First Resources Part 5 (2016 Q2 result)

It’s been 3 months since my last update (see this post). I bought the shares at 1.635 in May. It fell to 1.51 in July and rose to 1.825 today. That gives me ~11% return in 3 months. What has happened since?

Q2 production was as bad as Q1 production. 6M16 internal FFB yield fell by 22.6% from 8.4mt/ha to 6.5mt/ha. The mature planted area actually increased by ~13.8k ha or 9.5% in size, but because of the sharp fall in the yield, the FFB and CPO production were down by 15.5% and 18.8% yoy respectively. As a result, 6M16 net profit fell by 36.2% yoy.

First Resources - Production 16Q2.PNG

Source: First Resources’s 2016 Q2 Result Presentation

CPO price fell from mid RM 2,600s/mt in May to mid RM 2,200s/mt in July. Malaysia Palm Oil Inventory level rose from 1.65m tons in end-May to 1.77m tons in end-July. Lower production + Lower price + Higher inventory. Triple negative. If we apply trading mentality and adjust our valuation with every data instantly, then it’s a SELL in July.

However, we should think deeper. Experience helps too.

FR’s FFB yield fell by 22.6% yoy for first six month. Internal FFB production fell by 15.5% yoy. How about the peers?

  • Wilmar’s FFB yield was -19% yoy with FFB production -20% yoy.
  • Golden Agri’s FFB yield was -25% yoy with FFB production -24% yoy.
  • Indofood Agri’s FFB yield was -19% yoy with FFB production -20% yoy.
  • Bumitama’s FFB yield was -32.5% yoy with FFB production -17.6% yoy.
  • Malaysia overall palm oil production was -15% yoy.

The production numbers for whole sector are consistent: double-digit negative growth for first six months of this year. In my earlier posts, I have mentioned several times that severe drought in the beginning of 2015 was likely to impact the production 12-18 months later. It happened several times in the past and can be explained by biological effect. Therefore, the substantial production drop this year is not a coincidence. It has a high probability of occurring. People with knowledge and experience in this sector have an edge that general market don’t have.

If the supply drops substantially and the demand remains stable, then by basic economics theory, the price should rise. CPO price indeed rose to RM 2,600s/mt in May, but fell to RM 2,200s in July. The share prices of the producers fell accordingly. That price dip was the opportunity for people with an edge to take advantage of. It is not a certainty that the production for the rest of the year will fall by as much. There is no certainty in the stock market. But there is a high probability. Therefore, when the mispricing takes place (price dip), it’s the time to buy.

FR’s net profit for first 6 months dropped by 36.2% yoy, its TTM P/E rose to > 23x, and the market was selling its shares. But this huge production drop was temporary. When the production rises back to normal level next year, we’ll see a strong double-digit growth, and if CPO price averages in the range RM 2,300 – 2,500/mt, then earnings will also climb back to normal level.

From now on, Palm Oil production should continue to rise and peak in October. This up-cycle is generally negative to the price. For the CPO price to stay at RM 2,500 – 2,600s range, overall production growth has to continue to be strongly negative while demand stays stable. The effect of the drought in early 2015 will gradually ease in the second half of 2016, therefore, overall production in the sector will eventually recover. This will remove the support to good CPO price. I will hold my position at the current price of 1.825 for FR.

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