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This article first appeared in The Edge Malaysia, on November 9 - November 15, 2015.

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IJM Plantations Bhd (IJMP) is a common stock pick of investment analysts simply because of the young age profile of its oil palm plantations in Sabah and Indonesia.

The average age profile of IJMP’s oil palm trees is 8.3 years — one of the youngest in the industry. The group is perceived as among those that will benefit the most from an increase in crude palm oil (CPO) prices as it will have more to sell, relative to its competitors, since it has a large number of oil palm trees in the prime production phase.

But IJMP’s management does not appear to be that excited about this prospect, at least for now. Instead, it is more concerned about the adverse impact of the recent drought.

“Crop production in Sabah is expected to be down by around 5% for FY2016 (financial year ending March 31, 2016) as we are feeling the effects of the dry weather. But because of an increase in mature areas in Indonesia, the group expects total production to be flat or, at best, slightly higher than last year,” the group’s chief executive and managing director Joseph Tek Choon Yee tells The Edge.

The extended dry spell in the first quarter of this year has had a lagging impact on IJMP’s fresh fruit bunch (FFB) production, he says. “For our Sabah plantations, our woes started [during the drought] in February/March this year. FFB weight has dropped by 5% to 10% since then. The dry weather and El Niño have played a role in this. There are also studies that say a bad El Niño can reduce crop production by 30%.”

A drop in FFB production would mean less CPO and, in turn, lower revenue.

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“For FY2016, we will not hit our aspired target of one million tonnes [because of the effects of the weather] but we will probably be somewhere in the 850,000 to 900,000 tonnes range,” Tek says, adding that the group is targeting FFB production of one million tonnes in FY2017.

Based on these figures, IJMP is expecting its production to remain flat for FY2016. The group reported an 18% year-on-year growth in FFB production to 862,000 tonnes in FY2015, compared with 730,000 tonnes the year before.

Production growth is expected to remain flat in its Sabah estates while the maturing areas in its Indonesian plantations will account for most of its growth — and this trend is set to continue, according to Tek.

If his forecast comes true, the earnings of IJMP (fundamental: 1.60; valuation: 0.80) may shrink further before rebounding.

Already, it has seen its net profit fall 12.5% to RM22.9 million in the first quarter ended June 30, 2015, while revenue slipped 20% to RM141.7 million due to low CPO prices and foreign exchange losses.

The group’s net profit barely grew in FY2015 — it increased 2% y-o-y to RM90.4 million on the back of a 3.2% increase in revenue to RM667.7 million.

Currently, IJMP’s 25,207ha in Sabah contributes the bulk of its production, with some 19,000ha or 76.6% being mature palms between the age of 8 and 20. It also has 33,693ha planted in Indonesia, 97% of which is still under the age of eight (see chart above).

With over 18,000ha in Indonesia planted with trees under the age of three, growth in the medium term could be sizeable. “In two to three years, our Indonesian plantations will reach the age of six to seven [from 4.2 now] and see stronger crop production on an ascending yield trend, which can be expected from that age profile,” says Tek.

Nonetheless, while IJMP waits for these palms to reach peak production — which occurs when they reach the age of about 8 to 15 — the group will have to continue to weather the low CPO prices.

The benchmark three-month CPO futures has averaged at RM2,200 per tonne this year, having hit a low of RM1,867 on Aug 26. The price of the edible oil has since recovered to RM2,398 as at last Wednesday’s close, driven up by the expectation of El Niño and lower production.

Commenting on the CPO price movement, Tek says he expects the price to be on an upward biased trend next year. “El Niño is expected to lift CPO prices because production will come down. We reckon that CPO prices will be a bit more positive in the mid-term, meaning 2016.”

However, analysts expect CPO prices to be somewhat capped at current levels because of the low crude oil prices and competing edible oils such as soybean oil.

Another factor that may limit the upside of CPO prices is Malaysia’s growing palm oil inventory, which hit a new all-time high of 2.628 million tonnes in September. The previous high had been 2.627 million tonnes in December 2012.

To cultivate better earnings growth going forward, IJMP would need to expand its plantation acreage.

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“We are on the lookout for more land, preferably adjacent to our current Indonesian plantations, so that it can add value and synergise with our current operations,” Tek says, adding that the group is only considering brownfield sites due to the current high cost of land.

It is likely, however, that any land purchase will be funded by debt. IJMP had a total of RM717.5 million in borrowings as at June 30, with net debt at RM380.2 million. Gearing was at 0.24 times, a comfortable level for the group, says Tek.

IJMP’s share price has outperformed some of its peers this year and performed better than Bursa Malaysia’s plantation index, which fell 10.4% over a one-year period.

The selldown in the third quarter saw IJMP shed as much as 21.7% over a six-week period to a 52-week low of RM3 on Sept 7. But the stock has since rebounded 20% to as high as RM3.60 on Oct 27.

Some fund managers say the counter is pricey. IJMP currently trades at a 33.9 times 12-month trailing price-earnings ratio (PER), while its forward PER is estimated at 24 times.

According to data from Bloomberg, the 12-month consensus target price for the company is RM3.56, indicating a limited 3.2% upside as at last Wednesday’s close of RM3.45.

The street’s highest target price at RM4.05 (17.4% upside) comes from RHB Research, which has a “buy” recommendation on IJMP, while UOB Kay Hian Research has the lowest at RM2.70 (2.2% downside) with a “sell” call.

“IJMP is on course for steady bump-ups in its mature hectarage to circa 55,900ha in FY2018 from circa 44,300ha currently, mainly coming from its Indonesian land,” Alliance Research analyst Marvin Khor says in a research note dated Oct 30.

He concurs with the management’s view that the net effect of El Niño — higher CPO prices but lower production — could be negative for IJMP. He has a “hold” call on the stock with a RM3.25 target price, indicating a 5.8% downside.

In a note dated Oct 7, TA Securities Research analyst Angeline Chin says, “We now expect total FFB production to grow 9.3% to 942,700 tonnes in FY2016 and [for] FY2017 to be one million tonnes. All in, FY2016 and FY2017 profit forecast has been downgraded by 4.7% and 1.7% respectively.”

The research house still likes the long-term earnings potential of IJMP’s Indonesian operations.

 

 

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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