First Resources’ share price fell 5% today after releasing its bad 16Q1 results with net profit down 77.9% yoy. The bad result was partly expected after it released its bad Q1 production data with CPO production down 17.1% yoy in mid April. Other factors have caused the profit to be lower than expected.
Source: Company’s 2016 Q1 presentation
Causes of the bad performance:
- Internal FFB production fell by 15.3 yoy, partially offset by higher 3rd party FFB purchase, resulting in lower average margin
- Lower average selling price (ASP) for palm oil (CPO ASP fell by $150/mt in 16Q1 compared to 15Q1)
- Higher palm oil export levy since July 2015
- Hedging losses (my surprise)
- Higher net financial costs
- Higher effective tax rate due to non-deductible expenses
Seems like kitchen sink to me, throwing all the bad things to this quarter.
The 1st point (lower production) seems to be an industry-wide problem and is temporary. The dry weather from last year was expected to affect the production this year and it did. FR’s production suffered badly in 16Q1 and is expected to suffer for the remaining quarters this year. But mature planted area has increased by nearly 14k ha from 144.8k ha to 158.6k ha. When the production yield recovers to normal level, we can expect double-digit growth from this year’s low production number. As the lower production is an industry-wide problem, it’s not all bad news. The lower production has caused the CPO price to rise to the current level of above RM 2,600/mt.
The 2nd point (lower ASP) is the nature of commodity business, which sees fluctuating commodity price. CPO price for 16Q2-to-date has been higher and will reverse the low price in 16Q1.
The 3rd point (higher export levy) is hurting the business and not temporary unless the Government changes the rule (again!).
The 4th point (hedging loss) is one time (I hope). They made more hedging gains in the past. I don’t expect them to make gains every time.
The 5th point (higher financial cost) is likely to continue until they pay down the debt. The 6th point (higher effective tax rate) should revert back to normal later.
The first two points have the most impacts, but are short-term problems. The lower production could probably last for a year. If the share price falls because of this and other things remain, it creates an opportunity to buy at attractive price.
The 3rd point does reduce the intrinsic value of the Company, but it affects all the plantation companies in Indonesia that export palm oil, not only FR. Point 4 to 6 should be resolved in due time given the competent management.
Higher revenue in 16Q1 vs 15Q1
The higher revenue in 16Q1 could mislead investors who don’t understand palm oil business. FR refined more of their CPO into refined palm oil in 16Q1 compared to 15Q1. The refined palm oil could sell at a price more than USD 100/mt higher than unrefined palm oil (CPO), but earned a profit margin of around 3 – 5% only on that additional price.
For example, assume that the CPO price is $600/mt. The refined palm oil price could be $720/mt, which is $120/mt higher than CPO price. The extra $120 could earn a profit of just $4 (3.3% margin). So, if the profit margin for CPO is 30%, the profit for CPO is $180, and the profit for refined palm oil is $184 [180 + 4] (or 25.5% blended margin). Therefore, the more the Company refines its CPO, the lower the blended average profit margin. Investors, who don’t understand this, will think that costs have increased substantially and caused the margin to compress.
The share price fell by 16% in the past 1 month to 1.635 now. I suppose that many investors sold the shares after the release of Q1 production data. If you currently hold the shares, don’t worry. This fall is temporary. But don’t expect it to recover in few months. We just can’t predict the direction of the share price in short-term. It could even get worse before recovering.
Just 12 months ago, in my first post on FR, I valued the Company at $2.10 (base case). I was assuming that the CPO price could normalize to ~RM2400/mt. After all that have happened in the past year, my valuation on FR is now around $1.95 – 2.00 given the higher export levy and lower than expected production that occurs more often.
CPO price has risen to RM 2,648/mt now and should have pushed the share prices of palm oil companies higher in general. But, FR, in contrast, has experienced sharp drop in share price after bad Q1. I think this could be a buying opportunity. At current price of 1.635, my valuation estimate of 2.00 presents around 20% upside. I have just bought the shares at this level.
I have some concern that I might have bought too early. The production issue could last several quarters and could depress the price further down. Although this production issue is temporary, more attractive entry point could present later. Even worse is when the industry-wide production issue is actually better than expected and pulls the CPO price down to below RM 2,400/mt in next few months. We could potentially see FR’s share price falling further. FR’s lowest price in the past 4 year was 1.43, which happened in August 2015 when the CPO price fell to RM 1,900/mt. That’s 13% downside from current share price, not terribly lot. Of course, the worse can get worst. Given that I’m buying with 20% margin-of-safety, I know this industry and have been following FR for nearly 3.5 years, I have more confidence with my decision to buy at this level. My previous three trades on FR were all profitable. Hope to make it fourth in a row.