Analysing IOI Corp’s Loders sale

This article first appeared in The Edge Malaysia Weekly, on October 16, 2017 - October 22, 2017.
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IOI Corp Bhd has brushed aside concerns that the sale of a 70% stake in its speciality fats player, Loders Croklaan, to Bunge Ltd will lead to earnings volatility for the palm oil player due to a higher exposure to the upstream business, which is subject to fluctuations in crude palm oil prices.

“During the last few years, Loders has accounted for between 10% and 15% of the group’s profit. By selling 70% of the company, we will lose between 7% and 10.5% of the group’s profit but this will be offset by a reduction in interest expense on borrowings, and our profit will be less affected by foreign exchange gains or losses due to our reduced foreign currency borrowings,” IOI CEO Datuk Lee Yeow Chor tells The Edge.

Last month, the group announced the disposal of a 70% stake in Loders to Bunge for RM3.94 billion cash. The proposed sale is expected to be completed by the fourth quarter of next year.

Loders’ profit contribution is not disclosed separately in IOI’s financials. Instead, it is lumped with the resource-based manufacturing segment, which reported a profit of RM318.5 million for the financial year ended June 30, 2017 (FY2017) — 47% lower than the reported profit of RM606.4 million in FY2016. The drop was due to fair value losses on derivative financial instruments of RM70.3 million.

According to a report from Bloomberg Intelligence analyst Alvin Tai, Loders made up half of the group’s downstream revenue.

“IOI will be significantly less profitable after the sale of its speciality fats business. However, its profit margin could rise as the proportion of downstream business relative to upstream business is reduced. The downstream segment margin will fall drastically as it will be left with the relatively low-margin refining and oleochemical [businesses] after the disposal of the highly profitable speciality fats business,” he says.

The resource-based manufacturing segment reported revenue of RM13.8 billion in FY2017, making up 85.5% of the group’s revenue. In terms of segmental profit, resource-based manufacturing contributed 20.4% to the group’s operating profit — second to the plantation segment’s RM1.23 billion (79%).

Nevertheless, IOI did say in its 2017 annual report that the speciality oils and fats sub-segment reported lower profits in FY2017.

“This was fully attributable to the business that was lost due to the temporary suspension by the Roundtable on Sustainable Palm Oil (RSPO), and the subsequent campaigning by several non-governmental organisations (NGOs), pressuring our customers not to resume business with the group until all elements of their campaign had been sufficiently addressed,” it states in the annual report, adding that the effect of the loss was more prominent in Europe and North America.

IOI remarks that over the course of the year, it had won back most of its lost customers.

Recall that IOI’s RSPO certification was suspended in April last year, prompting it to sue the NGO in an unprecedented move. The suit was subsequently retracted and it regained its RSPO certification not long after.

IOI’s troubles with its RSPO certification caused it to lose major customers such as Nestlé, Kellogg’s and Unilever. Also, its speciality fats customers were caught in a bind as they suddenly found themselves without a supplier of highly specialised ingredients for their operations. Loders’ products are used to make confectionery, biscuits, cakes, chocolates and even infant milk powder.

IOI’s move to sell Loders was seen by some as a move to exit an increasingly challenging market, where palm oil producers’ sustainability policies have come under close scrutiny. However, Lee refutes this in his written reply to The Edge, saying that the rationale for the sale is as stated in IOI’s statements on the matter.

Those familiar with IOI and Bunge say that both had, in fact, been discussing a deal even before the RSPO suspension. IOI’s statement on the sale referred to a “period of discussion” with Bunge on forming alliances, which led to “collaborative arrangement” between the two.

“Having engaged with Bunge through this period of discussion as a shareholder of Loders, IOI finds that both IOI and Bunge share similar corporate values and are aligned on business priorities and commitments,” IOI’s statement on Sept 12 read.

Some view the sale as a “loss” for IOI given how big Loders has grown since it was acquired in 2003 from Unilever. In the speciality fats space, it competes with AAK AB, Fuji Oil Co Ltd and Japanese-owned Intercontinental Specialty Fats Sdn Bhd.

“It was a small company when IOI bought it. The group grew and expanded the business. It’s a pity but perhaps a limit has been reached as to how IOI can continue growing Loders,” an industry player says.

IOI’s Sept 12 statement reflects this sentiment: “In order to sustain its significant growth and better serve its multinational customers, Loders will need to expand its processing plant footprint to regions such as South America and South Asia, and offer more varied product offerings, including seed oil-based products. In IOI’s assessment, the faster and more effective way to do so is by leveraging Bunge’s existing plant assets in these regions and Bunge’s established integrated supply chain in seed oils.”

Bunge is a global agribusiness and food company, involved in food processing, grain trading, and fertiliser sale. It is in the same league as Cargill Inc and Archer Daniels Midland Co.

Tai’s report points out that with the sale, IOI would have lost its “key distinguishing factor”. He says speciality fats has been the fastest growing business in IOI’s portfolio over the last 10 years, averaging 5% annually.

It is noteworthy that IOI will be making a gain of RM2.5 billion on the sale, and analysts say it received a good price on the 70% stake. The price tag of RM3.94 billion values Loders at 13 times its FY2016 enterprise value/earnings before interest, tax, depreciation and amortisation (EV/Ebitda), which is the top end of its peers’ EV/Ebitda range.

Furthermore, IOI has said it will use 50% of the proceeds to repay borrowings, which will bring down its gearing from 0.76 times as at June 30 last year to 0.34 times.

Nevertheless, ratings agency S&P Global Ratings has maintained a BBB- long-term corporate credit rating on IOI “because we believe that more volatile earnings will temper the benefits of the debt reduction following IOI’s proposed asset disposal”.

It says it will consider upgrading IOI’s rating if its financial strength improves permanently.

“Post-transaction, IOI will be a smaller company (-20% Ebitda) with less debt (RM5.7 billion pro forma debt). However, IOI will deploy part of the proceeds in its operations (RM1.2 billion), so we are looking to see how the company’s long-term capital structure and earnings profile evolves as everything settles,” S&P analyst Ng Wei Kiat tells The Edge.

IOI has said it will use RM1.172 billion or 29.75% of the proceeds for future investment opportunities. When asked where along the value chain it will invest in, Lee points to the upstream.

“Investment in plantations is certainly an area we are considering. As a group, we will have more financial and management resources to look into acquiring and managing plantation assets, including established plantations,” he says.

This is despite the scarcity of land, and sustainability and local government issues.

Note that IOI has invested in listed plantation companies — it has a 31.8% stake in Singapore-listed Bumitama Agri Ltd and 2.1% equity interest in IJM Plantations Bhd.

IOI is not totally out of the speciality fats game, though. It will still retain a 30% stake in Loders, and has put and call rights over the next five years. This means that during this period, IOI has the right to require Bunge to purchase all of its 30% stake in Loders, and Bunge has the right to require IOI to sell to it the 30%.

“IOI will still be maintaining our business focus of being an integrated palm oil player with a global presence in speciality fats and oleochemical segments. We will still retain full ownership of a substantial oleochemical business and a 30% stake in what we expect to be a growing speciality fats business. In addition, we will maintain our position as a major palm oil supplier to the future Loders,” Lee stresses.

Industry observers say that with the sale, IOI will refocus on its upstream and oleochemical business.

Tai says, while IOI’s oil palm crop yield is still strong at five tonnes per hectare, it needs to replant more aggressively to prevent a decline.

“IOI and United Plantations Bhd are the only companies to have achieved oil palm yields of six tonnes per mature hectare. It is unlikely IOI can achieve that yield again as its prime age trees have dwindled to 58% of mature area versus a high of 81%. It can probably sustain five tonnes per hectare, comparable to peers,” he adds.

IOI’s oil palm yield peaked at 6.1 tonnes per hectare in 2008 when its prime-age trees made up 81% of its mature area.