‘Wilmar gains from business model’

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Recently, after its full-year results briefing, Kuok Khoon Hong, chairman and CEO of agribusiness giant Wilmar International, was overheard jesting with analysts that his luck was still rather good. The remark wasn’t about Kuok punting big at the local betting kiosk, but rather the company’s remarkable run in churning out profits, with a substantial part coming from trading gains.  Industry observers often attribute Wilmar’s success to its dominance in the edible oils, oilseeds and grains industry. The company essentially commands the entire value chain in the production, processing and selling of palm oil, soyabean and other grains. This unique position, along with its ability to hedge its bets both ways, has reaped significant profits. But as financial markets and commodity prices collapse, concerns are starting to surface over the sustainability of the firm’s trading gains.Kuok’s comment was made in an exchange with RBS analyst Nirgunan Tiruchelvam, who had earlier expressed concern that Wilmar’s “run of success cannot last forever”, particularly in a bear market.  In a Jan 30 report, Tiruchelvam had questioned the company’s dependence on trading profits, arguing that the stock is overvalued because it’s far too risky to depend on such gains in the current environment. The analyst likened Wilmar to a hugely successful gambler, who is “going to run out of luck” eventually.But during the briefing, Kuok took pains to explain to a room full of analysts, bankers and journalists how the company was anything but speculating, saying, “... because I personally would not allow it”.He points out that Wilmar’s hedging of commodities is a pure fiscal operation. “We try to build a business model, which makes us the most efficient, least-cost supplier of the products we are in, and I think to a large extent we’ve succeeded,” Kuok says, “Last year, when prices went up, we made quite good money, when prices came down, we also made quite good money. In this business, if you want to do well, you have to see what the market is likely to do,” he adds.The company, the world’s largest palm oil merchandiser and a top trader in soyabeans, also prides itself on shrewd customer-risk management. “When we thought palm oil prices [were] going to crash we examined all our sales, then we identified those customers where the sale could be in trouble. And then you hedge off all those sales so when prices drop you don’t suffer so much,” Kuok explains.  Such deft handling of the market is clearly evident in Wilmar’s stunning profitability so far. For 4Q2008 ended December, the company managed a 60% y-o-y rise in earnings to US$374 million (RM1.3 billion), although revenue slipped 10% to US$5.83 billion after commodity prices, especially that of crude palm oil (CPO), collapsed during the quarter. CPO traded at just RM1,400 in November last year, some two-thirds off its RM4,200 peak in March.For the full-year, Wilmar made US$1.53 billion on sales of nearly US$29.15 billion. This was 164% and 77% higher y-o-y respectively. Merchandising and processing of palm and lauric-acid oils were the largest contributors to profit before tax, bringing in US$644.9 million, a whopping 2½ times more than the year before, on strong volume growth and higher margins. The company says margins in this segment had grown in the last quarter “due to timely purchases of raw materials and sales of products”.It would have been difficult to not have made money in a commodities boom but as prices collapse, analysts are concerned about how the firm will fare. Indeed, DBS Vickers analyst Ben Santoso writes that Wilmar booked trading gains of US$77.8 million for FY2008, “down from US$300.5 million in 9M2008, which means that 4Q2008 trading booked a marked-to-market loss of US$222.7 million due to the drop in prices”.  In his recent report, Santoso acknowledges that such losses on derivative financial instruments based on the current commodities’ futures prices, is non-cash and does not necessarily reflect operating performance. Nevertheless, he writes “we should note that given relatively more subdued price movements this year, Wilmar may not extract as much hedging gain as it did last year”.With the stock trading at about 10 times its forecast 2009 earnings, DBS has a “fully-valued” call on Wilmar, with a target price of S$2.50. “We do not expect margins to return to last year’s peak levels anytime soon,” Santoso writes. “We believe the group’s growth rate should taper off this year.”No doubt CPO prices are hardly expected to reach their RM4,200 peak soon, but Goldman Sachs believes the CPO cycle has turned and “prices have now started a new up cycle”. CPO rebounded slightly to trade at about RM1,900 two weeks ago.  Analysts note that the CPO price cycle is typically affected by supply. With “tree stress” setting in after a bumper 2008, and Malaysia’s replanting scheme, CPO output is expected to be lower this year. Additionally, bad weather and low fertiliser usage in South America has affected crops of soyabean, a key palm oil rival, driving up prices and making CPO a cheaper and more attractive alternative, thus boosting demand.But, Goldman Sachs also cautions that these factors have been priced in “too much too soon” and expects CPO prices to fall up to 15% in the short term. The brokerage downgraded Wilmar to “neutral” from a “buy”, citing its already rich valuations and limited upside to its target price of S$3.15.For FY2009, Goldman Sachs expects Wilmar to earn US$1.12 billion, down 26% from last year, after a 35% decline in sales to US$18.96 billion. DBS Vickers forecasts FY2009 earnings to slide further to just US$987 million, on the back of US$17.34 billion in turnover.Nevertheless, analysts are still positive on Wilmar’s potential. Goldman Sachs notes the “compelling long-term sustainable growth potential for the company for its three major businesses — palm oil plantations, CPO refining and China agri-processing”.  With its significant downstream operations, some analysts also believe Wilmar’s integrated model makes its earnings more resilient than that of pure planters. “Longer term, investors may get more comfortable with Wilmar’s downstream earnings,” says Goldman Sachs, which estimates the segment to contribute more than 80% of FY2009 earnings.Meanwhile, Wilmar is not going to stop doing what it’s good at. Despite having lost his voice, chief financial officer Francis Heng was still compelled to rasp out during the briefing that the futures market “was not started by Wall Street. It was started by farmers to hedge their products, so we’re doing something that’s been in practice for over 200 years”.Kuok knows that this is the company’s forte. “The beauty of our business is, [whether] the market goes up or down, you can make money.”

Michelle Teo is a staff writer at The Edge Singapore

This article appeared in the Corporate page, The Edge Malaysia, Issue 746, March 16-22, 2009