite crude palm oil trading at record high prices, this has not been fully appreciated by some palm oil plantation stocks. In this article, we analyze the universe of SGX-listed palm oil stocks to select the one we believe has the most upside potential.
Article Summary
1) Crude palm oil trades at record-breaking levels
2) List of the largest oil palm plantation stocks
3) Two SGX-listed stocks with solid CPO production growth profiles
4) Why we like “First Resources”
5) Risks of “First Resources“
6) Analyst Ratings and The InvestQuest View
Appendix 1: CPO supply growth constraints
Appendix 2: SGX-listed palm oil stock fundamentals
Appendix 3: Enterprise value divided by companies’ plantation area
The InvestQuest View:
Among the palm oil stocks listed on SGX, we believe First Resources has the largest upside potential. First, as an almost pure-play palm oil plantation owner, the company is set to benefit from record high crude palm oil prices. Second, production volume growth has also been one of the highest among peers in recent years. Third, valuations remain inexpensive at 9x 2021 earnings and offers a good margin of safety. Lastly, we believe that the recent dividend policy update has been underappreciated, and it translates to an attractive 5.2% projected dividend yield for 2021.
Disclaimer: We bought into First Resources on 9th March 2021, and will be looking to accumulate further. This article is meant for our personal investment research and should not be construed as investment advice.
1) Crude palm oil now at record-breaking levels
CPO is now over MYR 4,200 per metric ton!
Crude Palm Oil (CPO) Futures now trades at record-breaking levels of over MYR 4,200 per metric ton, doubling in price since a year ago (see chart below).
Reasons for these record-breaking levels
- Supply growth constraints
- Slowdown in new plantings throughout Indonesia and Malaysia since 2015.
- Replanting of aging oil palms could hamper medium-term production.
- Labour shortage in Malaysia due to ongoing travel restrictions (75% of Msia’s plantation workforce comprises of foreign labour)
- For more details on CPO supply growth constraints, do read Appendix 1.
- CPO substitutes are also at record high prices: Soybean oil and sunflower oil futures have also doubled in price since Mar-2020.
- Biodiesel policies in Indonesia and Malaysia are supportive to CPO demand
- Indonesia has a mandatory biodiesel policy to reduce the country’s reliance on oil imports and support the local palm oil industry. Under the current B30 biodiesel mandate, 30% palm oil content is blended with 70% diesel. According to JPM estimates, 10 million metric tonnes of CPO is required to sustain the existing B30 mandate, equivalent to 12% of global CPO production. There are plans to further increase the palm oil blending ratio to 40-50% in the upcoming years, and research is also being done on a pure 100% CPO-based fuel. Progress on this front would help increase CPO demand in the medium-term.
- Malaysia is also planning to roll out a B20 mandate later this year, which is expected to consume over 1 million metric ton of CPO per year.
While we can’t say for sure where CPO prices are headed to next, the fact is current prices are at record highs and we believe that this has yet to be appreciated by investors – given the current valuations of some palm oil plantation stocks.
2) List of the largest oil palm plantation stocks
Largest Palm Plantation Owners DOESN’T mean Biggest Beneficiaries
In the below chart, we show the largest palm plantation owners in Indonesia and Malaysia. Do note that some of these companies have plantations in multiple countries and the below figures include the cumulative planted area.
The largest palm oil plantation owner might NOT be the biggest beneficiary of rising CPO prices. Some of these companies (i.e. Wilmar) do have sizable exposure to other types of agricultural produce. Hence, we do need to dig a little deeper to decide which company offers the largest palm oil exposure.
Within the above chart, we will be focusing on the companies that are listed on SGX:
- Golden Agri
- Indofood Agri
- Wilmar Intl
- First Resources
- Bumitama Agri
3) Two SGX-listed stocks with solid CPO production growth profiles
From 2015 to 2020, First Resources & Bumitama Agri have managed to grow production volumes…
While the current rally in CPO prices is a boon for all oil palm plantation owners, being able to identify plantation owners with production growth potential would be an extra bonus.
In the below chart, we show the Fresh Fruit Bunch (FFB) production volumes across the five SGX-listed palm oil stocks since 2011. FFB is the fruit from the oil palm tree, and it is processed to derive crude palm oil and palm kernel.
Between 2015 to 2020, only two of these companies have managed to grow FFB production volumes:
- First Resources: +3.1% per annum (2021 guidance: 0 to 5% growth)
- Bumitama Agri: +7.7% per annum
…which is likely a result of the growth in their mature plantation areas
Another way to assess the production growth potential of these companies is to look at the growth of their respective mature plantation areas used in cultivating oil palms, which we have plotted in the below chart.
First Resources and Bumitama Agri have expanded their mature plantations fastest since 2015, among the five SGX-listed stocks.
Both of them have relatively larger proportions of mature plantation area
Lastly, looking at the age profile of the palm plantations across the different owners, we note that First Resources and Bumitama Agri have relatively larger proportions of mature plantation area. This could also be a contributing reason why both of these companies have managed to more consistently grow their FFB production volumes in the past few years.
We’re more confident of these two players increasing their production growth going forward
In summary, from an operational point of view, it seems that First Resources and Bumitama Agri have a slight edge against peers. While historical production growth is not indicative of future growth, their past track records, growing plantation landbank, and plantation age profiles gives us greater confidence that they will be able to increase production volumes during a very favorable year for CPO prices.
4) Why we bought First Resources
Apart from its solid production growth profile, we reveal five other reasons why we are bullish on First Resources:
- Stock price has lagged the CPO price rally
- Profit growth of +78% projected for 2021
- Dividend yield could more than double to 5.2%
- Cheap valuation of 9x 2021 earnings
- Share buybacks send a positive signal
Stock price has lagged the CPO price rally
Despite the positive operating backdrop for First Resources, its stock price has lagged the broader rally in CPO prices. In the below chart, we plotted the share price of First Resources (grey line), against the CPO Futures Price (red line), from 2016 to date.
Given the positive relationship between the two, we see the recent share price weakness (resulting from a 4Q2020 earnings miss) as an opportunity to accumulate.
Within its peer group, First Resources has also lagged, with a negative 25% price return since 2020.
Profit growth of +78% projected for 2021
We have included the historical revenue and underlying net profit for First Resources in the chart below. Consensus analyst projects for 2021 and 2022 have also been included.
Profit projection for 2021 is coming in strong at +78% year-on-year. If CPO prices stay put for the rest of the year, the actual realized profit could be even higher, as analysts are currently using 2021 CPO price assumptions of MYR 2,400 – 3,300 per metric ton, vs the current price of MYR 4,200 per metric ton.
Dividend yield could more than double to 5.2%
During the latest earnings announcement, First Resources management lifted the dividend payout ratio from 30% to 50%.
The impact is significant in our view, as it could result in a more than doubling of the stock’s dividend yield to 5.2%. For context, the current dividend yield for First Resources is 2.1%, and its historical 5-year average has been 1.75% (see chart below).
We project the FY 2021 dividend yield based on the following:
- For FY 2021, assuming the company earns US$173M (as per analyst consensus) and pays out 50% of that as dividends, the projected dividend per share would be S$0.0737. At the current stock price of S$1.42, this equates to a 5.2% dividend yield.
- For FY 2020, the declared dividend per share was S$0.03, equating to a current dividend yield of 2.1%.
We note that several analysts have not yet updated their financial models to factor in the change in the dividend payout ratio, so the 2021 dividend yield illustrated on databases like Bloomberg are currently understated and only shows a 4+% figure.
Cheap valuation of 9x 2021 earnings
First Resources trades at an inexpensive trailing P/E of 16.6x, vs an average P/E of 18x since 2016.
What’s more exciting is that analysts are projecting a 78% year-on-year increase in net profits for FY 2021, which would imply a forward P/E of only 9x!
Share buybacks send a positive signal
In 2020, First Resources conducted share buybacks totaling 5.92 million shares (~US$6 million equivalent). This was done over two separate time frames:
- March 2020 at a price range of $1.22 – $1.53 (when CPO price was ~MYR 2,500 per metric ton).
- August-October 2020 at a price range of S$1.20 – S$1.31 (when CPO price was ~MYR 3,000 per metric ton).
- For context, CPO price is currently at ~MYR 4,200 per metric ton.
Share buybacks are typically done when company management believes that the prevailing share price is undervalued. This sends a positive signal for investors, and if one is to believe that we should see price support at S$1.20 – S$1.30, the downside from the current share price is only about 10-15%.
5) Risks of First Resources
First Resources is exposed to generic risks such as declines in CPO prices, lower than expected production volumes and adverse regulatory changes such as higher taxes and export levies for CPO-related products.
However in our view, the biggest short-term earnings risk is the undisclosed amount of forward sales. As a planation owner, First Resources has hedged a sizable amount of its expected 1H2021 output and some of its 2H2021 output. This means that First Resources had entered contracts to sell some of its 2021 output, at a price that was negotiated earlier (when CPO prices were lower).
As a result, the average CPO sales price for First Resources would come in below-market for 1H2021. This should improve sequentially as we head into 2H2021, when the benefits of higher CPO prices can be more fully captured by First Resources.
6) The InvestQuest View & Analyst Ratings
Among the palm oil stocks listed on SGX, we believe First Resources has the largest upside potential. First, as an almost pure-play palm oil plantation owner, the company is set to benefit from record high crude palm oil prices. Second, production volume growth has also been one of the highest among peers in recent years. Third, valuations remain inexpensive at 9x 2021 earnings and offers a good margin of safety. Lastly, we believe that the recent dividend policy update has been underappreciated, and it translates to an attractive 5.2% projected dividend yield for 2021.
Disclaimer: We bought into First Resources on 9th March 2021, and will be looking to accumulate further. This article is meant for our personal investment research and should not be construed as investment advice.
Analyst Ratings and Target Prices
Analyst consensus is very bullish on First Resources, with a median price target of S$1.85, implying a 30% upside potential.
Appendix 1: CPO supply growth constraints
Indonesia and Malaysia account for 85% of global palm oil supply. Hence, looking at supply-side policies from these two countries could offer insights on the longer-term CPO price trajectory.
Slowing growth of palm plantation cultivation area
Malaysia has capped its oil palm planted area to 6.5 million hectares, given increasing concerns on deforestation. The below chart shows the total area used for oil palm plantations in Malaysia since the 1980s, and its annual growth rate represented by the red line.
Based on current projections, the area used in Malaysia for oil palm plantations is expected to grow at less than 1% per year.
Indonesia’s oil palm plantations have also been in a similar slowing growth trend, with the area used for palm plantations projected to grow at ~1% per year (see chart below).
Aging oil palms in Malaysia and Indonesia
According to the Council of Palm Oil Producing Countries (CPOPC), there is an ongoing decline in palm oil yields due to ageing palms across Indonesia (24%) and Malaysia (30%). Plantation owners will have to replant, which could curtail supply in the medium term, as oil palms take 3-5 years to mature.
- In Indonesia, replanting at an average of 1.0% per annum will take about 1.5 million tonnes out of the supply chain.
- In Malaysia, the replanting rate average at 1.8% per annum is expected to withdraw about 1.1 million tonnes.
- The total withdrawal will be about 2.6 million tonnes out of the potential supply chain in 2021 (global production in 2020: 72.3 million tonnes).
Appendix 2: SGX-listed palm oil stock fundamentals
Appendix 3: Enterprise value divided by companies’ plantation area
Another way to assess if First Resources is attractively valued is to look at the Company’s Enterprise Value (that comprises of Equity + Debt), divided by the total “Plantation Area”.
The logic is similar to buying a house, and thinking of the purchase in terms of dollars per square foot.
In the chart below, we ran this exercise for First Resources and its peer group.
Overall, valuations on this metric have been inching down since 2014.
Within the peer group, we see no big deviation from historical norms. First Resources is currently the “most expensive” on this metric in absolute terms. However, we aren’t reading too much into it, as the company has historically traded at a valuation premium to its peer group average. The historical premium has been US$3,402 per hectare (between 2015-2020), vs the current valuation premium of US$3,059.
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