Potential impact on earnings if CPO yields do not improve, experts say

This article first appeared in The Edge Financial Daily, on April 16, 2018.
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KUALA LUMPUR: The absence of a significant increase in palm oil yield over the past decade is worrying because earnings of plantation players could be potentially impacted as it becomes more difficult to achieve amid factors such as crude palm oil (CPO) price volatility, higher production costs, and climate change.

Owing to the time value of money principle, a dollar received today is worth more than one received tomorrow, pointed out palm oil industry expert M R Chandran.

“Therefore the realised CPO price today has a greater value than the expected price for next year,” he said.

“Cost of production is also a factor due to price volatility. At the current CPO price level of RM2,400 and assuming a cost of sales (excluding land and finance costs but factoring in kernel credit) of RM1,600 to RM1,700 per tonne of CPO in Peninsular Malaysia, and RM1,800 to RM1,900 in East Malaysia, the margins are squeezed if the average CPO yield per hectare of a company is only four tonnes.

“If an average yield of five tonnes or more per hectare can be achieved, the cost will automatically be reduced bearing in mind the high fixed overhead charges, thus leading to better profitability,” Chandran told The Edge Financial Daily.

However, he stressed it was of paramount importance for plantation companies including independent planters and government scheme growers to focus on productivity per unit to remain sustainable.

“Our perennial tree crops like oil palm, rubber, coffee, tea and cocoa are unlike grains, soybean, rapeseed and sunflower. The latter have the advantage of switching crops if there is a crop failure due to extreme weather, pest and disease outbreaks et cetera.

“With our tree crops there is no such opportunity for once planted it has a productive life span of 25 years to 30 years. In the case of tea and coffee, even longer. This is the primary reason why oil palm estates must target an annual average yield increment of 1% to 1.5%.

“In other words, if an operating unit’s average yield this year is 20 tonnes of FFB (fresh fruit bunches) per hectare, it must aim for 20.2 to 20.3 tonnes per hectare the following year to be economically viable, taking into account the inflationary pressure and price volatility,” Chandran said, adding extreme weather events such as El Nino and La Nina climate also pose challenges to crop production.

For instance the prolonged drought in 2015 had a severe impact on yields in 2016 and 2017.

However, the rainfall in the past six months has been favourable to growers which augurs well for higher FFB yields this year and the next.

But to realise the potential gains, good management practices such as nutrient levels, soil moisture and water conservation must also be met.

The age profile of palms is another important factor in determining average yields.

“It is simple — low yield means low production, which translates into low earnings but this is a problem that is impacting smallholders as they are unable to carry out replanting schemes,” said Kenanga Investment Bank Bhd analyst Voon Yee Ping.

It is especially not easy for smallholders to replant even with incentives given by the government because of loss of income over a period of four to five years while the trees are growing, but “not so much an issue for larger players because they have a replanting target of 4% to 5% of total planted hectarage annually which would spread out their risk,” she added.

Last month, industry analyst James Fry said CPO yield per hectare has been slightly up but mostly flat since 2005, a factor that remains the biggest challenge for Malaysia and Indonesia.

He said after the Asian financial crisis of 1997, young estates maturing and fertiliser use saw CPO yields soar, but there has been little progress since 2007.

“So we know there are good seeds available [but] yield has been flat. Is it because of labour problems, because farmers are not managing estates fairly well, estates expanding at more marginal areas with lower yield or is it a lack of proper inputs and maintenance?” Fry asked.

He said data in some states in Malaysia showed lower yielding results than others but it was unlikely to be because of a migration of land to lower yielding areas.

“It doesn’t seem to be true. When you compare palm with soybean crop and rapeseed, they have big investments in new seeds. They are annual crop so they can change quicker [and] they are getting yield increases.

“To me, the labour problem [here] is well-known which was overcame in the fourth quarter of 2017 but the yield problem remains a big one,” he told The Edge Financial Daily recently.

MIDF Amanah Investment Bank Bhd analyst Alan Lim said the national yield level faces challenges because 40% of palm oil growers are made up of smallholders, and they could earn less if CPO prices fall due to lower yields.

Cooperatieve Rabobank UA’s RaboResearch Southeast Asia food and agribusiness senior analyst Oscar Tjakra said a bigger impact in lower yield could be expected in the next three to five years if replanting is not done sooner.

“But that involves cost, and it will take three-and-a-half years to four years before first fruit is harvested. Can smallholders take the loss of income for three to four years? They have limited source of funds and no safe income.

“In Malaysia, it is the labour problem but if it can bring more workers or increase productivity of labour, then in theory [one] can harvest more FFB and produce more CPO but that would not solve the issue of old palm trees.

“Government incentives are only given to smallholders. We need to see more effort to replant bigger areas if we want to maintain year-on-year production,” Tjakra said.

According to Chandran, owing to a labour shortage for harvesting tall palms and resulting crop losses, many planters are now resorting to a 5% to 6% programme to achieve an optimum age profile of 11 to 12 years (compared with the 4% target which is when palms are about 25 years of age).

“Labour shortages also lead to diminishing yields because of the extended harvesting intervals, especially in plantings over 20 years. Unfortunately there have been cases of misplaced investments for greenfield development and brownfield acquisition leading to lack of allocation of funds for replanting.

“Replanting is a major undertaking for it involves planning and adequate resource allocation. Under the current environment if planters can maintain a 4.5% replanting schedule it would augur well for sustained high production bearing in mind the improved quality of the planting materials available in the market.

The hybrid material is known for realising 15% to 25% higher start-up yields in the first three years of harvesting, he said.

Climate change is also an issue, Chandran pointing to 2016, a year that saw no listed company achieve an average yield of five tonnes CPO per hectare due to the impact of the 2015 El Nino.

“Investment in oil palm plantations is for the long term for there will be bad years and good years in terms of revenue and profitability. Therefore managing volatility in production and commodity prices is critical, for the industry is a price taker, and not a price maker.”

Chandran observed in 2017 export proceeds from palm products amounted to RM70 billion after hovering at between RM60 billion and RM65 billion between 2013 and 2016.

“However, we are far off the target of RM178 billion by 2020 set under the Palm Oil National Key Economic Area under the ETP (Economic Transformation Programme).”

Malaysian Palm Oil Board (MPOB) statistics show FFB yield rose 19% in 2013 from 18.89% in 2012, but dipped 17.89% in 2017 while CPO yield fluctuated around 3% over 2012 to 2017.

As at December 2017, MPOB said of 5.81 million hectares of Malaysian oil palm plantation, 5.11 million hectares or 87.9% had trees that are matured, reaching about 20 to 25 years.

From the total planted area, 61% is made up of private estates and the rest consists of independent smallholders (16.9%), Federal Land Development Authority scheme (12.1%), state schemes and government agencies (6%), Federal Land Consolidation and Rehabilitation Authority (2.9%), and Rubber Industry Smallholders Development Authority (1.1%).