The company subsequently issued a statement explaining that making losses or gains on forward currency contracts are part of the normal course of its downstream business.

Indeed, when the 1QFY2009 financial results ending Sept 30, 2008, were released, the company disclosed total realised forex loss of RM100.6 million, of which RM63.4 million was incurred by its downstream operations while the other RM37.2 million were due to partial conversion of proceeds from its US-dollar denominated borrowings. Unrealised translation loss on its US dollar bonds amounted to RM212.2 million.

Its 2Q2009 results showed even more exceptional item losses on the back of RM76.3 million in customer defaults, mounting translation losses — both realised and unrealised — as well as forfeiture of the proposed Menara Citibank purchase deposit.

And its 3Q2009 results are no better as the dollar continued to strengthen, resulting in unrealised translation loss of RM232.4 million on IOI Corp’s US dollar bonds. The company booked realised forex loss of RM49 million on the partial conversion of proceeds from its US dollar debts for 3Q2009.

Nevertheless, realised forex loss from its resource-based manufacturing declined to RM20.4 million compared with RM57.5 million and RM63.4 million in 2Q2009 and 1Q2009, respectively. Customer defaults also shrank to RM4.8 million.

However, on a cumulative basis, the figures look staggering with unrealised translation losses on the US dollar debt amounting to RM482 million over the nine months when the ringgit fell by about 12%. If you consider all these as exceptional items, they come up to RM905.1 million for the three quarters.

The market took all this in stride, as IOI Corp’s share price remained buoyant following the announcement of its 3Q2009 results despite the RM482 million translation loss for the nine-month period. Investors are likely less worried now than eight months ago because the RM482 million is just paper loss while the realised forex losses from its downstream operations have been dwindling.

Note that there are two elements to IOI Corp’s forex losses — first, those on the US dollar bond and then, those incurred by downstream operations. The long-term borrowings give rise to unrealised translation losses, or gains, when the company closes its books at the end of the reporting period. Gains, or losses, are realised when the company pays back or cancels the loan.

The realised losses and gains on the downstream operations are due to the company’s forward sales of palm oil products. As these sales are in various foreign currencies, the company utilises forward currency coverage and hedging to “match the respective income streams and raw material purchase costs to minimise its exposure to the foreign currency risk”, its October 2008 announcement to Bursa Malaysia said.

A source close to the company explains that in a forward sale, the company would hedge two parts of the transaction — the crude palm oil (CPO) price and forex rates — to minimise volatility and lock in profit margins. The realised losses or gains are due to the difference between the forex rate locked in and the actual rate on the day of delivery.

“It’s an opportunity loss (in the case of losses) and a non-cash flow item,” he says.

Note that in the cash flow statement for the period ending March 31, 2009, the non-cash items written back amounted to RM677.8 million — largely comprising forex losses — compared with -RM219.6 million for the previous corresponding period.

However, blogosphere chatter queries if the forex losses, especially from downstream manufacturing, could have been avoided at IOI Corp and if it should have just focused on being a pure plantation business instead of taking directional bets on currency movements.

But industry observers point out that if IOI had not hedged its forex risk at all, it would go into the market “naked” and the consequences could be dire.

Following the debacle last October, the company had said that it is not its policy to take speculative positions on foreign currency movements.

“Our forward foreign currency coverage and hedging contracts are intended to protect ourselves from the fluctuating foreign currency movements and ensure that the intrinsic value-added margins in our downstream businesses are intact,” it said in a statement.

Planters with huge land banks have little choice but to expand downstream to ensure take-up for its production and ensure they have control over the supply chain. It also ensures they are not subject to the bargaining power of larger buyers.

Analysts say one reason IOI Corp is exposed to currency fluctuations in its downstream operations is its geographical spread, namely, through its subsidiary Loders Croklaan, which is headquartered in the Netherlands and has primary manufacturing facilities in Europe and the US. IOI Corp’s peers are less exposed, given that their downstream operations are either smaller in scale or located in Malaysia.

Wilmar International Ltd, on the other hand, has a larger downstream operation than upstream, making it a net buyer of oil.

Furthermore, analysts say IOI Corp’s forward sales were likely longer than the positions taken by Wilmar. IOI Corp’s forward sales go as far as six to 12 months forward. However, buyers are increasingly less willing to lock in for long periods now due to uncertainty over the direction of CPO prices.

As for investors wondering if the forex losses will become a regular feature in the future, analysts say it all depends on how the US dollar trades. One analyst points out that when IOI Corp recognised forex translation gains in its books in the past, it went unnoticed as the amounts were not as large as the losses seen now. On the downstream side, given the high CPO prices of the last two years, coupled with increased volatility, the numbers became more substantial.

“Companies hedge to derive certainty or stability in earnings but there may be opportunity loss as is the case in any business. It’s very subjective whether you define it as being speculative or to lock in profit. They need to take a position. To be fair, running a business is not as simple as analysts or fund managers view it. It’s reasonable to assume they do it to ensure a degree of certainty,” an analyst says.

This article appeared in the Corporate page of The Edge Malaysia, Issue 757, June 1-7, 2009.