Username
Password
Forget Password?
  1. Indices
  2. Commodities
  3. Currencies
Straits Times 3,134.71 +18.54 +0.59%
Hang Seng 26,664.28 +160.35 +0.61%
Dow Jones 27,001.98 -22.82 -0.08%
Shanghai Composite 2,978.71 -12.33 -0.41%
Don’t Write Off Kencana Agri Just Yet
Corporate Digest | 22 May 2014
By: Louis Kent Lee
Articles (199) Profile

Ever wondered what can palm oil be used for?

It’s found in vegetable oil you use for cooking, toiletries such as soap, lipstick that women wear, and even biodiesel used to run machineries.

Possibilities of using Palm oil will span an exceedingly long list. But I’ll not bore you with that.

The palm oil business is no ordinary business. There are many elements to take into consideration when looking at palm oil players.

These factors range from the cost of fertilisers, the weather, the production rate of fresh fruit bunches (FFB), the land bank that you’ve got, and yes, the age of the plantation.

Age Of Plantation
Now, if you take a look at Kencana Agri’s (KA) plantation age compared to the other palm oil players (chart 1), you’d have realised that KA has the highest percentage of young crops.

Source: Annual Reports

For palm oil players, young crops would allow the company to see double digit growth in production yield abilities, and of course, translate to higher output and higher revenue.

That is, if Crude Palm Oil (CPO) prices don’t change too drastically or get depressed.

Imagine if you were an ice cream seller. Your revenue will directly be affected if ice cream prices determined by supply and demand goes lower.

Same concept lies for the CPO prices.

However, CPO prices have been gradually rising. This has largely been priced in by most of the Palm oil players, and technically, this should see average selling prices of Palm oil products KA produce.

Coupling this with expected strong growth from the young crops, this inflow of revenue should be something good to watch.

Price To Sales
Taking into consideration of the expected tailwinds from the revenue, assuming better production growth from its young crops’ profile and better CPO price, the price to sale (P/S) ratio revealed KA to be relatively cheap considering such expected growth.

Relatively close to its P/S is Indofood Agri, which was also affected by the correction of CPO prices last year, but looking relatively cheap if you build in the potential of CPO’s price appreciation and better contributions from its joint venture business (related to sugar).

Source: Factset Research Systems

High Production Cost
Of course, there are thorns sticking out of KA as well. Gross income and net income have been depressed as production costs are extremely high for KA.

This wasn’t helping at all when CPO prices were overtly depressed last year.

Cost of sales for 2013 was approximately 89.9 percent. The primary reason for the high production costs is mainly due to its significantly smaller base (in terms of land bank size), and the huge young crop base under its arm.

Although younger crops can fuel strong production growth, production costs needed to cater to the younger crops is far greater than that of mature crops.

    Investment Merits

  • Palm oil play with the highest batch of Young Crop to spear strong production growth
  • Gradually improving CPO prices, thereby improving average selling price of its products
  • 20 percent stake ownership by Wilmar
  • Relatively low P/S based on potential pick up in inflows expected (assuming CPO prices do not derail coupled with good production growth)

    Investment Risks

  • Adverse weather conditions affecting production rates
  • High costs of operation, big threat to eventual margins
  • Currency fluctuations due to global economic uncertainties that could wipe out earnings power due to currency translation
  • Decline in CPO prices affecting average selling prices of its products

SI Research Takeaway
To a certain extent, concerns that linger on high production costs which could depress margins, due to KA’s young crops’ profile is not invalid.

However, it is not valid to write it off completely when growth potential is normally the strongest in crops that are young and immature.

Coupling this with the gradually increasing CPO prices, this equation spells a pretty good inflow of things to come that is hard to write off.

Louis is a qualified accountant with the ACCA, and is the Research Editor at Shares Investment magazine.

Please click here for more information about this author.


Join The Conversation
The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

All Rights Reserved. Pioneers & Leaders (Publishers) Pte Ltd. Best viewed with Mozilla Firefox 3.5 and above.