Last updated on 25 July 2021
Plantation Stocks – Introduction to Palm Oil
The Golden Crop
Palm oil is a global commodity that is in over 50% of packaged foods. The oil is the world’s most consumed edible oil but has also found success as a raw material base in other industries such as chemicals, cosmetics, pharmaceuticals, animal feed and biodiesel.
The wide acceptance of the oil is largely due to its efficiency as a high yielding crop. There are four major oil seed crops; oil palm, soybean, sunflower and canola. However, palm oil yields 8x more oil than soybean, 7x more oil than sunflower and 4x more oil than canola per hectare per year. There is no oil crop in the world that comes close to palm oil’s production efficiency.
Despite the crop’s success, the industry is suffering from significant sustainability challenges. Activist and government bodies have been targeting the industry due to its deforestation practices, GHG emissions and labor mismanagement. This has led to a wave of anti palm oil campaigns which include promotion of products with palm oil free labels. However, the industry has not faltered and is actively improving its sustainability practices and adopting zero burning and deforestation practices. it’s now relatively impossible to clear forest in Malaysia for palm oil.
Although the industry is improving its practices, the investing community has largely shunned plantation stocks. The main reason for this is that most institutional investors are focusing on Environmental, Social and Governance investing or ESG investing. If you’ve noticed, although palm oil prices are at historical highs, prices of plantation stocks have remained unchanged. It’s because of this unusual phenomenon that I’ve decided to write this article. Honestly, there are some gems here that may be worth considering.
Disparity between CPO price and Stock price
For the most of 2021, CPO prices have been trading at its 10 year historical high which would signify huge profits for plantation companies. However, the PE value of most large cap plantations stocks are trading between the range of 9 and 27. In comparison, glove stocks which experienced a significant profit in 2020 had PE valuations of 80 or higher. This peculiar phenomenon is largely due to ESG investors shying away and I believe also due to the lack of excitement in plantation stocks. People simply prefer the latest Tech stocks (which are mostly not profitable or grossly overvalued).
Growth Drivers for the Industry
The growth drivers below are general factors which influence the demand or supply of palm oil in the global market.
- Population growth
- Biodiesel growth
As global population gradually increases, the demand for cooking oil and packaged foods would rise in tandem. Therefore, the rapid population growth around developing countries would increase the demand for affordable oil. Countries in Africa and Asia are likely the key drivers.
In 2020, Indonesia implemented its B30 Biodiesel program which will increase the percentage of palm oil blend in diesel to 30%. If fully implemented, the blend will increase Indonesia’s palm oil consumption by 3 million tonnes per year. Considering that the global palm oil production is around 70 million tonnes, the change in Indonesia’s biodiesel blend would be a bullish game changer for palm oil prices.
On a smaller scale, Malaysia has begun implementing its B20 Biodiesel program. In addition, Malaysia plans to expand the mandate for industrial sector from B7 to B10. The move is expected to increase Malaysia’s palm oil consumption by 0.6 million tonnes per year.
Traditionally, the management of palm oil plantation are labor intensive. Large numbers of workers are required to collect the palm fruits. Fruits left uncollected for more than 2 days would begin to rot which reduces the crop’s value.
To improve productivity, mechanization is necessary to ensure fruits are collected and transported within 48 hours of harvesting. Many plantations have yet to adopt the idea of mechanization buy companies that have made the switch have begun to enjoy increased productivity and reduced production cost.
What makes a Plantation Stock Profitable?
From this point onwards, I will only discuss on the factors which make Malaysia plantations stocks profitable while excluding other countries such as Indonesia and Thailand. Below are the highlights of the there main factors affecting profitability.
- High Oil Yield (Mt/ha) – total palm oil extracted from one hectare of land
- High Oil Extraction Rate (OER) – % of palm oil extracted from palm fruits
- Low Production Cost (RM/Mt) – cost of extracting palm oil
High Oil Yield
The estimated maximum output of palm trees are 6 Mt/ha. However, the Malaysian average oil yield is only 3.5 Mt/ha. The low national average is mostly due to poor plantation management and a shortage of labor. A poorly managed plantation would result in unproductive trees leading to lower yields. Secondly, a shortage of labor leads to many unharvested fruits.
To quickly determine if a plantation company is well managed, we first need to know its oil yield. Anything above 4.5 Mt/ha indicates a decently well managed plantation. Looking at the table below, the best managed plantations are United Plantation at 6.10 Mt/ha while the closest competitors are KLK (4.80 Mt/ha) and IOI Plantations (4.60 Mt/ha). The worst managed plantations are SOP, FGV, Far East and Genting Plantations.
|S/N||Company||Oil Yield (Mt/ha)|
High Oil Extraction Rate (OER)
To obtain palm oil, the palm fruits are crushed in mills to squeeze out the palm oil. The total percentage of “extracted” oil is known as oil extraction rate. Typically, a well managed mill is able to achieve 21% OER.
Kim Loong and United Plantation were the only companies capable of producing an OER of 22.30% and 22.20% followed closely by KLK and IOI Plantations. The worst performing company was Far East at 18.80% followed by Chin Tek, SOP, IJM and FGV.
Low Production Cost
The main contributor to plantation stock’s profitability comes from its production cost. Production cost can be reduced by mechanizing harvest procedures, improving oil extraction rates and maintaining a healthy balance of matured and immature palm trees. Since palm oil is a commodity, the selling price of palm oil is determined by supply and demand whereby the plantation company’s have zero control.
The best way to remain profitable is to maintain a production cost which is lower than the average selling price of palm oil. The 10 year average selling price of palm oil was approximately RM 2,500/Mt. Therefore, well managed plantation company should have a competitive production cost of RM 1,500/Mt or lower.
|5||United Plantation||RM 1,235/Mt|
|9||Kim Loong||RM 1,540/Mt|
|11||Far East||RM 1,124/Mt|
|12||HS Plantation||RM 1,682/Mt|
The data for production cost is not widely available but the idea is to have the lowest possible production cost. The companies with the lowest cost are Far East and United Plantations while the highest cost produces are HS plantation and FGV.
It’s regretful that I am unable to compile the production cost of all the listed companies.
Best Plantation Stock
For those with a keen eye, you would have noticed that United Plantation outperformed in all three profitability aspects.
- Highest Oil Yield amongst its peers (6.10 Mt/ha vs national average of 3.5 Mt/ha)
- Second Highest Oil Extraction Rate (22.20% vs average of 20.9%)
- Second Lowest Production Cost at RM 1,235/Mt.
United Plantation is undeniably the best managed mid cap plantation stock available.
Best Large Cap Plantation Stock
Amongst the larger plantation stocks such as Sime Darby, IOI Plantations, KLK and Genting Plantations; the best managed company would likely be KLK and a close second would be IOI Plantations.
KLK and IOI Plantation had the second and third highest oil yield per hectare while the companies’ oil extraction rate were above average.
Best Small Cap Plantation Stock
Kim Loong is likely the best small cap plantation stock available. The company has a decent oil yield per hectare while boasting the best oil extraction rate in the industry. The only negative point is the the company’s production cost is on the higher side.
I hope this article was helpful. Cheers.
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Disclaimer: The article is written purely for the purpose of education and entertainment only. The content of this article is an expression of my opinion and should not be taken as professional advise. If you are seeking for professional advise, please consult your financial advisors. You should do your own research and/or seek expert’s advice when doing your investments. Any decision that you made is your own and the author should not be held accountable