Bumitama Agri

Received the annual report few weeks ago. I seriously think that companies should just send a letter to the shareholders to tell them that they can download the annual reports from their website or provide a form to request the hardcopy annual report. Most shareholders don’t read the annual reports. It’s waste of money and trees to print such nice and thick report and send to every shareholder.

So, yes, I hold some shares in this company: Bumitama Agri and I’ll be sharing why I own the shares.

Bumitama is in upstream palm oil business with the plantation estate located in Indonesia. Upstream palm oil means they plant the oil palm trees, harvest the fruits and process them to get crude palm oil (CPO), which they sell to customers. The customers will process (refine) the CPO further (this is considered downstream business) to produce cooking oil or other products.

The fruits are called Fresh Fruits Bunches (FFB).

Strength
– Young and fast-growing producer of crude palm oil & palm kernel.
Oil palm tree takes 4 years to produce fruits. The efficiency of the trees is measured in FFB yield per hectare (in tonnes per hectare or t/ha).
For 0-3 years old -> immature.
For 4-7 years old -> young. FFB yield 5-21 t/ha (increasing as it gets older)
For 8-18 years old -> prime. FFB yield 21-26 t/ha
For 18 – 25 years old -> old. FFB yield 15-21 t/ha (declining as it gets older)
For > 25 years old, planter may consider re-planting the trees.

 

The FFB yield depends on weather, estate location, terrain and estate management. It can even differ widely between two estates with same age profile. Above FFB yield is just for guidance.

Consider those other mature palm oil producers. Their plantation estate average age profile for the mature estate is around 11-14 years old. Those with average age 9-11 years old are considered quite young.

Bumitama’s estate average age profile is just 6.9 years old as at end 2014. About 31% of their planted area is immature in 2014 (was 39.5% in 2013 and 43 .4% in 2012).

Therefore, their production growth can come from two things:
1. growing mature estate size (i.e. from immature to mature).
2. Young mature estate turning to prime age, hence the FFB yield increases.

Look at the plantation statistic below. Total planted area has grown by 42.5% over the past 5 years, while the FFB yield has grown by 21.8% to 18.4 t/ha. As a result, FFB production has grown by 162%. Note that they also bought FFB from third party to process, hence their CPO production growth rate is lower at 140.8%.

CPO is the end product that they sell. So, usually we measure production growth in this term. 2014 saw CPO production growth of 18.3%.

This year, CPO production growth should be in the range 15-20% (assuming normal weather and third party FFB purchase has small increase). I don’t usually estimate to a single figure because it’s really subject to weather and the trees’ production cycle. In 2015, 15,000 ha is estimated to mature. That’s about 14% of current mature area. However, the FFB yield from newly mature estate will be low, hence, the FFB production from this 15k ha newly mature area is only about 100kt (5% of 2014 total FFB production). So, the remaining growth has to be from increasing FFB yield of the young and prime estate.

Given this age profile, the production growth for next 3-4 years should be above 10% per year.

– IOI Group is the major shareholder of Bumitama.
IOI is mature integrated palm oil producers in Malaysia with high FFB yield. The founder is known as a “tree talker”, who talks to the tree and cares for them. A billionaire.

Bumitama’s CEO said IOI wasn’t involved in any of their decision making during the last meeting. With IOI as major shareholder, I do think good practices from IOI (considering their high yield) can be brought over to Bumitama.

– Low production cost
Their nucleus unit cost of production in 2014 was Rp 3704/kg of CPO or roughly USD 310/t. This is considered quite low compared to the peers (many other producers are in the range USD 300-400/t). As the estate becomes more mature, FFB yield will increase, hence pulling down the unit production cost in future. But, of course, production cost in this sector keeps rising because the minimum wage in Indonesia keeps rising. Salary contributes about 40% of the production cost for Bumitama (keep increasing in proportion)

– High margin
This relates to the low production cost above. Their EBITDA margin for the past 3 years was 36 – 37%. Net margin 23.8 – 25.6%. With such high margin, there is much room for the price to fall or cost to increase before the company incurs losses. So, with this margin, this is a company in good shape and has low risk of running losses.

Weakness
– Keep facing issues with NGO on planting new trees.
Available landbank to plant trees is reduced after more stringent survey was conducted.

– Slowing new planting
New planting has reduced from 10-13k ha per year in the past to ~4k ha per year in the last 2 years. Going forward, new planting will be around ~4k ha as well. This is due to the issues they faced with NGO above. This will only impact the production 5-6 years from now, but the company is not able to perform at the capacity that it intends to perform.

– High customer concentration.
86.4% of the revenue came from just two biggest customers in 2014. Bumitama doesn’t have refinery to better manage its product pricing.

Opportunity
– Indonesia government has come out with a few regulation to support palm oil price. The recent one was biodiesel implementation. This will increase palm oil consumption, hence increase the price. The regulation is aggressive, but the implementation doubtful. The officials were so confident and bullish at the start on the announcement, only to report disappointment later. This is well known in the market.

– Given its strength above, the production growth for next 3 years will be above 10% per year. This year is expected to record 15-20% production growth. It’s a strong growth for the company.

– Market estimates that the marginal cost of production is around RM 1800 – RM 2000/t. Current CPO price is in the range RM 2100-2300/t. RM 2100/t seems to provide a support level to the pricing. So, CPO price is near the bottom of the range, hence any pick up in demand or disruption to the supply will raise the CPO price.

Threat
– Fluctuating Palm Oil price.
This is the risk in all commodity business. It can be positive or negative. See the earlier post on forecasting CPO price.

– Rising cost
Minimum wage in Indonesia is rising by double-digit percentage every year. This year at about 9-13% depending on the region.

– Bad regulation kicks in
This is rather unpredictable. Some bad regulation in the past was like limiting the estate size to 100k ha.

CEO

Analyst 1: what area can the company improve?
CEO: which area have we not done well?
… (silence in the room)

Analyst 2: Given that you (CEO) are involved in the parent company’s business (not exactly parent company, but larger group’s business, which can demand lots of attention), how much time do you spend on running day-to-day business of Bumitama?
CEO: How long have you been covering this business?
Analyst 2: not very long.
CEO: No wonder you asked this question. …
The CEO continued to explain that it’s not about the time spent but about how to solve problem, how to contact, etc.

That’s part of the conversation in the last meeting I attended during their result briefing. Not exact quote word-by-word as I didn’t tape it. But you get the idea. What do you think of the response? Quite defensive? I think so. But I do think it’s quite true that in Indonesia, especially for things that need government approval, relationship is the key. Who you know may be more important than any brainstorming to solve the problem. I do hope the CEO is focusing 100% on this business. If the top leader is letting the 2nd in command run the whole show, while he himself focuses on some other business, then why not let the 2nd in command take full charge and title away from the top leader. The CEO can just run as chairman, not CEO. This is a public listed company with many shareholders, not a family business. Shareholders deserve full commitment from the CEO to run the business.

Other drivers
There are many other drivers that I didn’t discuss here that could affect the business of Bumitama to certain extent. It’s more sector drivers than company-specific drivers. Being in commodity business, any change in the price will surely affect the company itself. But by discussing every single driver, this is more like a report to initiate a coverage on Bumitama, which typically takes a dozen to three dozen pages. What I have written above is already quite long. Let’s go to something more interesting.

CPO Price
The most important driver is, no doubt, CPO price. I have discussed in my previous post that forecasting CPO price does not have high chance of success. But, if CPO price falls sharply, then all the reasonings to invest in Bumitama do not matter anymore because a sharp fall in prices can bring the company to losses in short time. So, here, we’ll discuss the CPO price again.

Is current CPO price of RM 2156/t sustainable? Is it facing more downtrend or uptrend in near future?

Look at the CPO price chart below (unfortunately, without bloomberg, I can’t pull out a nice chart instantly and have to rely on available price chart on internet)

CPO Price 2011-2015

As you can see, 2011 was the peak of all time. The bottom in the past 4 years is around RM 2000-2100/t. In the last 1 year, prices fluctuated in the range RM 2100-2300/t. Technically (I will share in another post about my experience in technical analysis), RM 2000/t provides a support level, meaning the price will usually bounce upwards when it’s approaching RM 2000/t.

Marginal Cost of Production
Any reason why RM 2000/t is the support level? Coincidentally, market research reported that marginal cost of production is around RM 1800-2000/t. That means, if the price falls below RM 2000/t, the highest cost producers will start losing money. Usually, when the producers start losing money, they may be forced to cut their production to reduce losses. Once production is cut, overall supply is reduced, and price will be supported and lifted up.

These marginal cost producers are those small planters in Malaysia. They are not managing their small estate as efficiently as the big players, and their FFB yield could be lower than that of those big players. Indonesia small planters have lower cost because of their lower labor cost and land cost.

It’s theoretical that once the price falls below marginal cost of production, supply will be cut. However, I think this may not necessary happen because marginal cost producers may have their other internal fixed cost, which they have to incur anyway, and by cutting the production, they get lower sales and may incur higher losses. Also, once you cut the production and retrench some staff, the morale drops and productivity may drop. They may end up in worse shape. Palm oil business is a very labor intensive business.

Therefore, the argument that RM 2000/t provides support level is described above. I’ve also provided the counter argument that it may not work. Technically, based on the price chart, that shows a good support level though. Just like when general stock market falls, a certain stock price may fall and hit certain price level that it never breaks. It will always bounce upwards near that support level. It can be hard to justify that support level for that company but it does happen several times. So, psychologically, investors will rush to buy in when the support level is reached.

I’m of the view that RM 2100/t provides a good support level to CPO price. As current CPO price is already at RM 2156/t, it’s already near the bottom. Current share prices of palm players may have reflected this low CPO price level. So, any upside move of the CPO price will bring upside to the earnings potential of the palm oil players, thus bringing upside move to their share prices.

So, for now, the price is considered bad. That means if we invest now, we are not buying when the price is high. We are buying near the bottom instead.

Share Price Support Level
Technically, based on the price chart, 0.90 provides a support level to the price. 0.90 was hit or nearly hit in each of 2012, 2013 and 2014. From 2012 to 2014, EPS has grown by 46% in local IDR currency while CPO production has grown by 33.8%. However, current share price is slightly lower than 2012’s year end price. So, either 2012 was overpriced or current price is undervalued/fairly valued. Of course, current price could also be overvalued, but the company has indeed grown its business bigger with 46% higher EPS and 34% higher production than two years ago.

The downside for Bumitama’s share price, based on the support level, is 10% fall, while the upside could be more than 40% gain in 3-4 years provided that CPO price does stay around RM 2100-2300/t range. If CPO price recovers to higher price, that will provide additional boost to the earnings, hence the share price.

There is a flaw to assume that the downside is just 10% based on technical analysis. In short term, stock market is rather unpredictable and 20-30% fall in some share prices is not uncommon. This even happens to super large and outstanding companies. So, bear that in mind. I highlighted support level at 0.90 just to share my experience and my little technical knowledge to look at price chart.

Bumitama - share price - 2014 Apr
Source: https://sg.finance.yahoo.com/echarts?s=P8Z.SI

Valuation
Bumitama EPS for 2014 was Rp 696 or SGD 6.9 cents. Currently, it’s trading at 0.995. So, (TTM) P/E ratio of 14.4x.

Its bigger peers who are listed in SGX are trading at 12-14x PER while their production growth rate is just 5-10% per year vs Bumitama’s 15-20% per year. These peers have other downstream palm oil business, which is less profitable, and other smaller businesses, such as sugar, soybean crushing or consumer pack, but generally less profitable than palm oil upstream business. Compared to these larger peers, Bumitama would have been considered cheaper.

Given the production growth of >10% over the next 3-4 years, Bumitama will be able to grow its earnings from current SGD 6.9 cents to 9-10 cents in 2016-2017. After that, the growth can be around 10%, still faster than the growth rate of the bigger players. If we assume a conservative PER of 12x at that time, the company will be valued at 1.20. If we assume a more aggressive PER of 14x, the company will be valued at 1.40. That’s 20-40% higher than current share price.

Above estimation has factored in the earnings growth rate of 10-20% for next 3 years. Bumitama has demonstrated its ability to grow at this rate in the past, and based on the current estate profile, it is able to repeat the growth for next 3 years. When analysts are projecting future earnings growth, it’s almost always positive growth, and that’s why forecast miss happens so many times. Just look at the analysts’ reports of those companies waiting to be listed. Almost always fast growth supported by good reasonings. So, I could have made the same wrong assumptions (aggressive assumptions). (I will share in another post how it can be dangerous to rely on analyst’s forecast earnings to buy the stocks because the forecast earnings tend to be more bullish and less reliable)

Now, assume that company is not able to grow its earnings as CPO price falls or costs have escalated faster than expected. So, earnings remain flat at 6.9 cents. With potential growth rate of 15% this year and next year, current share price of 0.995 at PER of 14.4x looks fair to me.

Do note that commodity is a cyclical sector, and current CPO price is at down cycle. Palm players’ share prices have also been near the bottom of the cycle. Any potential rally in CPO price will lift the share prices, and that provides a bonus to investors. I’m not expecting CPO price to recover anytime soon though.

Valuation using P/B multiple. I don’t use this method because the book value of the biological assets (plantation estate) can get adjusted (re-priced) following changes in CPO price. Also, for two plantation estate of same size but at different location, they can have different yield due to different style of management, fertilizer applications, terrain, quality of seeds, weather, etc. Therefore, the estate should be valued differently. There is no way I can value the estate based on the quality. I may use the market benchmark or recent market transactions to value them but that sorts of classifying all the estate under the similar quality. So, I’m not attempting it here.

Valuation using DCF. Theoretically, DCF is a very good valuation method. However, for a commodity business like this, where price can fluctuate widely (see my earlier post on forecasting CPO price), your CPO price assumptions for future years (10 years!) are almost definite to be wrong. Since we can’t even get that right, how do you expect to do DCF properly?

Forex
It’s true that IDR (Rupiah) has been weakening in recent years. That means if Rupiah weakens further, the local currency earnings will be worth less SGD when converted. Commodity products, including palm oil, are traded in USD in international market (i.e. export and imports transactions are done in USD). Malaysia and Indonesia domestic consumption of palm oil is just a small part of overall global consumption. So, the market for palm oil is still on export. When Rupiah weakens, domestic CPO price usually gets adjusted up. That is, if Rupiah weakens by 10%, domestic CPO price goes up by ~10% (just theoretical, not perfect correlation, but the effect is there). So, there is a natural hedge here. The cost (mainly labor cost) remains in local Rupiah currency. Hence, a weakening Rupiah environment usually benefits palm producers as they’ll have higher earnings. If both Rupiah and USD weaken against SGD, then you’ll get less when everything is converted to SGD.

Price Range
Here, we have discussed that the downside is technically supported at 10% fall, current share price is considered fair and potential return for next 3-4 years could reach 20-40%. Therefore, I consider it a safe investment to provide satisfactory return in future.

However, in short term, don’t be surprised if the share price falls by 20% or more. As mentioned earlier, in short term, stock market is unpredictable. If luck is on your side, you may see a short term rally in CPO price to above RM 2500/t, hence lifting Bumitama’s share price to above 1.20. I can’t predict the price of CPO nor the price of Bumitama in short term and it’s best not to waste too much time predicting it.

Conclusion
That’s my analysis on the attractiveness of Bumitama. I consider it fairly valued and have potential to return 20-40% in 3-4 years. If CPO price, which is near the bottom of the cycle now, rallies, I’ll get added bonus of perhaps another 10-20% return. I bought the shares based on this reasoning. I have skipped several drivers that can affect the earnings, such as weather, biodiesel, export tax, refinery, substitution, etc to avoid making this post overly long (it’s already very long, isn’t it?).

I’m not recommending anyone to buy. It’s just a sharing of my analysis. Read my disclaimer at About section.

What’s next?
If the share can return 20-40% in next 3-4 years, what’s next after that?
I think the company’s production can still grow at around 10% for several years after next 4 years (I didn’t work out all the estimation after 4 years). The production will grow at slower pace as time passes unless they make more land acquisition and plant trees more aggressive or buy over other plantation estate to boost their earnings. They may eventually venture into downstream business in future or invest outside palm oil business.

I’m not making prediction what the company is going to do. The current business is good, making good profit, and by having young plantation estate, it is able to grow at a fast rate, providing decent return to shareholders. We should follow the company’s story from time to time and re-assess if there’s any substantial change in the company’s business and prospect, which can impact its future earnings. If the business remains good, we can stay invested. If it gets worse or better in long term, then we should make the decision accordingly.

Thank you for reading.

Bumitama - Operation 2014
Source: Bumitama’s Annual Report 2014
 Bumitama - Financial 2014
Source: Bumitama’s Annual Report 2014
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