Two months ago, I thought First Resources was a good BUY at 1.78. See this earlier long post.
Since then, the share price has rallied to today’s 2.13. That’s 19.6% return. Actually, I didn’t expect the share price to rally given that CPO price has fallen back to RM 2200/t after momentarily rising to above 2300/t, and First Resources’ 2015 Q1 result was bad (20% yoy drop in EBITDA and 38.5% yoy drop in net profit).
The revenue dropped even more (45.9% yoy), however, if you know their business, you should understand that the revenue can fluctuate widely because of the refinery business, which sell at higher price than CPO, but has much lower margin. So, do not follow the revenue change that much. Focus more on EBITDA and earnings instead.
Having said that, if you read the quarterly report, you’ll realize that Q1 comparison between 2014 and 2015 is not apple-to-apple because 14Q1 had 20k tons inventory sales while 15Q1 had 20k tons inventory build-up. So, on the surface, the big drop in earnings looked like disaster. But, digging deeper, the year-on-year quarterly big change will be balanced out in subsequent quarters. It is a cyclical sector with seasonal fluctuation. This is the case in which understanding the business you are investing in is important. Otherwise, you’d be freak out upon seeing such large drop in Q1 earnings.
One day after the Q1 result was released, the share price rose nearly 7.5% to 1.94. To my surprise, investors didn’t see the large drop in Q1 earnings as signal to sell immediately. As far as I know, this sector attracts many retail investors. Perhaps, there are some funds that were buying after the result, thus pushing up the price. Well, predicting market action is dangerous, so we better don’t.
I think the investors got more confident with the palm oil sector and First Resources as the time went. The monthly production result was also very promising. For first 5 months, CPO production rose by 14.5% yoy (May CPO production was up 22.8% yoy). That could partially explain the rally. Again, predicting short term price move is just speculation. Only in retrospect, we could do some analysis on why up or down. In short term, a bad weather, a seasonal factor or any one-off event can cause large change in earnings. It’s the long term sustainable earnings that we care about.
In my first post, my target price for First Resources was $2.10-2.45 while the price at that time was $1.78. Today, at 2.12, I decided to sell out all my shares in this company.
1. it has reached my target price, albeit at the bottom end of my target price range.
2. CPO price, soybean oil price and brent crude oil price are still near the bottom of their trading range for some time. Don’t see any time they’ll pick up soon. So, this isn’t good news for the overall sector, but it isn’t bad news either. It’s just nothing new.
3. CPO production will be going into the peak season in Aug-Oct. That is not doing the CPO price a favor. Although price can still rally during peak season as it did in the past, the normal supply-demand effect is acting against it currently (theoretically).
4. Q1 result clearly shows that refinery business is suffering. Even though it has low margin, it’s still negatively impacting the overall earnings.
On the bright side, the yield recovery is real. Coupled with more mature estate, the production growth will be double digit. So, earnings should grow. This confirms my view that it’s experiencing recovery process from bad years and it’s still well managed company.
I sold because I think it’s fairly valued at current price. It could go up by another 10-20% in short term, but I’m not predicting short term move. The reverse is also true. It can fall by 10% too in short term. Given the understanding of this company and its potential growth, I’ll buy back the shares when the price falls, perhaps at $1.90 or below given that it’s cyclical sector and in short term, price fluctuation always takes place. I may also buy back at this price or even higher if I see that CPO price has started recovering. It’s not a stock that we can buy and forget for 5 years. As mentioned in earlier post, following a company’s story every quarterly or half-yearly is the least we should do. Following the share price doesn’t count. Commodity sector is a bit more tricky as a large price swing can change the fundamental valuation of the company even more than price swing.