First Resources

First Resources is in palm oil business (upstream and downstream). Upstream: it plants the oil palm trees, harvest the fruits and mill them to produce Crude Palm Oil (CPO). Downstream: it refines the CPO to produce refined CPO products (un-branded, hence earning a small margin of 3-5% for refinery process; branded refined products, e.g. branded cooking oils, earn better margin)

Like Bumitama (see earlier post), First Resources is a young and fast growing palm oil business in Indonesia. It is the darling in palm oil sector because it’s fast growing and it has the lowest unit cost of production at $260/t of CPO among those listed names (industry average $300-400/t). Among all analysts I know, First Resources is consistently in their BUY list for palm oil sector.

Hedging
When CPO price crashed down from the high of RM 3500/t to low of RM 2100/t in 2012, First Resources sold CPO forward for 2013. Hence, in 2013, when everyone else was selling CPO at the spot price of RM 2100 – 2400, First Resources was still selling CPO at RM 2700-2800 because of the hedging they did in previous year. That’s a fantastic move, earning them high margin. This solidified its darling status in this palm oil space. Hedging commodity price is a double-edge sword. It’s a zero-sum game. Those at the winning side take all the profit, and those at losing end take all the losses. You may consider First Resources to be lucky this time, and they may hedge at the losing end the next time. The next time has not happened yet. For what they did, they deserve the credit and they were rewarded for the risk they take.

Note on hedging: fund managers may not like companies that do this kind of hedging because it makes the business less predictable. You never know if the company hedges as the winning or losing end. In 2007-2008, another palm oil company in Malaysia bragged that they sold forward CPO at good price (RM 2000-2500/t). But CPO price continued rallying higher. That company didn’t really lose money, but it would have earn much more if it didn’t hedge.

 CPO Price 2011-2015
Advantage
– High production growth
First Resources’s period of very high production growth (15-20% per year) is over, so, its growth rate is below Bumitama’s now, but still above other large and mature palm oil players. Management is guiding production growth of 5-10% this year. Let’s check if it’s achievable.

It’s mature estate size was 132k ha at end 2014. See the table at the bottom of the post. This year, about 10k ha matures. Assume that newly mature estate produces 7t/ha FFB yield, so that’s additional 70kt of FFB this year. Last year’s FFB production was 2.47mt. So, 70kt adds additional 2.83% to total production. Given their average plantation estate age of 8 years old, FFB yield will increase further. When the average age is 9 years old this year, FFB yield could reach 20t/ha or above. If we assume 20t/ha, that’s 7% higher than last year’s FFB yield of 18.7t/ha. So, 7% + 2.8% = 9.8% production growth estimated. There, management guidance of 5-10% is conservative.

The plantation estate will continue to see more than 10k ha maturing every year for next 4-5 years. Given average age of just 8 years old now, FFB yield can continue to rise. First Resources still has production growth of about 10% per year for next 3-4 years. Don’t expect that 10% to be stable because biological cycle and weather can affect production in every year.

– Low cost producer
Its unit cost of production remains the lowest in the sector. Labor cost is expected to rise 10% this year. Fertilizer cost about 0-5%. However, if First Resources’s FFB yield recovers and rises to 20t/ha, then unit cost of production may stay relatively flat (could be up at most 5%).

– high new planting
Unlike Bumitama who faces problem with NGO on planting new trees (new planting dropped from >10k ha per year to 4k ha per year), First Resources has been consistently planting new trees at the rate of 12000-15000 ha per year over the past 5 years. 2014 achieved nearly 24000 ha of new planting. Growth rate slows down now because they have a bigger base now, not because their planting activity slows down. It also has larger plantable reserves than Bumitama.

Management
Like Bumitama’s CEO, First Resources’ CEO, Ciliandra Fangiono, is a billionaire. Unlike Bumitama’s CEO, Ciliandra seems to me a more hands-on CEO. I met him once in a one-on-one meeting. I was very new that time to this sector and I didn’t understand how the VAT and export tax worked. He immediately took a piece of paper and wrote down how it worked. I felt embarassed and impressed at the same time. He knew the business and numbers well. The Investor Relation manager, Yuh Chien, is also very professional. She knows her numbers very well and answers questions promptly. So, the management gives me better confidence that it’s managed professionally, not like a family-run business.

Setback
In 2013, its plantation estate was experiencing biological downcycle (the trees have production cycle of few years and had low productivity cycle in 2013). Its new estate acquisition was also producing at lower FFB yield than its other estate. As a result, its overall FFB yield fell substantially from the industry high of 23.0t/ha in 2012 to 18.7t/ha in 2013 (see the table at the bottom of the post). That’s 18.7% drop in productivity!

In 2014, its tree production cycle has picked up, but still lower than market expectation. With newly 12k ha of estate (10% of total mature estate size) turned from immature to mature in 2014, average FFB yield remained flat at 18.7t/ha in 2014.

So, you have a palm oil darling who grew very well in 2010-2012 (from FFB yield 20.2t/ha to 23.0t/ha, and mature estate size from 78.6k ha to 98.2k ha), and suddenly not performing so well anymore in 2013-2014.

In 2015, for first 3 months, the FFB yield has improved from last year’s 3.8t/ha to 4.0t/ha. Internal FFB production has increased 15.8% yoy, while CPO production +10.5% yoy. Note that monthly production can fluctuate, e.g. a bad February production could be covered by good March production, so you can’t extrapolate full year 2015 production based on first 3 months production. Will it make more recovery in 2015? I think so. Given that oil palm trees biological downcycle usually lasts 1-2 years, First Resources’s worst productivity period seems over to me. So, I expect it to recover more this year.

Valuation
The price has fallen to $1.78 after CPO price kept falling recently to RM 2082/t now. Its (TTM) P/E ratio is 12.8x, considered low in the sector.
 First Resources - share price - 2014 Apr
So, here, you’ve got the lowest cost producer, growing at above average rate, proven track record, selling at lower earnings multiple than the peers. Why? Why selling at lower valuation multiple? If it’s on every sell-side analysts’ BUY list, then it should be trading at a premium, not trading at lower multiple than others. Possible reasons: 1. this sector is losing popularity. When I spoke with a sell-side analyst last time, he said this sector was dead. No fund managers were interested. 2. Market expects the CPO price to stay low or gets even lower, hence earnings will eventually be cut. Hence, with lower earnings, P/E ratio will rise higher even though share price has fallen.

However, these two possible reasons (and there could be other reasons) apply to the whole palm oil sector. It didn’t explain why First Resources was trading at lower valuation multiple than others though given its better prospect. That’s why I pick this one up. I see value in this company that is not fully appreciated by the market.

Its EPS in 2014 was USD 10.95 cents. Average USDSGD exchange is around 1.27 in 2014. So EPS was SGD 13.9 cents. With roughly 10% production growth per year for next 3-4 years, First Resources’s earnings could grow to SGD 17.5 – 19 cents in 3 years. This has assumed that the margin stays flat throughout the next 3 years, which is not likely. The production cost is rising every year as minimum wage in Indonesia has been rising by double digit percentage over the past few years and looks to continue the trend for next few years. However, I do think that the CPO price is near bottom of its cycle and should recover slightly in coming years. Also, with increasing FFB yield from the maturing plantation estate, unit cost of production for First Resources could be maintained or rise at slower rate. That’s the same assumption I made for Bumitama, I didn’t explicitly mention this point in Bumitama’s post though.

First Resources’s peers are trading at P/E ratio of 12-14x in SGX at the moment. If we assume that First Resources can achieve earnings of SGD 17.5 cents in 3 years and we apply P/E ratio of 12x, we get valuation of $2.10. If we assume 14x PER, we get valuation of $2.45. With target price in the range $2.10-2.45, that’s 18-38% return on current share price in 3 years. On top of that, it paid dividend of SGD 3.55 cents last year, which provides dividend yield of 1.5-2%. So, the overall return is quite decent. This is still my base case. With more aggressive assumption, we can assume that CPO price has recovered more strongly, the earnings will be higher and so will valuation multiples. If we assume earnings have grown at 12% per year and we apply PER of 14x during good time, the share could be valued at 2.73, which is 53% higher than current share price.

First Resources has demonstrated its ability in the past to grow at above this rate and has a good management and cost control to be the lowest cost producer in the sector. That gives me confidence that future earnings growth is achievable. The major risk is really that CPO price stays flat at this price or continues to fall. Current CPO price of RM 2100/t is lower than last year’s average of around RM 2400/t. No one can predict commodity price with high accuracy. With some understanding of this sector, as mentioned earlier, I see current price to be around bottom of cycle and may recover in 1-2 years. That gives me confidence to invest in this sector at current price.

Let’s assume that future earnings margin has actually fallen, offsetting the production growth, hence earnings is flat. So, let’s value the company based on current earning potential (past 12 months). With earnings of 13.9 cents, if we price the share at 12x PER, the value of company will be 1.67 (6% lower than current price). If PER 14x, the value is 1.95 (9.5% higher than current price). There seems to be more upside than downside to me. That’s my bear case.

Forex
It’s difficult to predict forex rate. It’s a different game entirely, and even forex specialist can’t get it right most of the time. Predicting where forex is going in short term is like predicting where the stock market is going in short term. Unpredictable! However, having a view with good reasoning is important. If all our valuation analysis is right but forex depreciated too much against us, our net return in local currency will be nearly wiped out. So, here’s my view. Given that US economy is getting stronger year by year, and US interest rate is going to rise this year, its USD currency should get better. Singapore, on the other hand, is facing downturn in its property market, which can last another 2 years. Its other sectors are doing ok. Overall, USD has a better chance to appreciate against SGD. By how much? I don’t know. But at least, this should support my analysis that USD earnings will be converted to the same or more SGD earnings in future.

Bet: my fund manager vs me
When CPO price crashed in 2012, and so did palm oil players’ share prices, my fund manager wanted to make a bet with me in December 2012. We knew that First Resources’s production growth rate was good and expected to remain good for next few years, but CPO price has crashed. So, he bet that First Resources’s share price would never cross 2.20 for next 2 years. I remained bullish with the prospect of this company. I accepted the bet. The loser to treat lunch. In late 2013, the share price crossed 2.20 and I won the bet.
Later, it came down to 2.0 before climbing back to 2.50 when the market was most bullish on CPO price recovery (El Nino risk, bad drought to disrupt supply, production to catch up). When the optimism was gone, everything came done. Investors who bought First Resources at the most optimistic time would have lost 30% by now. Remember, commodity is a cyclical sector. The cycle is getting shorter and rather hard to predict. Full time analysts and fund managers can get it wrong almost half the time. So, if you are retail investor, don’t expect that you can beat the analysts and fund manager.

Disclosure: I owned shares of First Resources and may buy more in future, especially at around this price range. See, I put my own money to what I say. I covered this sector for 2.5 years when I was in hedge fund. I won’t be the one telling you how good this company is, how much you could get in return, but putting my money in the pocket. There are many advisors/experts who will aggressively tell you how good a particular company is but never invest their own money. This post is not to recommend anyone to buy the shares. It’s just a sharing of my analysis. See the about section of this blog for disclaimer.
First Resources - Operation 2014
Source: First Resources’s Annual Report 2014
First Resources - Financial 2014
Source: First Resources’s Annual Report 2014
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