First Resources Part 3

What has happened since my last writing on First Resources 1.5 months ago? 

  • Market sell off globally: US market down 10%, Shanghai down 24%, HK down 14%, Nikkei down 17%, Singapore down 10%.
  • Commodity prices fell to even lower level. CPO price dropped to below RM 1900/t. In Rupiah, it fell to below IDR 6,000/kg.
  • Forest fire in Indonesia polluted the air quality in Indonesia and neighboring countries. This fire is on palm oil trees!
  • El Nino was expected to develop, if not already.
  • USD continues to strengthen while Indonesia Rupiah and Malaysia Ringgit weaken
  • I won’t mention every political and macroeconomic events here to shorten the post.

Basically, things are bad, financially and environmentally. Most long-only funds should have suffered losses.

What’s caught my interest to write this post on First Resources (again!) is that CPO price has suddenly spiked to a level above my expectation. It climbed to nearly RM 2400/t and above IDR 7,500/kg yesterday.

What could have caused such a spike while the global equities are still fighting for gradual sell off in the market? If anything, the fire rage should make palm oil a public enemy at the moment. The spike could be lagged adjustment to CPO price given that MYR has fallen by 25% this year. Commodity exports are transacted in USD. So, if USD price remains stable (or not down so much), then MYR price for CPO should get upward adjusted. That’s what happened to IDR price of CPO when IDR fell substantially in 2013-2014.

Other possible reason causing the spike in CPO price could be related to El Nino. As happened in the past, bad weather could disrupt supply, which drove up the price. Many times, the price rose up before the fall in supply as the market has anticipated (or speculated) in advance. This happens not only to palm oil, but also to other agriculture products. We don’t know how long the recent spike can last before falling again (fluctuation takes place all the time so don’t predict the short term move). If El Nino does take place, then the rally became justified with the anticipated production cut and might go up even higher. If it fades away like what happened in 2014, then so will the price rally.

Despite the forest fire in Indonesia occurring nearly every year and the resulting condemnation, it hasn’t reduced the yearly consumption of palm oil in meaningful way. General supply-demand principle holds better though. When supply is disrupted, buyers are willing to pay more. When supply is abundant, sellers are willing to sell cheaper (see what happened to soybean last year and this year).

Buying/selling based on weather forecast is speculation. I will treat it as a bonus to plantation sector if El Nino does materialize and affect supply materially. This bonus could generate an additional return of 10% or more.

Back to investing:

First Resources’s first 8 months of production is available below. Internally harvested FFB achieved production growth of 14.2% yoy while 3rd party FFB purchased fell 8.9% yoy. The CPO production growth was 11.4% yoy. CPO is the end product they sold, so most people would just look at this growth number. However, an attentive investor should note that internal FFB grew at higher rate while external FFB drop. Internal FFB generates higher margin than external FFB does. That means, First Resources would achieved higher margin in the first 8 months this year than last year if everything else the same. In other words, the higher production is accompanied with higher margin. A nice operation to celebrate.

Of course, not everything is the same, especially the price, and that’s beyond what they can control unless they do hedging. First Resources did time its hedging very well in 2013 and produced superior results in that year, but I doubt they could repeat the same feat this time. In fact, I hope they don’t as hedging is a double-edge sword. I’d rather invest based on the information and expectation I have than surprises from the management in any direction.

The general market has been highlighting that Chinese stock market has fallen by 40% and seems like crashing, but if we look at the return over the past 12 months, it’s still up 30%. That should reverse highlight that the rally has been spectacular from mid 2014 to mid 2015. That rally did not come from the spectacular economic development in China. But the market has been linking the sharp fall to the slow down and bad economic data in China. So, the strong rally needs no reason, but the inevitable fall will be justified by everything negative that market can think of, including the soft landing of China that has been going on for years.

Is First Resources a buy at current price 1.52? Again, I let my action do the talking. I just bought the shares recently. So, that’s my answer.

My reason to buy it:

  • Its CPO production grew 11.4% yoy for first 8 month with lower average cost due to higher internal FFB and lower external FFB.
  • Operationally, it has been outstanding compared to its peers. It suffered lower yield in 2013-2014 due to new estate acquisition and biological downcycle, but it has demonstrated recovery this year (note the word, demonstrated, not predicted/forecast)
  • CPO price fell to the worst in recent years, but I still believe that it will bounce back to above RM 2200/t level once the current market pessimism (sell off) is over.
  • Its share price has fallen further to 1.52, an attractive price to me. My previous posts recommended to buy it at 1.78 and sell at 2.12. When it fell back to 1.79, I suggested to hold given the market pessimism at that time. The recent sharp fall in CPO price to below RM 1900/t should justify the lower share price if that low CPO price sticks for a long time. But given my view that CPO price would bounce back in short term, current share price becomes an attractive entry point, especially recent spike in CPO price brought it to nearly RM 2400/t now.
  • El Nino, if really takes place, is an enemy to CPO production but a friend to its price. The net effect is usually higher earnings for the planters. For investing purpose, we should exclude El Nino from valuation when making investment decision. For speculating purpose, traders should pray that it happens.

My recommendation in this post is buy at 1.52. Let’s see how it turns out.

Source: Company

Source: Company


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