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This article first appeared in The Edge Malaysia Weekly on February 5, 2018 - February 11, 2018

HAVING started developing its Indonesian estates almost eight years ago, IJM Plantations Bhd is now reaping the benefits as its oil palm trees mature. But in a sector weighed down by back-to-back El Niño dry spells, the company stands out as one of the worst-performing planters. The counter touched a five-year low of RM2.40 last week, down 25.45% year on year.

For perspective, the Kuala Lumpur Plantation Index gained 1.64% in the same period to close at 8,049.13 points last week. Owing to IJM Plantations, 52.2 points were knocked off the index, making the planter the biggest laggard.

Even analysts concur that the stock is to be avoided — there is not a single “buy” call on it. Meanwhile, there are four “hold” and eight “sell” calls.

But for investors taking the longer-term view, the bearish sentiment on IJM Plantations could be an opportunity to accumulate shares on a potential cyclical upturn for the sector. Barring any unforeseen circumstances, such as bad weather, the upside will come as the group’s trees in Indonesia mature.

“Over the last four years, an increasing amount of palm acreage at our Indonesian estates achieved young maturity, thereby requiring costs associated with fertilising, palm maintenance and overheads to be expensed as opposed to being capitalised previously. At present, these palms produce start-up yields, although they attract full maintenance and overhead costs. This puts pressure on profitability in the initial years of the palm,” explains chief financial officer and executive director Puru Kumaran.

However, a significant portion of the group’s 35,000ha of palm plantings will attain prime maturity (8 to 20 years old) over the next three years, he points out. By the financial year ended March 31, 2018 (FY2018), the area of prime mature plantation in Indonesia is expected to increase by 4,000ha from the 1,557ha in FY2017.

Recall that IJM Plantations began investing heavily in Indonesia in 2010. Since then, the group has planted a relatively hefty 35,000ha, more than doubling its pre-existing acreage.

For perspective, the group only has about 25,000ha in Malaysia, around Sandakan in Sabah.

However, it takes roughly three years before the trees start bearing fruit, and more than eight before they truly start producing at prime output. When the trees are still immature (one to three years old), all associated costs can be capitalised. But once they reach maturity — four years and older — these costs hit the group’s bottom line.

Simply put, IJM Plantations has been slowly digesting its aggressive plant-up — the trees are too young to generate strong yields, but the costs are weighing down its bottom line. Of course, it does not help that two seasons of unusually dry weather from the back-to-back El Niño have pushed down the group’s overall yield.

In FY2017 and FY2016, the group saw fresh fruit bunch (FFB) yields fall roughly 20% to 20.1 tonnes and 20.8 tonnes per mature hectare respectively. Thus, despite the maturing acreage (and the accompanying costs), the group’s overall FFB production stagnated at around 860,000 tonnes from FY2015 to FY2017.

But that could be changing.

Indonesian production rose almost 57.5% to 125,290 tonnes in the second quarter ended September last year. It marked the fourth consecutive quarter that the group’s Indonesian operations have outperformed its Malaysian production. On a trailing 12-month basis (ended Sept 30, 2017), the group produced 904,511 tonnes of FFB, an increase of 11.8% year on year.

As the palms recover from the stress induced by the dry spell, and the Indonesian trees continue to mature, so should IJM Plantation’s FFB output, explains Puru.

“In each of the next two financial years (FY2019 and FY2020), over 8,000ha will achieve this status respectively. By FY2021, there will be over 27,000ha of prime mature trees in Indonesia,” he says.

For perspective, the average age of the group’s Indonesian estates is about 6.9 years. Meanwhile, the average age of its Malaysian palms is about 14.2 years, giving the group an overall average age profile of 9.7 years.

“Based on our prime mature trees in Indonesia, we are seeing yield averaging 25 tonnes per hectare. In some of the better areas, yields are as high as 28 to 30 tonnes per hectare,” says Puru, who is confident that output in Indonesia will also be efficient.

If weather conditions are fair, the group’s Malaysian yields should recover to around 25 tonnes per hectare over the coming year, he says. In turn, its Malaysian output should recover to around half-a-million tonnes a year, he adds.

Meanwhile,  its Indonesian output is expected to continue growing.

“By 2020, we hope to hit our target of 1.2 million tonnes per year,” says Puru.

Of course, for the output to translate into strong earnings, crude palm oil (CPO) prices have to hold up. The commodity lost 18.88% year on year to RM2,492 per tonne last Thursday, after nearly touching RM3,200 per tonne last year.

Certainly, the negative newsflow has not helped — the European Union has proposed a ban on palm oil biofuels, reigniting the controversial topic of palm oil sustainability.

Putting the environmental debate aside, Puru argues that an actual ban should not have a strong impact on prices over a period of time, assuming other demand and supply factors remain unchanged.

“The ban would exclude palm oil from being used as a biofuel in the EU, hence requiring a replacement oil to fill the void. This could come from other sources like rapeseed and soy oil but that will, in turn, create another gap in the oils and fats market — a gap that only palm oil can fill. Ultimately, the overall demand and supply of oils should not change,” argues Puru.

Nonetheless, he says the EU’s action that singles out the palm oil industry could have negative consequences in the long run if the ban passes — adding to the unfair negative stigma surrounding the production of palm oil.

On a more positive note, the strengthening ringgit should be a boon for IJM Plantations. The bulk of its borrowings undertaken to fuel the Indonesian expansion was denominated in US dollars. The depreciation of the ringgit had hit the group’s bottom line, with foreign exchange losses of RM11.8 million over the 12 months ended Sept 30, 2017.

The group is expected to book foreign exchange gains going forward.

“Above RM2,400 per tonne [for CPO prices] is comfortable for us. Currently, our Indonesian operations are able to cover costs and service the associated debts,” says Puru.

In fact, depending on CPO prices, IJM Plantations could begin to trim its borrowings with the surplus income over the next few years. And once debt levels come down and interest costs are reduced, the group will be able to pay more dividends.

 

 

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