Golden Opportunity with Golden Agri

Highlights: 

- El Nino weather phenomenon is slated to support crude palm oil (CPO) price as lower palm oil production is expected.

- The group has seized advantage of the higher EBIT posted in recent years to translate it into a sturdy cash position. On top of that, gearing ratio has been reduced in a gradual manner.

- GAR’s plantation productivity remains on par with its peers despite ageing palm oil tree profile.

- We retain our positive view on the GGRSP 5.420% 08Apr2027 Corp (MYR). The sukuk is currently trading at 4.8% with around 3.5 years to its maturity date. It is rated as AA3 by RAM.

Introduction

Golden Agri-Resources Ltd (GAR) is one of the world’s largest soil to table (vertically integrated) palm oil agribusiness company in terms of CPO production. The group’s plantations are located in Indonesia with more than 500,000 hectares of managed plantation area. This is almost 7 times the size of Singapore (last recorded in FY22: 73,430 hectares).

Currently, the group has operations across 14 countries and products delivered to circa 100 countries worldwide. It is listed on SGX since 1999 with a market capitalisation of SGD 3.3 billion as of 4 October 2023.

El Nino is slated to support CPO price

National Oceanic and Atmospheric Administration (NOAA) has declared the arrival of El Nino in June 2023 which would bring warmer than average temperature to Southeast Asia. The odds of it lasting through winter is now higher than 95% and the chance of a strong event is above 70%. Unfortunately, Indonesia is among one of the countries that is bracing for a hot weather, with the nation’s dry season forecasted to be the most severe since 2019.

As palm oil crop is sensitive to heat and drought, it is highly likely that we will see a drop in Indonesia’s palm oil production from 4Q23 until 2Q24. We view that the potential resultant supply side constraint will help in supporting the current CPO price level and may even elevate hereupon. This is fitting with the view of Indonesian Palm Oil Association (GAKPI), which predicts that CPO prices in 2024 are likely to average at least 11% more than this year.

Chart 1: Price movement of crude palm oil (CPO hits an all-time high in early 2022 due to supply constraint)

Decline in 1H23 revenue due to moderation in CPO price

GAR posted a revenue of US$4.9 billion in 1H23, which is a 11% decline y-o-y. Correspondingly, net profit also dropped by 53% y-o-y to US$182 million. This is due to the moderation in crude palm oil (CPO) price after the record high in 2022. From our perspective, the moderation is completely normal considering that the average CPO price in 2022 was at an outrageous US$1,177 per metric ton, which is higher than the 10-year average CPO price of US$743 per metric ton. Another reason for the lower revenue is the high fertilizer cost carryover and the dwindled fruit production due to heavy rainfall.

Over the years, GAR has expanded its downstream business as attested from the increase in downstream revenue. However, we note that the industry remains competitive and that the margins are likely to stay within the 5% range. As for its upstream business which is highly susceptible to CPO price, the segment has largely benefitted from the upward trajectory of CPO price in recent years. Consolidately speaking, GAR has maintained a moderate level of EBIT margin between the approximate range of 5% to 12%. 

As a side note, GAR integrated business model to some extent has provided the group with a natural hedge against CPO price. For example, in instances when CPO price is high, GAR will post a higher EBIT margin in plantation and palm oil mills (upstream business) while corroding its downstream margin (CPO treated as cost in downstream business). This works inversely when CPO price is low.

Chart 2: GAR’s revenue and consolidated EBIT margin

Chart 3: GAR’s EBIT margin as opposed to average CPO price

*When CPO price is higher, EBIT from plantations and palm oil mills tends to be higher. Vice versa.

Stable build-up in cash position; improving gearing position and coverage ratio

GAR has seized advantage of the higher EBIT posted in recent years to translate it into a sturdy cash position. This is attested where the group’s cash position has increased from US$192.8 million in 2018 to US$557.1 million in 1H23. Accordingly, cash coverage ratio has surged to 11.7 times in 1H23 from the low of 3.3 times in 2018.

On the other hand, GAR has reduced their gearing level gradually, where debt to equity ratio has fell to 0.57 in 1H23 (FY18: 0.70). Net debt to equity has also improved promisingly from 0.57 in FY18 to the current 0.35 level. These are mainly due to the rising cash reserve and the notable reduction in long-term borrowings. The group also posted a healthy interest coverage ratio of 2.8 times, implying the ability to pay off interest cost.

Table 1: GAR’s credit profile

High reliance on short term financing, but risk remains manageable

GAR has a track record of borrowing large amount of short-term debt and refinancing it. This is exhibited in the cash to short-term debt ratio, where GAR only has a ratio of 0.34 in 1H23 (FY18: 0.13). However, we think that the short-term refinancing risk is mitigated given its sizeable asset base and longstanding banking relationships. If the refinancing option fails, the palm oil producer should still be able to liquidate its PPE (property, plant and equipment) and inventories for short-term repayment obligation. The clearing of current assets would also be sufficient to pay off short-term debt as demonstrated by the current ratio of 1.52 times in 1H23.

Table 2: GAR’s liquidity profile

In a bid to reduce the reliance on imported crude oil and maximise the consumption of domestic palm oil, the Indonesian government has pushed for the mandatory implementation of B35 mandate – the blending of 35% palm biodiesel with 65% diesel fuel. Currently, biodiesel sales contribution for GAR is still minimal, where it contributed a minor 5.7% to the group total revenue in FY22. Reassuringly, GAR has completed its biodiesel plant expansion at the end of 2022 that brings in additional capacity of 450 thousand tonnes. This has brought GAR biodiesel total annual capacity to 1.05 million tonnes. Going forward, we deduce GAR biodiesel sales to reach around 10% of the group’s total revenue.     

Ageing palm oil tree, but productivity remains on par with its peers

The average age of GAR’s palm oil tree stood at 17 years, which is utterly higher than the other palm oil plantation companies (Sime Darby Plantation: 12 years, Wilmar International: 13 years). Despite the poorer tree-age profile, GAR productivity performance is rather on par with its peers.

For instance, GAR scored a fresh fruit bunch yield of 8.9 tonnes per hectare in 1H23, which is higher than Sime Darby Plantation at 7.9 tonnes per hectare and comes lower than Wilmar International at 9.9 tonnes per hectare. In terms of oil extraction rate, it recorded a rate of 20.9% in 1H23, just slightly below Sime Darby Plantation at 21.1% and is much higher than Wilmar International at 19.7%. Notably, GAR is much superior than its two peers in terms of palm kernel extraction rate.

We opine that the replanting with higher yielding seeds, namely the Eka 1 and Eka 2 to be the cause of satisfactory productivity performance. Nonetheless, we hope to see a more aggressive replanting to bring down the proportion of old trees.

Table 3: 1H23 palm oil production comparison with peers

Risk

While being a vertically integrated model, GAR profitability is still exposed to the volatile CPO prices. As such, any unfavourable movement in the CPO price will be reflected in the group’s performance. Other than that, it goes without saying that GAR business model is highly susceptible to the changes in weather as a heavy rainfall season or a draught will affect the palm oil’s fruit production.

GAR is also exposed to any changes in Indonesia palm oil export levy and export ban (1H23 sales in Indonesia: 20%, sales outside Indonesia: 80%). If there’s any substantial changes in the government plantation policies, it is likely to put a dent in GAR’s financial performance. Lastly, the by-product of having operations across 14 countries is foreign currency risk. However, we are aware that GAR enters into forward exchange contracts and cross currency swap to hedge its currency exposure.

Recommendation

We retain our positive view on the GGRSP 5.420% 08Apr2027 Corp (MYR). The sukuk is currently trading around 4.8% with around 3.5 years to its maturity date. It is rated as AA3 by RAM. Compared with the Sime Darby Plantation - SIMEMK 5.650% Perpetual Corp (MYR) which is trading at 2.83%, GAR is definitely the more attractive option, not forgetting that the Sime Darby Plantation is a perpetual sukuk which carries higher risk.

For clarification purpose, Golden Assets International Finance Limited is the funding vehicle for GAR, where GAR is obliged for the coupon payment and the sukuk principal redemption.

Table 4: Relative comparison of bonds

Conclusion

Golden Agri-Resources Ltd (GAR) is one of the world’s largest soil to table (vertically integrated) palm oil agribusiness company. Currently, the group has operations across 14 countries and products delivered to circa 100 countries worldwide. Notably, El Nino is slated to support CPO price as palm oil crop is sensitive to heat and drought. It is highly likely that we will see a drop in Indonesia’s palm oil production in the coming months which help in supporting the current CPO price level.

A feature of GAR integrated business model is that to some extent, this model has provided the group with a natural hedge against CPO price. The group has also increased their cash position over the years and reduced their gearing level gradually. All things considered, we retain our positive view on the GGRSP 5.420% 08Apr2027 Corp (MYR). The sukuk is trading at 4.8% with around 3.5 years to its maturity date.

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds positions in GGRSP 5.420% 08Apr2027 Corp (MYR). The analyst who produced this report holds a NIL position in the abovementioned securities. Picture is by courtesy of frimufilms.

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