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This article first appeared in The Edge Malaysia Weekly on May 15, 2017 - May 21, 2017

TIMBER and oil palm group Ta Ann Holdings Bhd may see its plywood division slip into the red following the Sarawak government’s drastic tax hike on hill timber logs from July 1.

The group says it was originally expecting the plywood segment, which contributed over a third of revenue and 4% of pretax profit last year, to break even in this financial year ending Dec 31 (FY2017).

But the tax increase is estimated to add about RM100 per cu m in costs for every cu m of plywood produced by the group. With costs of local plywood ranging from RM1,600 to RM1,700 per cu m, that represents an increase of up to 6%.

To recap, in mid-April, the Sarawak government announced the first increase in the hill timber premium — the tax chargeable on logs harvested from hill forests and hill species logs from agri-conversion areas — in over three decades.

The premium had remained unchanged at 80 sen per cu m for hill logs and RCu m per cu m for logs of hill species from agri-conversion areas since 1986. Beginning July 1, both categories will be charged RM50 per cu m.

However, the impact for the plywood segment is magnified as it takes two cubic metres of raw logs to produce one cu m of plywood, the company explains. “Given the weak market for plywood in Japan, there is little chance of passing on the costs via higher prices to buyers,” a spokeperson for Ta Ann tells The Edge. “Worst case scenario, [we may see] a small loss on the plywood side, in single-digit millions.”

That said, the possibility of the segment posting a loss is only on a worst-case scenario basis, he stresses, given that the hike’s impact would only be felt for six months in FY2017.

He adds that the plywood segment’s performance would depend on selling prices achieved in the coming months, sales volume and the ringgit’s performance against the US dollar.

In FY2016, Ta Ann saw revenue rise 9.4% year on year to RM1.15 billion but pre-tax profit declined by a quarter to RM175.7 million. Group net profit fell 29.4% y-o-y to RM135.1 million.

The group attributed the slowing performance last year to challenging conditions for its timber operations, which offset stronger earnings from its oil palm plantations.

In particular, the average selling price (ASP) for export logs fell 12% y-o-y to US$235 per cu m while the ASP for plywood declined 10% y-o-y to US$450 per cu m.

For perspective, Ta Ann’s timber business has three divisions — logging, sawmilling and plywood. The plywood division made up 34% of revenue and 4% of pre-tax profit, the logging operations contributed 12% of revenue and 35% of pre-tax profit, and the sawmilling division contributed 2% and 1% respectively in FY2016.

It is noteworthy that FY2016 saw Ta Ann’s oil palm segment contribute the majority of group revenue for the first time at 52.9% compared to the timber segment. The oil palm segment also made up 60% of pre-tax income last year.

The oil palm segment has been on a four-year growth streak up to FY2016 on higher volume of fresh fruit bunch (FFB) and crude palm oil (CPO) prices. That may continue if Ta Ann manages to achieve a higher average CPO ASP in FY2017 compared to just below RM2,400 per metric ton (mt) last year.

In a report released last Friday, CIMB Research expects that CPO prices will reach as high as RM2,800 in May and average RM2,600 for 2017 overall.

After rising from around RM2,300 per mt to just above RM3,200 per mt in the second half of 2016, CPO prices have since retreated to just over RM2,600 per mt as at end-April. Ta Ann’s share price has tracked the decline, falling about 16% from the start of the year up to May 12.

Closing at RM3.52 per share last Friday, Ta Ann is trading below all analysts’ target prices at the time of writing. Out of nine analysts tracking the stock, two have “buy” calls, while the remaining seven have a “hold”, with target prices ranging from AmInvestment Bank’s RM3.60 up to Affin Hwang Investment Bank’s RM4.79.

“We still expect to do reasonably well in the oil palm segment given [anticipated] growth in FFB output by around 10% due to growth in mature area and increase in age profile,” Ta Ann’s spokesperson says.

In terms of CPO ASP, “we should be able to do better than last year”, says the company, adding “we have some forward sales which locked in prices at higher levels (above RM2,800 per mt) entered into earlier which will help increase overall sales price”.

Should the segment’s performance remain robust this year, it may offset further softening of the timber division. Overall, the tax hike will add RM8 million to RM10 million to the group’s log costs as half its production is from hill logs.

For FY2017, Ta Ann expects a lower log output of around 350,000 cu m compared to 447,000 cu m last year due to its ongoing forest management units (FMU) certification exercise.

Recall that the state has reduced the log export quota to 30% beginning June 2016. This means roughly 105,000 cu m of the expected log output this year will be exported and Ta Ann is confident that the additional costs from the tax hike will be manageable for export logs.

“The extra RM50 works out to just US$12 at the current forex rate, which is 5% of the export log price — manageable and not impossible to pass on. Furthermore, with tight supplies for logs given the reduced export quota, a 5% to 10% price increase isn’t unreasonable,” says the Ta Ann spokesperson.

For the remaining 70% of Ta Ann’s expected log output, however, processing costs will rise significantly. The group says it typically transfers its non-exportable logs to downstream units via inter-company sales and the transactions are based on market prices.

“Milling logs typically transact at around RM360 per cu m, so a RM50 increase translates into around a 13% increase,” adds the spokesperson.

 

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