Bumitama Agri has caught my attention recently. According to DBS, it is trading below its average PE multiple, and far below the multiple of its peers. I also understand that palm oil prices have been going up recently. So I took a closer look. These are the 3 main reasons for why I have invested in Bumitama Agri’s stock:
1. Divergence between share price and palm oil futures that should be corrected
As a commodity producer, Bumitama’s profitability and valuations are expected to track the commodity prices. After all, there is little (if any) product differentiation. So their fortunes go up and down with the commodity prices. Indeed, we can see that Bumitama’s share price has roughly moved in the same direction as palm oil futures – until the start of 2020.
It seems that after the initial covid plunge, palm oil prices were able to recover and then exceed pre-covid prices. However Bumitama’s stock price has failed to even recover to pre-covid prices. As a result, since the start of 2020, palm oil prices have increased about 60%, whereas Bumitama’s stock price has decreased by 45%.
One key reason for the poor performance in the last two years is hedging. Bumitama has not benefit fully from the run up in CPO prices has it had hedged its sales. However, its 2H2021 sales (and beyond) are not yet hedged. They are therefore expected to see a large jump in selling prices. If they do decide to continue hedging, the hedged price will be based on higher current market prices. So in any case, we can expect sales and profitability to improve significantly in 2H2021 and in 2022.
The market has taken a backward-looking instead of a forward-looking view on Bumitama, causing it to be underpriced. I think this will be corrected this year when their full year financial statements are announced.
In fact, Bumitama’s 3Q21 profits were at an all-time high. Perhaps due to low trading volume and the fact that the 3Q21 results were just a presentation slides rather than financial statements, the stellar performance seems to have been overlooked. Nevertheless, I expect 4Q21 to be better than 3Q21, and for 2022 profits to be better than 2021’s.
2. Favourable age profile of trees
Oil palms take 4 years to reach maturity and produce fruits suitable for harvest. Thereafter, they continue to produce fruit for up to 30 years. Bumitama’s trees are on average a youthful 11.6 years old.
Bumitama’s trees have on average more than 22 years of productive life ahead. This means that Bumitama will enjoy good harvests without having to spend much on planting new trees and nursing immature trees that do not yet yield fruit.
3. Decent ownership structure
Generally, I prefer companies where there are more than one big shareholder. For Bumitama, there are two key shareholders: the Lim family (about 52%) and IOI Corporation Berhad (about 31%). While it would have been better if the main shareholder has less than 50% of the shares, the presence of another big shareholder does add some level of check and balance.
Besides, in this case, the number 2 shareholder is IOI Corporation. IOI is a big company mainly dealing with real estate (they are building 2 huge developments in Marina Bay) and palm oil plantations in Malaysia. Being in the palm oil business themselves, IOI would have done good due diligence before doing this venture with the Lims. They will also be able to share best practices and business contacts. Given that IOI is a pretty big company (bigger than Bumitama), they will not be pushovers. This means that cannot be run like the Chairman’s personal company and that some level of good governance must be observed.
The main result of good governance (to me) is the equitable sharing of profits with all shareholders. This means dividends. Bumitama Agri has a dividend policy to “distribute up to 40% of its distributable income”. I think their record is not too bad. They have been paying dividends every year. Although the amount fluctuates along with their profitability, I am convinced that they do try to pay out about 40% of profits each year.
Key risks
1. Increases in supply will cause palm oil prices to moderate
I expect prices to moderate somewhat. Palm oil prices are high now partly because of a supply shortage from Malaysia. Malaysian producers are facing a shortage of workers due to covid travel restrictions, leading to lower rates of harvesting. Some plantations are so short on workers that fruit are left to rot on trees. As the labour shortage eases, production in Malaysia should improve as well.
That said, palm oil prices have generally increased over the years, supported by strong and growing demand. As people live more modern lives, they eat more packaged food, use more soap and cosmetics, eat more fried food (“vegetable” oil that is the main oil used in F&B is actually palm oil), and so consume a lot more palm oil.
2. Increasing fertilizer costs may erode profit margins
According to this Reuters news report, fertilizer costs have increased by 50-80% in the second half of 2021. This will affect profit margins of Bumitama. However, the increased fertilizer costs has also caused a slowdown in production growth in the palm oil industry, leading to reduced supply and hence higher prices. How much of the increased costs can be passed on to consumers remains to be seen.
3. ESG scrutiny could dent palm oil demand
It is well known that large tracts of rainforests are illegally burned every year to clear space for palm oil plantations. Demand for palm oil has come under scrutiny as the commodity gets blamed for causing deforestation. However, demand remains resilient. Yet despite the flak it is getting, palm oil remains in high demand for two reasons – it is cheap, and it has properties which allow for longer shelf life in the products it is used in. I don’t know if the green groups will be successful in reducing palm oil demand, although I know that they are trying.
My view is that instead of reducing demand, more focus should eventually be paid to forest management, to ensure that the clearance of rainforests for plantations is done in a controlled manner and with a slower pace. Better still if there is some mechanism in place to ensure that cleared forests are replaced elsewhere. If this is done well, the rate of increase in supply of palm oil will slow, leading to upward pressure on palm oil prices.
A Wandering Elephant 