Indonesian Palm Oil Production Sector
A Wave of Consolidation To Come
25th October 2016
Doug Hawkins [email protected] Yingheng Chen [email protected] Thomas Wigglesworth [email protected]
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Contents Indonesian Palm Oil Production Sector – A Wave of Consolidation To Come ...... 3
Straws In The Wind ............................................................................................ 3
Country Profile ................................................................................................... 5
The Indonesian Palm Oil Sector ............................................................................. 8
An Important Element of the Indonesian Economy .......................................... 8
Area Under Cultivation .................................................................................. 8
Sector Valuation ................................................................................................. 9
A More Difficult Era For Expansion .................................................................... 9
Structure of Indonesian Upstream Producer Sector 2015 .............................. 10
Planted Area ................................................................................................. 10
Smallholder Cultivations .............................................................................. 10
State Owned Entities ................................................................................... 11
Commercial Plantation Sector ..................................................................... 12
Drivers For Consolidation Within the Commercial Plantation Sector ............. 16
Palm Oil Commodity Pricing ........................................................................ 17
Tighter Regulatory Controls ......................................................................... 20
Production & Cost Efficiencies ..................................................................... 22
Labour Costs & Employee Rights ................................................................. 23
Nationalism and Limits on Foreign Ownership ............................................ 23
Capital Markets Valuations .......................................................................... 24
Downstream Integration .............................................................................. 25
Dharma Satya Nusantara Tbk: Growth Ambitions ....................................... 29
Sustainability / Certification......................................................................... 30
Efficiencies ................................................................................................... 30
Conclusion ............................................................................................................ 32
Disclaimer ............................................................................................................ 33
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Indonesian Palm Oil Production Sector – A Wave of Consolidation To Come
Since 2012, as the commodity cycle turned down, the Indonesian palm oil sector has been buffeted by negative headwinds, compounded in 2015/16 by a vicious El Nino weather pattern. The resulting impact on profitability and balance sheets has pushed valuations below replacement cost for many high quality names. Sensing a ‘buyers’ market’, the larger names have been biding their time, looking for attractive opportunities; the KLK unsolicited offer for MP Evans, announced today, should be seen in this context. Prior to the bid, MP Evans was trading at a substantial discount to capital employed in its successful palm oil production business. We detail herein a series of factors that we believe are likely to drive consolidation in the Indonesian palm oil sector: the bid for MP Evans, like the acquisition of a strategic stake in REA Kaltim by DSN in May of this year, are ‘straws in the wind’, heralding a likely wave of further consolidation to come.
Straws In The Wind
On 25th October 2016, the Malaysian plantation company, Kuala Lumpur Kepong Berhad (KLK), valued at $6.2bn on the Kuala Lumpur Stock Exchange, announced an unsolicited all cash bid for MP Evans PLC, the owner of some 34,650 ha of young, high quality palm oil plantations in Indonesia, and listed on the London Alternative Investment Market (AIM). Offering £6.40 per MP Evans ordinary share, the bid represented a 51% uplift on the closing price of £4.26 on Monday 24th October, and 57% on the volume‐weighted average closing price of £4.08 per ordinary share for the twelve months ended on 24 October 2016. The KLK offer, values MP Evans at approximately £359.3m (before inclusion of interim dividend entitlement), or US$438.35m (using $1.22: £ rate). $438.5m equates to some $9,072/per planted ha after adjusting for the value of MP Evans 40% stake in Bertam Properties (our most recent valuation $35m), the value of Bertam Estates in Malaysia ($16m as per 2015 Report & Accounts), and our estimate of $73m net cash on the balance sheet (post the NAPCo disposal). Making these adjustments, the KLK offer nets out (for the palm oil plantation operations) at $314.35m, or $9,072/ha (34,650 equity hectares). Subject to this analysis, the offer for the palm oil business of MP Evans, looks low; in the context of the Indonesian palm oil sector, we would describe the KLK bid as a ‘straw in the wind’. A wind that is gathering pace. In December 2014 Cargill, one of the world’s largest traders of wheat, corn, oilseeds, vegetable oils, meals and biofuels, with revenues of more than $120bn annually, announced completion of the acquisition of the Poliplant Group. Poliplant comprised approximately 50,000 hectares of contiguous, planted smallholder and company land adjacent to Cargill’s existing palm oil operations in West Kalimantan. Industry sources indicate that the purchase price was in the region of $13,500 per planted ha. For both the Poliplant and MP Evans transactions, the contrast with the M&A values for the largely Malaysian group detailed in the table below only a year earlier in the case of Poliplant, two years in the case of MP Evans, confirm both a traditional premium for Malaysian assets over Indonesian assets, (ranging
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between 15%‐30%), and a marked change in valuations consequent upon the decline in the commodity price cycle. Grossed up for the average Malaysian asset premium (22.5%), the rumoured acquisition price for Poliplant, would have translated into circa $17,420/planted ha: suggesting a 15% decline in value relative to the average reported below in 2013/14. For MP Evans, the KLK bid price (adjusted as above), and adjusted for the Malaysian premium would out turn in the region of $11,113/ha, for a discount of approximately 46% to 2013/14 values. For a business like MP Evans, with the potential to produce $4,500‐$5,000 per ha in revenues (assumes average yields of 24 mt ffb/ha and 24% OER) annually (assuming a CPO price of $720 FOB), and with potential for $1,500 per ha in ebit, the actual bid price implies a whacking return of 16.5 % per hectare. In the current zero rate / negative bond rate environment, and noting the long term nature of the palm oil business, the value gap with the transactions detailed below, looks anomalous. But MP Evans is not an isolated opportunity. Across the sector companies are trading at a significant discount to underlying value.
Source: Hardman Agribusiness
Sector valuations on international stock markets declined steeply during 2015, so it is not surprising that current anecdotal reports of M&A discussions involving Indonesian palm oil production assets, indicate a typical price point in the region of $10,000 / planted, although, on an adjusted basis, the KLK offer for MP Evans looks to be worth only $9,072/ha. In May 2016, an initial conditional agreement was signed between REA Holdings (REA) and PT Dharma Satya Nusantara Tbk (DSN), for the purchase of a 15% stake in REA’s principal operating subsidiary, REA Kaltim (REAK). The consideration for the 15% shareholding in REAK will amount to $15m in cash with (up to) a further $0.85m payable (by year end 2017), depending upon the recovery of certain over payments of taxation. REAK is financed by a combination of equity and shareholder loans and DSN will be putting up additional shareholder loans proportionately to its equity interest. These comprise $ and Sterling loans to REAK of $10.0m and £3.9m respectively, on terms mirroring the terms of existing shareholder loans. It is expected that DSN will provide further shareholder loans to subsidiaries of REAK of $17m during 2017 to reflect existing shareholder loans to those subsidiaries. The total enterprise value of the outlined transaction for 15% of REAK, is estimated at circa $47.6m. The implied enterprise value per planted hectare was estimated by Hardman Agribusiness (based on 39,600 ha planted at time of agreement) at some $9,750/ha. This marks what is expected to be a long term relationship between the two companies: DSN may increase its holdings in REAK to 49% over a period of 5 years on the basis that each increase will be subject to agreement on price and consents from other stakeholders including REA shareholders. REA and its shareholders are optimistic that successive sales of equity in REAK to DSN will take place at progressively higher prices. This is supported by the expectation that over the
Date of Proposal /
Transaction
Offered Price
($m)
Adjusted Implied
EV* ($m)
Land Bank
(ha)
Planted Hectares
(ha)
EV/planted hectare
($/ha)
FFB Yield
(MT/ha)OER (%)
CPO Price at
Offer ($/MT)
Operating
CountryAcquiror
Asian Plantations Aug‐14 172 348 24,622 16,300 20,300 10.0 e 22.5% 766 Malaysia Felda Global Ventures
New Britain Palm Oil Oct‐14 1,717 1,916 134,600 79,800 24,009 21.7 22.2% 722 PNG Sime Darby
Pontian 4Q‐13 367 n.a. 16,188 16,000 22,938 22.7 22.0% 897 Malaysia Felda Global Ventures
Unico‐Desa 4Q‐13 120 303 13,660 12,700 23,891 23.8 20.6% 897 Malaysia IOI Corporation
Al‐Hadharah Boustead 3Q‐13 214 400 19,945 19,945 20,055 20.4 ‐ 827 Malaysia Boustead Holdings
Total/Average 2,967 209,015 144,745 20,501 19.7
* EV adjusted for non‐palm operations
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next five years the company is on target to complete its principal planting programme for a 60,000 ha estate. The parties will be hoping also that the commodity price will strengthen, supporting better financial returns. These various transactions reflect the currents that will shape the future development of the Indonesian palm oil sector. After more than 30 years of fast, some might say, easy development, the course of development in the second decade of this century has become tougher. Access to land is becoming progressively restricted as the Indonesian government bows to international pressure to protect its natural forests, and this is providing an incentive for M&A activity amongst ambitious palm oil producers. A widely ‘connected’ (across the mobile internet) rural population of 120 million, and increasing politicisation of the natural resources sector in Indonesia, has encouraged local communities, and their politicians, to demand a greater share in the wealth generation of the palm oil production sector. Social and environmental duty of care obligations are therefore growing progressively onerous, putting a considerable burden on smaller producers, and creating reputational risk for the large fully integrated producers such as Wilmar, Golden Agri or Indofood Agri. Demand for palm oil products, whilst still robust, is qualified by slowing growth in the emerging markets of Asia and strong competition from an ever expanding soya crop in the Americas. Over the past 4 years these factors have produced CPO price weakness which in turn has impacted the profitability of the sector, degrading balance sheets in the process. At the half year 2016 (after buffeting 2016 operating conditions impacted by the El Nino drought and soggy achieved commodity prices), REA’s net debt to equity ratio stood at 72.5%, so with an ambition to complete development of its 108,000 ha land bank, the company’s decision to accept a strategic investment from DSN, is easily understood. DSN is an ambitious and successful Indonesian company. Already within the top 20 group of largest producers in Indonesia, DSN has ambitions to be a top ten producer, and perhaps ultimately to become a whole value chain producer. To achieve this ambition, we estimate that DSN will need to amass a total production base of more than 140,000 ha. Today it has a combined (nucleus and plasma) production base of 90,000 ha, so when complete at 60,000 ha, REAK would, if acquired by DSN, neatly propel the group into the top 10 ‘club’ (on the basis of current plantation sizes). For DSN and any other of the major operators, there is considerable appeal in acquiring a ‘ready built’ plantation, especially if that plantation occupies scaled contiguous estates, well planted and RSPO certified. Our review of the evolutionary drivers at work in the Indonesian palm oil production sector suggests that their influence can be seen in the REAK/DSN transaction, and in the KLK bid for MP Evans 25th October. We believe that these drivers will continue to exert pressure for further consolidation within the sector.
Country Profile
The Republic of Indonesia, situated between the Indian and Pacific oceans, is the world's largest island country. It lies between latitudes 11°S and 6°N, and longitudes 95°E and 141°E, extending 5,120 kilometres (3,181 miles) from east to west and 1,760 kilometres (1,094 miles) from north to south. Surveys indicated that the country comprises 13,466 islands, on both sides of the Equator, of which
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may be 6,000 are inhabited. The largest of these islands include Java, Sumatra, Borneo/Kalimantan (shared with Brunei and Malaysia), New Guinea (shared with Papua New Guinea), and Sulawesi (the centre for cocoa production). The other islands are all well known for the production of palm oil. Indonesia shares land borders with Malaysia on Borneo, Papua New Guinea on the island of New Guinea, and East Timor on the island of Timor. Indonesia shares maritime borders across narrow straits with Singapore, Malaysia, the Philippines, and Palau to the north, and with Australia to the south. At 1,919,440 square kilometres (741,050 sq miles), Indonesia is the world's 15th‐largest country in terms of land area and world's 7th‐largest country in terms of combined sea and land area. The population of Indonesia, with a median age of 28.6 years, is estimated at over 261.5 million (http://www.worldometers.info/world‐population/indonesia‐population/), making it the world's fourth most populous country. Typical household size was given at 4.6 persons (FAO 2008/ “Indonesia Family Life Survey, Wave 1”, the Agricultural Development Economics Division, Food and Agriculture Organization, December, 2008). More recent surveys from diverse sources indicate this has reduced to 3.9 persons. Assuming around 4.0 persons per household would imply a total of some 65.4m households. The Indonesian economy is the world's 16th largest by nominal GDP and the 8th largest by GDP at PPP. It is also the largest economy in Southeast Asia. Indonesia is a founding member of ASEAN and a member of the G‐20 major economies. Indonesia has a mixed economy in which both the private sector and government play significant roles. Indonesia's estimated gross domestic product (nominal), as of 2014, was US$887 billion while GDP in PPP terms is US$2.685 trillion. As of 2014, per capita GDP in PPP was US$10,651 (international dollars) while nominal per capita GDP was US$3,518. (IMF/World Bank references). Since 2012, the service sector has employed more people than other sectors, accounting for 47.9% of the total labour force, compared with agriculture (38.9%) and industry (13.2%) (Indexmundi references). In the 2016 year, government spending has been supporting economic growth in the face of a weak outlook for the external sector. Panel economists from Focus Economics, anticipate Indonesian GDP expanding 5.1% in 2016, and a growing a further 5.3% in 2017. Lying along the equator, Indonesia has a tropical climate, with two distinct monsoonal wet and dry seasons. Average annual rainfall in the lowlands varies from 1,780–3,175 millimetres. Temperatures vary little throughout the year; the average daily temperature range of Jakarta is 26–30 °C (79–86 °F). Despite its large population and several densely populated regions, Indonesia retains significant areas of wilderness that support the world's second highest level of biodiversity. The country has abundant natural resources including coal and natural gas, tin, copper, gold and fertile agricultural land. The country comprises 34 provinces, of which five (Aceh, Jakarta, Yogyakarta, Papua, and West Papua) have Special Administrative status (greater legislative privileges and a higher degree of autonomy from the central government than the other provinces). Each province has its own legislature and governor. The provinces are subdivided into regencies (kabupaten) and cities (kota), which are further subdivided into districts and again into administrative villages. The village is the lowest level of government administration, but villages are further divided into community groups and then into neighbourhood groups. A kabupaten, is headed by a bupati. A kabupaten represents a local level of government, beneath the provincial level. Kabupatens enjoy greater decentralisation of affairs than
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provincial bodies, including authority for provision of public schools and public health facilities. Kabupatens and city authorities have local government and legislative capacity. The difference between a regency and a city lies in differing demographics, size and economics. Kabupatens typically administer larger areas than city administrations and have influence over agricultural economies. Bupatis and mayors, and their respective representative council members, are elected by popular vote for a term of 5 years.
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The Indonesian Palm Oil Sector
An Important Element of the Indonesian Economy
In 2015, Indonesia produced some 33 million metric tonnes (mt) of crude palm oil, being slightly more than 53% of total global production of 62 million mt, making the country the undisputed leader in global production (Oil World). Malaysia, in second place, will produce some 18 million mt in 2016. The Indonesian government is projecting a national crop of almost 41m mt (40.8m mt) of CPO by 2020, against which it is aiming to operate a biodiesel blending mandate of 30%. The projection is based on current production patterns with no added output due to possible expansion of planted area. The palm oil sector is an important constituent of the Indonesian economy and especially the rural economy. It contributes some 4.5% (Global Business Guide, 2010) to national GDP, and employs upwards of 3.2m people in the upstream sector alone (Forest News, 2011), supporting maybe 4.9% of households, or total ‘pops’ amounting to 12.8m.
Area Under Cultivation
Palm oil plantations extended to nearly 11 million hectares in 2015 (USDA 10.8m ha), out of a total land area of circa 192 million hectares, of which 12% is thought to be under use for arable agriculture (almost 25m ha). This means that the palm oil sector utilises more than 40% of currently available arable land within Indonesia. The growth of the Indonesian sector has been remarkable as evidenced by the tables below, courtesy of USDA. Planted area was barely 100,000 ha in 1970, but has grown at an annual average rate of some 245,000 ha to give Indonesia, a dominant supply position in global production.
With just under 52% of the Indonesian land area under forest, there is tension between the pressure (particularly from external forces) to conserve the country’s unique forests and biodiversity, and the economic and political
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imperatives of providing employment and opportunity for Indonesia’s 120m rural citizens. In 2010, USDA reported that Indonesian government land capability surveys pointed to approximately 24.5m hectares of land being suitable for palm oil cultivation. Data from the Center for International Forestry Research in Indonesia (CIFOR) suggest that Indonesia has “enough degraded or already logged forest land to sustain current oil palm expansion for the next 20 years…Indonesia could theoretically double current national oil palm acreage by 2030 and increase palm oil production to 60m‐65m mt…”. USDA Commodity Intelligence Report 8th October 2010 (Indonesia: Rising Global Demand Fuels Palm Oil Expansion). However, growing consumer pressure for greater sustainability in the production of all goods, and palm oil commodities in particular, coupled with an increasing emphasis on environmental controls within Indonesia, has seen permissions to develop land, including already conceded land parcels, tighten for commercial plantations.
Sector Valuation
As a consequence of the rapid growth of the sector over the past 30‐40 years, significant wealth has been created: notwithstanding the downturn in the price of palm oil commodities since 2011/12, the Indonesian listed palm oil companies have a combined market value today in the region of $30bn. This excludes the contribution to the value of those Malaysian listed companies with substantial palm oil production assets located in Indonesia. Using Indonesian average sector values, the planted area of the group shown below (representing the principal Malaysian presence in Indonesia), may have a value in the region of $5.0bn to $5.5bn. The implied valuation for Indonesian palm oil production assets, listed on the Jakarta, Kuala Lumpur, Singapore, London and Belgian stock markets, prior to the KLK offer for MP Evans, was some $35bn. Company Indonesian Planted Hectares
Sime Darby 203,475
KL Kepong 109,251
Genting Plantations 67,702
Felda Global Ventures 35,422
IJM Plantations 34,544
United Malacca 24,585
IOI Corporation 21,500
United Plantations 9,560
TH Plantations 5,467
Total 511,506 Source: Hardman Agribusiness
At 23% of the planted area, but closer to 27% of total national production, it might be inferred that the total Indonesian palm oil plantation sector has a combined capital value of some $130bn.
A More Difficult Era For Expansion
Since 2011, with commodity cycle weakening, the price of crude palm oil has slipped from a high of $1,200/mt to below $500/mt. It is now trading above $700/mt on the back of an El Nino induced collapse in production in 2016:
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cropping is down across much of Indonesia and Malaysia by 20% and more. After a period of rapid growth in global demand for palm oil and in capacity building within Indonesia, the Indonesian palm oil production sector has sustained a series of setbacks in addition to weakening commodity prices and the recent, severe El Nino weather pattern. Regulatory pressure on land use has been tightening, making it more difficult to get control of new concessions for land development and reducing the percentage of conceded land banks that can be planted. Rural communities have demanded a greater share in the palm oil production sector and this has been supported by legislative action in the Indonesian parliament and at the kabupaten level. While outside the country, consumer pressure for a focus on sustainability, reduced environmental impact and protection of biodiversity, have all combined to slow development and to increase the cost of compliance. Against this background the Indonesian sector is expected to undergo a process of consolidation, with upstream production concentrating amongst fewer and larger actors.
Structure of Indonesian Upstream Producer Sector 2015
The Indonesian palm oil production sector remains relatively fragmented. The sector’s industry association, the Indonesian Palm Oil Association (GAPKI), boasts 644 members with more than 3.36m hectares of planted oil palm under their control. This grouping largely comprises the professional, or industrial commercial sector, accounting for 47% of the total planted area, but it also includes some of the state owned enterprises. The other 53% of the planted area is represented by smallholders and various other state owned enterprises.
Planted Area
The total area planted to oil palm in Indonesia is variously estimated at 10m – 12m hectares; we use 10.8 mil ha (USDA 2015). Of the current planted area, approximately 8.9m hectares are thought to be mature/harvestable plantations (USDA 2015). The ownership profile of this production sector is estimated as follows:
Smallholders: 44%
State owned enterprises: 9%
Commercial Plantations: 47%
o Of which 50% of planted area is owned by companies listed on stock markets in Jakarta, Singapore, London, Colombo, Brussels or Luxembourg.
The relatively wide range in estimates for the total planted area, turns on estimates for independent smallholder plantings.
Smallholder Cultivations
In one of its regular Palm Oil Plantation Update (2012), PwC noted that smallholder planted area had increased from 28% of the total in 2000 to 38% by 2010; today that percentage has increased to 44%. Even at this level, it is likely
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that smallholder cultivations are understated: they may be undeclared, or even planted in unpermitted forested zones. Anecdotal reports indicate that smallholder plantings have grown materially in recent years and especially in the last two years when drought conditions have made land clearing easier for smallholders. Recent efforts in Indonesia to clamp down on burning, are expected to slow the pace of these developments, but nevertheless, smallholder cultivations are anticipated to continue growing in size. It should also be noted that under legislation introduced in 2007, a ratio of 4:1 between Inti, or nucleus: Plasma, or community cultivations, must be adhered to.
PlasmaObligation:The "plasma obligation" was introduced by Indonesia’s Department of Agriculture in Article 15 of Permentan No.26/2007. This regulation states that a company applying for a plantation business license (Izin Usaha Perkebunan or "IUP") for an area of 250 hectares or more, must facilitate the community development by providing the local community with at least 20% of the total plantation area conceded under the IUP. Once developed, the plasma plantations are transferred to the small community landholders who then operate the plasma plantations under the supervision of the nucleus plantation developer. As the plasma plantations mature, the community farmers are obliged to sell all their harvests to the mills operated by the nucleus plantation.
Pre‐2007IUPs:A plantation company which obtained an IUP before 28 February 2007 is not required to implement the "plasma obligation", but it does have to provide productive ‘business activities’ for the people in the local community. Projects to increase employment, infrastructure and education are among the most prominent schemes implemented by plantations companies within the spirit of this legislation. However, local communities and various agencies working on their behalf have seized on the ambiguous nature of this regulatory guidance, and this has seen a number of plantations conceding existing planted area, or developing new plantations for local communities notwithstanding that their IUPs predated February 2007.
PoweroftheBupati:The Bupati has within his or her powers, scope to set the allocation rate for plasma obligations. In some kabupatens this has run to as high as 40%.
Impact:Golden Agri reported 101,219 hectares of palm plasma area in 2015, compared with 82,103 hectares in 2007 (+23%). Indofood Agri reported 87,107 hectares of plasma area in 2015, compared with 61,000 hectares in 2007 (+43%). Golden Agri reported that its plasma area produced 2,301,089 tonnes (FFB) in 2015, compared with 1,687,022 tonnes in 2007 (+36%).
State Owned Entities
State owned entities (SOEs) are estimated to own up to 9% (14% 2010) of the area planted to oil palm in Indonesia. They are generally considered to play a modest role within the sector and their percentage of planted area has been consistently reducing as the private sector and the smallholder sector continue to grow. Consolidation within this group is not excluded as these enterprises also strive for greater efficiencies and perhaps access to capital. The businesses may include a number of agri‐activities including the production of cocoa, sugarcane,
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tobacco, rubber, tea and other tropical crops. The SOEs are not present in palm oil related downstream processing. As with other producers across the sector, the SOEs have begun to focus on the production of sustainable oil and RSPO Certification, both at the corporate level and with affiliated smallholders. In 2012 the SOE, PT Perkebunan Nusantara III Persero (PTPN III), signed a MOU with IDH, the European financed sustainable trade initiative, and the RSPO, to provide assistance to the independent smallholders working in PTPN III’s 8,000‐hectare plantation located in North Sumatra to achieve RSPO certification.
Commercial Plantation Sector
As noted previously, the Indonesian Palm Oil Association (GAPKI) boasts 644 members with more than 3.36m hectares of planted oil palm under their control. GAPKI members include the largest plantation companies in Indonesia, some listed on the Jakarta, Singapore or London Stock Exchanges, some private, large and medium size family owned plantations and certain of the larger state owned enterprises. The top 20 commercial producer entities in Indonesia own some 2.7m ha of the total area planted to oil palm in the country, (around 25% of the total production area). Of the commercial planted area, these top 20 entities own more than 44%. In the event of further sector consolidation, it is this ‘Top 20’ group that will likely seek to accrete more of the existing commercial planted area to their existing production platforms. Especially amongst the largest names, with valuable brands and international trading relationships to safeguard, there is a strong instinct to increase upstream productive capacity with existing planted area, thus avoiding the requirement to negotiate complex and sensitive regulatory requirements pertaining to environmental and social impact.
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Source: Company Report & Accounts/Company Websites/Hardman Agribusiness
It is interesting to note the percentage of plasma hectares relative to the nucleus area of the top 20 largest of the Indonesian producers: 19.2% of nucleus plantings, close to the mandated level of 20%. However, there are significant differences between the ratios for the group, with a range of 1.3% (Anglo‐Eastern Plantations) to 62.5% (Sampoerna Agro). Sampoerna, along with Asian Agri and Makin Group look to be practising a more significant 3rd Party milling business than the other leaders – more reminiscent of Univanich in Thailand or DekelOil in Ivory Coast. Noting that two of the private producers are amongst those with the higher percentages of plasma to nucleus planted area, it is interesting to compare ROIC for the Indonesian group against Univanich of Thailand, the acknowledged leader, internationally, in 3rd Party milling. With 10.1% ROIC in 2015, Univanich leads the group, mostly be a considerable margin. In both 2014 and 2013, Univanich, whilst not the sector leader, was in second place in both years,
IndonesianPlantedAreaRanking
CompanyNo.ofPlanted
Hectares(Nucleus)
No.ofPlantedHectares(Plasma)(*Palmand
Rubber)Total
PlasmaAs%ofNucleusPlanted
AreaGoldenAgri
PublicListed‐SingaporeIndoFoodAgri 246,345
PublicListed‐Singapore(SIMP‐152,172LonSum‐94,173)
AstraAgroPublicListed‐Indonesia
SimeDarbyPublicListed‐Malaysia
FirstResourcesPublicListed‐SingaporeWilmarInternationalPublicListed‐SingaporeEagleHighPlantationsPublicListed‐Singapore
AsianAgriPrivate
PTPerkebunanNusantaraIVStateOwnedMakinGroup
PrivateMusimMasPrivate
SampoernaAgroPublicListed‐Indonesia
KLKepong naPublicListed‐Malaysia
CarsonCumberbatch(Colombo) 24.2%PublicListed‐Colombo
DharmaSatyaNusantara(DSN) 30.4%PublicListed‐IndonesiaGentingPlantations 12.4%PublicListed‐Malaysia
BakrieSumateraPlantations 11.4%PublicListed‐Indonesia
Anglo‐EasternPlantations 1.3%
PublicListed‐London
SipefGroupPublicListed‐Brussels
AustindoNusantaraJayaPlantationPublicListed‐Indonesia
TotalAllEntities
3.1%
5.0%
19.7%
12.4%
60.0%
15.4%
53.8%
na
62.5%
2,641,807 520,096 3,253,029
20 43,415 2,190 45,605
8,363 76,065
13 109,251 na 109,251
14 80,000 19,340 99,340
90,000
16 67,702
26.3%
36.7%
23.8%
21.0%
16.4%
19.0%
19 44,762 1,407 46,169
17 55,358 6,304 61,662
18 60,064 796* 60,860
15 69,000 21,000
11 130,000 na 130,000
12 80,000 50,000 130,000
9 137,350 21,200 158,550
10 91,000 49,000 140,000
7 153,000 18,931 171,931
8 100,000 60,000 160,000
5 178,338 29,237 207,575
6 166,800 31,666 198,466
3 240,623 57,239 297,862
4 204,412 43,000 247,412
1 384,387 101,219 485,606
2 90316* 336,675
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marginally behind the sector leaders. For private owners, the lower capital intensity in upstream production of having significant 3rd Party supply, appears to be attractive.
ROIC
Plasma Ha for Indonesia Producers
As % of Nucleus Ha 2015 2014 2013
Univanich Proprietary estates contribute only
20% of FFB processed 10.10% 18.40% 22.60%
Bumitama Agri 9.00% 13.00% 11.50%
First Resources 16.40% 6.80% 10.30% 14.50%
Dharma Satya Nusantara 30.40% 5.70% 14.70% 5.90%
Wilmar International 19.00% 5.10% 5.30% 6.60%
Sampoerna Agro 62.50% 5.00% 8.50% 3.40%
Goodhope Asia (Carson Cumberbatch) 24.20% 4.70% 5.80% 9.00%
Astra Agro 23.80% 4.40% 21.10% 18.70%
Sipef 3.10% 3.30% 7.80% 8.80%
Indofood Agri 36.70% 1.40% 5.70% 4.20%
Golden Agri 26.30% ‐0.20% 1.00% 2.60%
Anglo‐Eastern Plantations 1.30% ‐0.90% 7.60% 23.80%
Eagle High Plantations 12.40% ‐1.40% 2.10% ‐0.60%
Bakrie Sumatera Plantations 11.40% ‐11.30% ‐4.80% ‐18.60%
Source: Thomson Reuters Eikon
It is anticipated that local political and social pressure will progressively lead plantation owners with less than 20% plasma to nucleus planted area, to increase the plasma area relative to their proprietary holdings. The availability of capital, and the intensity of capital utilisation, are differentiating features for sector players, with the greatest concentration of capital (per planted ha basis) being found amongst the largest producers with fully integrated operations (decisively lead by Wilmar and then at some distance by GAR), including refinery capacity and well developed downstream businesses. The data for Wilmar do not easily compare with the data for the rest of the sector names. Readers should note that Wilmar has total refining capacity of some 29 million metric tonnes of vegetable oil annually: expressed in terms of the annual production of palm oil, this is equivalent to nearly 47%. While Wilmar’s plantation base is substantial, the capital employed in upstream production is overshadowed by the investment in the company’s internationally diversified refinery, manufacturing and distribution platforms. The data below are for the listed companies within the sector only, as we have not been able to access the financial data for the private palm oil production companies and SoEs.
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Planted Ha Average Cap Employed
Average Capital Employed / planted hectare
US$M US$M
1H 16 1H 16 1H 16
Wilmar International 238,287 31,810 133,494
Golden Agri 381,854 7,060 18,488
Sawit Sumbermas Sarana 34,164 483 14,141
Bakrie Sumatera Plantations 73,462 978 13,308
R.E.A. Holdings 41,639 509 12,220
MP Evans 34,650 376 10,851
Austindo Nusantara Jaya Plantation 43,415 470 10,828
IndoFood Agri Resources 246,345 2,380 9,661
Dharma Satya Nusantara Plantations 62,700 552 8,802
First Resources 178,823 1,546 8,646
Provident Agro 40,890 353 8,627
Salim Ivomas Pratama 246,055 2,070 8,415
Eagle High 137,606 1,134 8,244
Bumitama Agri 119,679 974 8,142
Astra Agro Lestari 235,432 1,796 7,627
Anglo Eastern Plantations 65,561 432 6,590
Sampoerna Agro 77,000 503 6,538
London Sumatra 92,135 554 6,010 Source: Company Report & Accounts/Hardman Agribusiness
Within the data presented there is a ‘back story’: balance sheet structure. The ratio of total debt to capital employed for the majority of group, is centred in a range of 29%‐56%, the outliers include a financially weak Bakrie, and DSN at the top end, and MP Evans and Anglo Eastern at the bottom end (London Sumatra is a subsidiary of SIMP (Salim Ivomas Pratama). Noting that Sawit Sumbermas Sarana is one of the most highly valued companies in the sector ($39,513/EV/ha), an upper end ratio of debt: capital employed is not of itself a key driver of valuation. Wilmar, which by some measures, is the highest valued company in the sector on a per hectare basis ($54,520), also has a debt: capital employed ratio of more than 50%. By contrast, DSN with a ratio in excess of 65%, is apparently punished with a lower end EV/ha valuation, as are companies like MP Evans and Anglo Eastern, who in contrast to DSN, have low end debt: capital employed ratios. Capital structures which are out of kilter with the patterns established by the sector leaders, appear to negatively impact business valuations. This explanation is probably too simplistic, other factors are likely to be involved, including technical factors such as liquidity in the trading of a company’s shares, the size of the free float, and the characteristics of the plantation assets.
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Debt as % of Capital Employed
Bakrie Sumatera Plantations 73.3%
Dharma Satya Nusantara Plantations 65.4%
Eagle High 56.3%
Wilmar International 52.9%
Sawit Sumbermas Sarana 51.3%
Provident Agro 50.7%
Sampoerna Agro 50.6%
Bumitara Agri 50.1%
Golden Agri 45.8%
First Resources 45.3%
R.E.A. Holdings 42.5%
Salim Ivomas Pratama 36.2%
IndoFood Agri Resources 34.6%
Astra Agro Lestari 29.6%
Austindo Nusantara Jaya Plantation 28.3%
MP Evans 10.9%
Anglo Eastern Plantations 8.2%
London Sumatra 0.0% Source: Company Report & Accounts/Hardman Agribusiness
Drivers For Consolidation Within the Commercial Plantation Sector
On the basis of our research, there is an expectation within the commercial sector that ownership will concentrate progressively into fewer entities, due to the combination of relatively low palm oil prices, rising production costs, market valuations below replacement cost, and tightening availability of suitable land. Ambitious companies can be expected to seek membership of the ‘150,000 + planted ha club’. A ‘club’ that already has significant entry restrictions, including regulatory limits on land ownership:
Foreign owned entities – 100,000 ha limit
o We understand that there a number of mechanisms available to foreign owners to manage larger operations but within structures that comply with the legislation. The fact of the legislation makes such ownership more complex and will likely slow the rate of such developments. It will also engender a climate of caution amongst foreign developers and investors.
Single Corporations – 100,000 ha limit
o Ministry of Agriculture Article 12 Regulation No.26/Permentan/OT.140/2/2007 stipulates that a plantation company can have a maximum of 100,000 ha in plantation area or twice that area if located in Papua
o This limit is subject to conditions established under a separate regulation: State Minister of Agriculture / National Land Agency No.2/1999 which stipulates that a plantation company must only own or control a maximum of 20,000 ha in one province or twice that area if located in Papua, and no more than 100,000 ha throughout Indonesia.
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o The limitations under No.2/1999 applies to individual companies and also to companies within a group of companies.
Palm Oil Commodity Pricing
While CPO has tightened by some $147/mt, from $548 / mt in January 2016, to $720/mt in October 2016, on the back of suppressed production due to El Nino effects, the sector expects to see production rebound in 1H 2017 with a possible further easing in the price. Commentators are calling the price as low as $550 / mt during 2017 on weaker demand from China (including growing competition from soya bean oil), and on expected continuing supplies of crude oil at around the current level of $52 bbl. Soya oil represents a significant competitive challenge to palm oil. Annually some 280m‐300m tonnes of soya beans are being produced on an ever increasing planted area: circa 112m ha. While palm oil production over took soya bean oil production in 2005/6, the soya product has subsequently gathered momentum.
Source: USDA
Being an annual crop means that production can be quickly scaled up and given the scale of the soya sector, it is also a well‐researched crop with new commercial varieties being made available to farmers on a regular basis. In the tables below, readers will note the rising trend of soya bean oil imports to India and further below, the rising volume of soya beans imported into China.
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The data forming the chart reveal a definite trend of rising soya bean oil imports into India since 2008/9, albeit after a period of slumping imports 2004/5‐2007/8. Imports more than doubled in the period 2004/5 to 2015/16, and have risen over 5x since 2007/8. While palm oil has also enjoyed more than a trebling in demand since 2004/5, its lead over soya bean oil has shrunk since the period 20078/ to 2013/14. Currency weakness in Brazil and Argentina may have played a role in soya’s rising share of the Indian market for vegetable oils in the period.
Source: USDA Data
The growth in imported volumes of soya beans into China during the period 2004/5‐2015/16 contrasts with a flatter picture for palm oil. From just over 4m mt in 2004/5, palm oil peaked at circa 6.5m mt in 2011/12, but overall, the commodity looks to have plateaued for the time being at around 6m mt. The prolonged weakness in the price of crude palm oil (CPO) since the highs seen in 2011/12, has put pressure on the profitability, cash flows and balance sheets of newer plantations. The price squeeze has put even greater emphasis on investment in measures to drive up productivity and to take costs out of the production process. The weak commodity price has been a considerable handicap
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for less efficient producers and operators of immature plantations, and especially those with undeveloped land banks. In the event of further sluggishness or weakness in the price of CPO, some of these operators can be expected to seek to exit their investment in the sector. Indonesian Biodiesel Blending Mandate: Indonesia entered 2016 with a B15 mandate, but this is due to rise to 20% before the year end and then to rise again to 30% by 2020. In the current period of low crude petroleum oil prices, it is being questioned whether Indonesia and other countries (Colombia/Malaysia) with ambitious blending mandates, can maintain fidelity to their objectives. These concerns have heightened as the CPO price has climbed back over $700/mt, while crude oil continues to trade around $50 bbl. Currently, Indonesian palm oil derived biodiesel, is overwhelmingly used for on‐road transportation. With the use of subsidies to maintain the price at attractive levels for motorists, Indonesia has developed a successful sector with domestic demand sufficient to offset a decline in exports due to the application of duties in a number of key export markets. Indonesia has been pushing to drive up biodiesel consumption for three compelling reasons:
1. To reduce energy imports
a. The Bali Clean Energy Forum (February 2016) was told by Dr Bambang Supriyanto, head of Research & Development at the Social, Economic, Policy and Climate Change Centre of Ministry of Environment & Forestry that “…by 2030 the nation will need to import 1.3m bbl/day…”.
b. Mr Supriyanto went on to say that on current projections, Indonesia will have used all its reserves of coal and natural gas by 2050
2. To cut Greenhouse Gas emissions
3. To support the oil palm sector.
The existing blend mandate in Indonesia is supported by a levy on palm oil exports. The levy is paid into a fund (BPDPKS) set up by the government to subsidise biodiesel at ‘the pumps’ in an environment of low crude oil prices. In instituting the levy, the government stated that its aim was to support the production sector, using palm oil‐based BD to soak up excess CPO stocks. The levy was imposed in July 2015. Shippers pay a levy of $50 / metric ton for palm oil and $30/mt for processed products. The levy is payable when the price of palm oil is below $750/mt. Previously crude palm oil shipments attracted no tax if the average price was $750/mt or lower, over four weeks, with export tax rates set at 7.5% to 22.5% at higher prices. USDA (GAIN ID1619) notes that with the revenues raised from the levy, more than 1bn litres of BD was absorbed during the period January to June 2016. The BPDPKS fund is anticipating total receipts from the levy to total circa US$700m in the 2016 year. USDA (GAIN ID1619) estimates that the subsidy reached US$0.37/litre in April 2016. Thomas Mielke, of Oil World, noted at the April MPOB PAC Forum, that he did not expect policy or popular opinion to support blending mandates, describing them as “…a luxury that will not be supported by policy and the public”. Mr Miekle advocated to the Forum, that investment in biodiesel capacity should cease, giving priority to the demands of the food sector. Whereas Mr Mielke was looking
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5‐10 years ahead, the recent low prices for crude oil have also caused industrial and political groups to question if current mandate objectives are sustainable. In January 2016, Reuters reported that Mr Bayu Krisnamurthi, head of Indonesia’s Estate Crop Fund Agency, observed that the Indonesian government might only be able to subsidise biodiesel for 8‐10 months if crude oil remained at the then prevailing low values. The Reuters article (21st January, 2016) noted that national consumption declined in 2015 to 863,000 kl from 1.78m kl in 2014. In May of this year the government revised down its projection for biodiesel (BD) consumption in the current year from 3.2bn litres to 2.7bn litres. In July 2016, USDA (GAIN Report ID1619) expected BD consumption in Indonesia for 2016 to outturn at some 2.45bn litres, 9% below the government projection. At circa 2.5bn litres consumed in 2016, the effective blend rate would be 7.6%, about half the prevailing national target. Indonesia’s National Energy Council’s 2014 national outlook concluded that diesel consumption would rise to 44 bn litres by 2026 (33bn litres in 2016). Talking about the 2016 enforcement of the B‐20 blending mandate, Mr Budi Susilo, senior adviser of Gaikindo, the Association of Indonesia Automotive Industries, stressed that in preparation for the mandates, it had conducted automobile tests in conjunction with the Japanese Automobile Manufacturers Association for both B‐15 and B‐20 fuels and found that cars worked satisfactorily with both fuels. However, Mr Susilo stressed that for B‐20 fuels, there was a requirement to reduce the monoglycerides to 0.5% from the current level of 0.8%. Monoglycerides produce performance issues for automotive engines by clogging engine filters. Because around 96% of cars in Indonesia are of Japanese manufacture, the higher mandate may depend partly on co‐operation with the Japanese automobile manufacturers, alongside furtherance of the subsidy scheme and improved logistics outside the major conurbations. Even without the concerns surrounding the future outlook for biodiesel manufacture, not all integrated production businesses want to be in this product segment due to unpredictability of demand and margins. While producers may welcome government support in the form of blending mandates and sponsored subsidisation of the product class, they are also mistrustful, concerned that policy priorities could change (as discussed above).
Tighter Regulatory Controls
Since the rapid development of the country’s plantation sector, starting in the 1980s, Indonesia has been a focus of concern amongst international environmentalist groups. Significant deforestation driven by logging (permitted and illegal) has provided scope for the planting of perhaps 50% of Indonesia’s current oil palm cultivations. But against this background of deforestation and its impact on fragile species (the Orangutan has been a particular concern), pressure from Western consumers has driven international companies to commit to only purchase sustainable palm oil that meets the criteria of the Roundtable on Sustainable Palm Oil (RSPO). In turn this has led to pressure on Indonesian plantations and the national government to strengthen their practices and policies in respect of sustainability. In 2011 Indonesia established a national response to external pressures and an alternative standard to RSPO: Indonesian Sustainable Palm Oil (ISPO) which sought to bring national production under stricter environmental legislation. All Indonesian palm oil producers are compelled to receive ISPO certification.
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Indonesia also signed up to a two‐year primary forest moratorium that came into effect on 20 May 2011 and expired in May 2013, but on expiration of the treaty, Indonesia's president Susilo Bambang Yudhoyono (2004‐2014) extended the moratorium by two years. The moratorium implied a temporary stop to the granting of new permits to clear rain forests and peat lands. In exchange Indonesia received a USD $1 billion package from Norway. In May 2015, new President Joko Widodo extended the moratorium for another two‐year period. "They can no longer ask for concessions for palm oil [or] mining," Widodo told reporters in April 2016, when asked about the moratorium plans. President Widodo was also reported to have observed that growers needed to double productivity and he exhorted the sector “to use the right seeds".
Critics argue that the burning of forests continues and that the huge land banks conceded already are exempted from the reach of the moratorium. In April 2016, Reuters reported that the government's anti‐monopoly agency had announced it would investigate suspected cartel practices amongst a grouping of the country's largest palm oil producers. The companies included:
Wilmar International
Cargill
Golden Agri‐Resources
Asian Agri
Musim Mas
Astra Agro Lestari
These companies are all members of the Indonesia Palm Oil Pledge (IPOP), a pact between the six refiners to purge their supply chains of environmental destruction and human rights abuses. In July 2016 (reportedly under government pressure) the group unwound the agreement. The end of the pledge does not necessarily mean that the signatories will roll back on their individual commitments to eliminate deforestation, peatlands conversion and human rights abuses. Each of the companies has undertaken to uphold the objectives of the pledge. Reportedly, influential politicians were concerned that the IPOP standards were imposing a burden on smaller operators who could not keep up with what were seen as “Western” standards for sustainable palm oil production. Yet the Indonesian government is taking some action to limit environmental destruction. Speaking at the Global Biodiesel 2015 Focus conference in Singapore, December 2015, Muhammad Ferian, deputy director of the Indonesia Estate Crop Fund for Palm Oil, noted that “there were sustainability issues relating to forest fires caused by farmers clearing forest land for palm plantation” and that “the government would only subsidize biodiesel derived from RSPO‐CSPO or Certified Sustainable Palm Oil sources”. While the government must play to both domestic and foreign audiences, attempts by national authorities to respond to external criticisms and concerns, have inevitably resulted in a more restricted environment for development of the domestic palm oil sector. If as expected, government policy, (under external pressure in particular), continues to tighten the award of new planting concessions and the environmental controls on sector development, operators seeking greater scale are likely to acquire other established operators and those with permitted land banks. The unfavourable image of palm oil in the minds of
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Western consumers has challenged food manufacturers and retailers to be rigorous in their support for sustainable practices. However, the commodity is dogged by a number of ethical concerns ranging from forest burning, carbon releases from peat land, deforestation and associated threats to biodiversity, community conflicts and more recently, a growing focus on workers’ rights and treatment. The growing sensitivities around land use also have implications for cost of development: the need to agree land use compensation with local communities is reliably reported to be running at $500/ha in Kalimantan, but in Sumatra the cost is reported 3x‐5x higher, up to $2,000 / ha. Negotiating with and gaining community agreement, is a time consuming activity, delaying development by anything up to 12 months and this in addition to the previous time required for gaining permitting. Additionally, nucleus developments are required to allocate 20% of developed area for plasma schemes. Given the downward pressure on plantable area due to environmental restrictions, established players seeking to grow, can be expected to give serious thought to acquiring smaller and ideally earlier stage plantation businesses. To establish a greenfield plantation, developers will need to allocate significant time and financial resources to obtain permits, licences and approvals. These processes can take many months, or even extend from one year to another.
Production & Cost Efficiencies
Increased scale can be expected also to drive down production costs for the larger players and this in turn may also lead to greater consolidation amongst less efficient, smaller producers. Producers have long complained of the bureaucracy levels that must be managed at both national and regional levels. The increasing burden of complying with diverse regulations covering land use, environmental protocols, community rights and producer obligations are more easily handled by larger organisations which are able to dedicate resources to manage these demands. Efficiency of palm oil production is being pursued through a number of channels:
Greater agricultural production (industry best field practices)
Optimal milling efficiencies (higher extraction levels and lower FFA counts)
Investment in field efficiencies with automation and machinery
Expanding the ratio of cultivated hectares per FTE worker.
In all cases the implementation of these measures requires capital investment and for some smaller participants, the returns, especially in the context of a muted price performance for palm oil commodities, may not be sufficient to encourage them to make these additional investments. One particular focus is labour efficiency. Wage rates have been rising inexorably in Indonesia and across the region, offset in the last few years, by Rupiah depreciation versus the US$. Nevertheless, Minimum Wages in Indonesia increased to 3.10 IDR Million/Month in 2016 from 2.70 IDR Million/Month in 2015, an increase of 14.8% (Trading Economics for Jakarta Region). Provincial rates were reported to have increased from 7%‐12%.
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For a new plantation development, minimum commercial scale for the nucleus plantation would be targeted at 10,000‐15,000 ha along with a 60t/h mill. For existing plantation operations there can be compelling commercial logic in securing additional land (in smaller parcels) that is relatively contiguous to the existing operations and in particular, with acceptable logistics to access the existing mill. Additional volumes of palm fruit can thereby be made available to the mill via the existing management infrastructure and overhead regime.
Labour Costs & Employee Rights
Rising wage costs are not the only sensitivity for planation employers. Working practices have come under the intense scrutiny of various NGO actors. A 2015 investigation by the Indonesian Labour Organisation (OPPUK), Rainforest Action Network (RAN) and International Labor Rights Forum (ILRF) accused the palm oil production sector in Indonesia of exploitative labour practices. Criticisms focused on the relatively high percentage of casual staff relative to full time employees. It is alleged that casual workers are not entitled to typical employment benefits including healthcare and that the wages paid are in some cases unethically low. It was also alleged that some casual workers are more like permanent temporary staff, employed over a number of years, yet without job security, typical benefits, scope for job progression or the chance to be taken on as permanent staff. The report noted that it was difficult for workers within the sector to gain the protection of an independent union. It is anticipated that this rising focus on worker rights and benefits, combined with escalating wage costs, will require the palm oil production sector to review labour policies and the role of labour in the production of palm oil.
Nationalism and Limits on Foreign Ownership
In September 2014, Indonesia’s House of Representatives (DPR) passed a new plantations bill that sought to maximize land usage and to open up Indonesia’s plantation sector to smallholders. However, to the relief of foreign owners, a retroactive clause that would limit foreign ownership to a maximum of 30% (from 95% then and now) was dropped from the final version. This clause was highly controversial and would have been a major obstacle for foreign companies engaged in Indonesia’s plantation sector including Singapore listed names such as Golden Agri‐Resources and Wilmar International. The plantations law confirmed the requirement of Indonesian plantation firms to allocate 20% of the concessions to local communities and mandated commercial operators to support local communities with the development of this land. Companies were given five years to comply with the new law. The controversial clause that was removed from the legislation has left a legacy of doubt about the future of foreign owners and a number of foreign firms are now seeking to adopt Indonesian domicile including listing on the Jakarta Stock Exchange. Previously Indonesia has implemented protectionist policies in the mining sector, leading to widespread outcry as legal certainty was undermined. Law 4/2009 on Mineral and Coal Mining stipulated larger domestic ownership in the mining sector and included a ban on mineral‐ore exports (implemented in January 2014), forcing miners to process mining output domestically first (an effort to boost domestic processing facilities in order to generate more revenue by increasing the value of exports). For non‐Indonesian owners of plantation assets, the existing limitation on ownership, combined with a rising nationalist rhetoric in Indonesia, might also encourage sales to Indonesian owners.
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Capital Markets Valuations
The data below include valuation data as of 24th October 2016 for the listed Asian producers. A number of sector names were trading below replacement cost. Company Name Adjusted EV/ha ($/ha)
Wilmar International 54,520
Sawit Sumbermas Sarana 39,513
United Plantations 27,062
IOI Corporation 23,433
Univanich Palm Oil 21,172
Genting Plantations 18,978
Golden Agri 16,494
TSH Resources 16,063
KL Kepong 15,997
IJM Plantations 15,490
First Resources 14,229
United Malacca 14,152
Austindo Nusantara Jaya Plantation 14,031
Kwantas Corporation 13,830
Sime Darby 13,543
Bumitama Agri 11,792
Felda Global Ventures 11,691
Provident Agro 10,501
Astra Agro Lestari 10,486
TH Plantations 10,439
Sipef (Brussel) 9,193
R.E.A. Holdings * 9,063
Eagle High (BW Plantation) 8,037
Bakrie Sumatera Plantations 8,028
Socfinasia (Luxembourg) 7,803
London Sumatra Indo 7,241
Carson Cumberbatch (Colombo) 7,229
Dharma Satya Nusantara Plantations 7,153
MP Evans 6,742
Sampoerna Agro 6,232
Indofood Agri Resources 6,084
Salim Ivomas Pratama 6,019
Anglo‐Eastern Plantations 3,724
Socfin (Luxembourg) 3,410
Global Palm 2,576
Weighted average 14,504.0
Indonesian EV/ha 14,697.0
Indonesian EV/ha (ex Wilmar) 10,416.0
* Estimates FY2016
Source: Company reports, Hardman Agribusiness, Reuters Eikon
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Downstream Integration
Palm oil producers with fully integrated / whole value chain businesses, include upstream plantations and mills along with downstream refinery operations which may include:
refining crude palm oil
o CPO can be separated by physical processes into 2 major fractions and one by‐product
o Olein (liquid)– 75%
o Stearin (solid)– 19%
o Palm Fatty Acid Distillate (PFAD) – 4%
processing olein and stearin into specialty fats, oleo‐chemicals or biodiesel.
The relatively simple process of fractionating palm oil: breaking it down into olein and stearin, is not a high margin activity. For better marginal returns and for strongly defensible market shares, those companies looking for strength in end‐to‐end operations, have developed processing capacity for differentiated end user segment products. These might include speciality chemicals or biodiesel in the industrial sphere, or branded cooking oil in the consumer sector.
RefinedProductsPalm olein, is the liquid fraction obtained from fractionation of palm oil. The fractionation process involves a physical process of cooling the oil under controlled conditions to low temperatures, followed by filtration of the crystals through membrane press. Palm olein, is fully liquid at ambient temperature in warm climates. It can be blended with various vegetable oils in different proportions to obtain liquid oils which can withstand lower temperatures. For example, blends of palm olein with more than 70% soft oils such as soyabean oil, corn oil or canola oil remain clear at 0°C for at least 5 hr. Oxidative stability of soft oils are also extended and improved by the palm olein. There are two major grades of palm olein: standard olein and super olein (iodine value greater than 60). The standard olein has an iodine value of about 56‐59 and cloud point of 10°C max. Super olein is more suited to cooler climates and has cloud points of about 2°C‐5°C. Both olein and super olein are suitable as cooking oils, especially for deep fat or shallow frying. The high stability of the oil makes it exceptionally suitable for use in frying. A high content of tocotrienols (members [alpha, beta, gamma, delta] of the Vitamin E family) is generally present in olein. Super olein has a higher iodine value of 60 or above, and has better clarity and a lower tendency to turn cloudy compared to standard olein. Blending normal or super olein with unsaturated oils results in mixtures with different compositions and clarity to cater for different market requirements. Palm stearin, is the solid fraction from the fractionation of palm oil. It can be used for obtaining palm mid fractions (PMF) and also in blends with other vegetable oils to obtain suitable functional products such as margarine fats, shortenings, Vanaspati (a popular Indian cooking oil) and others. It is also an important component in noodles – a mainstay of the ASEAN larder. Palm stearin is a useful natural hard stock for making trans‐free fats. Besides edible usage, palm stearin
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also possesses suitable properties for making soaps and formulating animal feeds. It is also an excellent feed stock for oleo‐chemicals and biodiesel.
StateInfluenceonSectorDevelopmentThe Indonesian authorities have structured trade tariffs (2011) to encourage Indonesian producers to focus on adding value to crude palm oil commodities and this led to a surge in investment into refinery capacity. By 2014 this was thought to have peaked at circa 45m tonnes capacity, well in excess of annual production of crude palm oil (typically 30m mt – 35m mt). BMI Research, a Fitch Group Company, in an article published in July 2016 (ASEAN Palm Oil Companies: Four Key Trends) noted that “…refining capacity remains very elevated, at around 40m tonnes”. The impact of the margin ‘squeeze’ on the smaller refiners, most of which are not supplied by proprietary plantations, has driven a number from the sector, others are reported to have ‘moth‐balled’ their refinery assets. This underlines the importance for refiners of having control over a significant portion of the supply of raw product into their facilities.
Consider the marginal profitability of Mewah International Inc. Its principal operating subsidiary Mewah Oleo, an independent refinery business, produces a range of refined and fractionated vegetable oils and fats principally from palm oil. It also produces oils and fats from lauric oils, such as palm kernel oil and coconut oil, and from soft oils, such as soybean oil, canola oil, sunflower seed oil and corn oil. It operates through two business segments: bulk segment, which sources, manufactures and sells edible oils and specialty fats and oils in bulk for a variety of end uses, and consumer packed segment, which manufactures and sells edible oils and bakery fats and rice to consumers in packaged formats. Mewah has four refineries and processing plants, two packing plants, a biodiesel plant. In contrast to the other names shown below, Mewah does not own significant upstream production assets. This may help to explain why Mewah has the lowest gross margin and the weakest EBIT margin within this group. Scale may also be a factor.
Table: Comparative Financial Data for Refinery Operators FY 2015 Gross Margin % EBIT Margin % ROE % ROIC %
Golden Agri 17.5% 1.6% ‐0.3% ‐0.2% IndoFood Agri 24.4% 9.0% 0.4% 1.4% Mewah International 9.2% 0.9% 1.3% 1.2% Wilmar International 10.2% 3.6% 7.0% 5.1%
Source: Company Report & Accounts/Hardman Agribusiness
StrengthInDiversityDiversification into downstream distribution of finished or semi‐manufactured products has been the path adopted by the largest producers. The addition of value to the crude palm oil commodities, and the creation of strong consumer and industrial brands has the potential to add value to the business (note Wilmar), and to insulate financial performance, to a degree, from commodity price volatility, as amply demonstrated by the data in the table below. The integrated players have exhibited the stronger performances across the sector during the very difficult conditions of 1H 2016. Reported gross margins for 1H16 and 1H15 are compared below for the fully integrated Indonesian producers (shaded) and pure upstream producers. The data are broadly consistent with the premise that downstream diversification provides insulation against commodity price volatility.
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In general, the companies with significant refinery capacity and strong downstream distribution businesses, reported lower disruption to financial performances than their upstream peers (with one or two notable exceptions including REA Holdings). The weaker performances amongst the refinery operators were produced by those with less well developed downstream operations. The strongest of the integrated operators: Wilmar, Indofood Agri and Golden Agri, all recorded single figure changes to gross margins. Volatility was much higher amongst the pure upstream producers. Gross Margin
1H 16 1H 15
Anglo Eastern Plantations 18.3% 21.2%
Astra Agro Lestari 21.1% 22.7%
Austindo Nusantara Jaya Plantation 28.5% 33.4%
Bakrie Sumatera Plantations 21.0% 23.8%
Bumitama Agri 17.7% 22.1%
Dharma Satya Nusantara Plantations 21.7% 27.5%
Eagle High 14.0% 29.1%
First Resources 36.7% 50.4%
Golden Agri 13.2% 13.5%
IndoFood Agri Resources 18.7% 20.5%
London Sumatra 20.6% 26.1%
MP Evans 16.9% 23.3%
Provident Agro 22.8% 26.3%
R.E.A. Holdings 15.6% 10.1%
Salim Ivomas Pratama 19.6% 21.4%
Sampoerna Agro 12.6% 28.5%
Sawit Sumbermas Sarana 44.4% 51.3%
Wilmar International 7.9% 8.3% Source: Company Financial Statements / Hardman Agribusiness
TheImportanceofScaleThe data in the table above tend to confirm a widely held belief that upstream palm oil production is more profitable than the downstream activities of refining and distribution. Note that gross margins for Wilmar are in single figures whilst upstream sector leaders (based on operational efficiencies) and investor favourites: Sawit Sumbermas Sarana and First Resources enjoy leading gross margin efficiencies in excess of 40%. The traditional explanation for the lower marginal returns for downstream businesses, is that palm oil, at the consumer interface, has had less value added to it than soft commodities such as cocoa/chocolate confectionery, or coffee. The end consumer market value for cocoa and coffee can be worth 10x‐13x the value of the traded raw material. In respect of the palm olein cooking oil segment, the ratio struggles to hit 2x. Our sources in Indonesia report that the retail price of palm olein derived cooking oil is approximately twice the price of bulk oil, but when adding logistics/distribution costs, the implication is that the retail market price is lower than 2x the cost of sales. In Europe the ratio is very similar, we are told. Meanwhile, at the commodity end of the spectrum – think Mewah’s bulk business, margins may struggle to top 1%, but at the branded, speciality end of the consumer and industrial segments of the market, margins can be 3% or more.
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Businesses with significant market share in important downstream sectors can still generate substantial annual wealth because of their market reach and control. Wilmar is the leading example of this principle: with some 29m mt of annual refinery capacity, Wilmar has significant presence in the downstream sector in a number of important geographic (China and Africa), and product segments (speciality chemicals, consumer goods, food industry ingredients, biodiesel). As at 31 December 2015, Wilmar had 40 liquid bulk vessels and 14 dry bulk vessels under its owned and controlled tonnages. Wilmar processes more than 35% of all the palm oil produced in the ASEAN region. Moreover the company has deep reach into the major consumer markets for its products, including China. Wilmar therefore, has significant control along each link in the palm oil value chain. The company also has a sophisticated trading division which is able to manage price volatility risk across its huge in‐flows of raw materials and outputted manufactured product. Margins are thin, but wealth can be generated even on thin margins when the trade flows are as large as Wilmar’s. Indofood Agri Resources, in contrast to Wilmar’s international footprint, dominates the Indonesian market for branded consumer cooking oil. Indofood Agri owns and operates 5 refineries with a total annual processing capacity of 1.4m mt CPO, with its facilities located in major Indonesian cities and near deep water ports for logistical advantage. Indofood Agri is thought to own significant market share in the Indonesian market for domestic cooking oil with a strong portfolio of branded lines. The branded segment makes up only 30% of the total cooking oil market, but this has grown sharply from 19% only 5 years ago according to Indofood Agri. Golden Agri does not detail specific asset classes but its Report & Accounts 2015 state that “Our shipping and logistics capabilities are bolstered by our ownership of vessels, sea ports, jetties, warehouses and bulking facilities in strategic locations”.
Company Total Indonesian
Production Area (ha) Annual Refinery Capacity
(mt)
Golden Agri 485,606 4,680,000
Public Listed ‐ Singapore
Salim Ivomas Pratama 336,675 1,400,000
Public Listed ‐ Indonesia
Astra Agro 297,862 900,000
Public Listed ‐ Indonesia
Sime Darby 247,412 825,000
Public Listed ‐ Malaysia
First Resources 207,575 850,000
Public Listed ‐ Singapore
Wilmar International 198,466 29,000,000**
Public Listed ‐ Singapore
Bakrie Sumatera Plantations 61,662 54,750
Public Listed ‐ Indonesia
Source: Company Report & Accounts/Company Websites/Hardman Agribusiness ** includes refinery capacity internationally and includes capacity for a variety of vegetable oils
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It is generally accepted that commercially scaled refineries in Asia (2,000 mt ‐ 6,000 mt per day) should have controlled supply of circa 600,000 mt of crude palm oil. Breakeven for a refinery business is often given as 60% capacity utilisation: for a company processing 4,000 mt CPO per day (1,040,000 mt annually), controlled supply of 60% of requirement would entail a plantation with mature planted area of 110,000‐120,000 ha. Consider the upstream productive capacity (within Indonesia only) of the six largest refiners in Indonesia:
Golden Agri‐Resources: 485,606 ha
Astra Agro Lestari: 297,862 ha
Wilmar International: 198,466 ha
Asian Agri: 160,000 ha
Musim Mas: 130,000 ha
Companies with ambitions to operate business along the entire length of the value chain must achieve appropriate scale and be able to secure their position at each of the vital stages of commercialisation, from upstream production (Wilmar has control / access to production of some 420,000 ha across the region), to refinery and downstream distribution (Wilmar markets edible oil and noodles under its own brands to wholesalers and distributors in China, Indonesia, India, Vietnam, Bangladesh and Africa, having established a comprehensive sales and distribution network reaching out to traditional retail outlets, supermarkets, convenience stores and hypermarts). One such company, with ambitions to scale its operations, is DSN.
Dharma Satya Nusantara Tbk: Growth Ambitions
Founded in 1980 by the heads of four Indonesian business families, DSN owns and manages operating subsidiaries in the palm oil and wood products industries. Collectively the Oetomo, Rachmat, Lim and Subianto families control 69% of the company’s shares. The family of President Director Andrianto Oetomo, has the largest single shareholding in the company with 28.4%. Initially DSN started operations as a logging and wood products manufacturing company, but in the late 1990s, DSN began to acquire agricultural land in order to establish a palm oil production business. Today the wood products business has transitioned away from the original operations centred on the logging of forestry concessions, to the manufacture of higher margin finished products for international markets, using timber sourced only from sustainable forestry suppliers. However, today the growth focus for DSN is the production of sustainable palm oil. In this segment the company has established a reputation for achieving upper quartile efficiencies and productivity, and it has articulated an ambition to become one of the ten largest producers of palm oil in Indonesia. To realise its ambitions, DSN will need to at least double, and perhaps triple the planted area supplying its milling operations, taking the total planted area to between 150,000 ‐ 250,000 ha. With access to I million tonnes of crude palm oil annually from its own plantations, DSN would then be well positioned to develop profitable downstream refinery operations and manufacturing of oleo‐chemicals and biodiesel. It is in this context that DSN has taken an initial 15% equity stake in the Indonesian palm oil operations of REA Holdings via the London company’s principal operating subsidiary, REA Kaltim.
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LandBank&PlantedAreaDSN began commercial production of palm oil as recently as 2002. The first land, some 19,766 ha was acquired in 1997 and there have been another 11 land bank acquisitions since. The total land bank comprises some 235,000 ha, of which 69,368 ha planted are nucleus estates (at Q1 2016), complemented by a further 20,920 ha of planted plasma cultivations. In total, 71% of the planted area is located in a single contiguous block of land in East Kalimantan. This area comprises 5 nucleus plantations with associated milling facilities, all covering some 56,000 ha. DSN’s management estimates that of the existing land bank, perhaps 100,000 ha are plantable. Some 6,000 ha have been set aside for conservation. In Q1 2016, a little over 72% of the total planted area, 65,180 ha was mature. The maturity ratio is in line with the Indonesian sector. By 2019, the company is targeting have 69,368 mature hectares producing palm oil. Palm Oil Plantations Q1 2016 2015 Reported 2014 Reported
Planted Area (hectares) 90,288 90,085 80,066
Nucleus 69,368 69,292 62,779
Plasma 20,920 20,793 17,287
Mature/Productive Area (hectares)
65,180 58,044 53,649
Nucleus 56,279 51,783 48,038
Plasma 8,901 6,261 5,611
Mature Area as % of Total Planted Area
72.2% 64.4% 67.0%
Source: Company Report
It is notable that 23.2% of DSN’s total planted area (30% equivalent of the nucleus estates) is represented by Plasma plantations. DSN asserts that its commitment to the Plasma system in general, and its relationship with the Plasma farmers supplying its mills, is “a critical element in the success of [its] palm oil activities”. The company states that title permissions are eased because of this commitment and relationships with local communities are more harmonious and constructive.
Sustainability / Certification
DSN is a member of RSPO and to date the company has received RSPO certification for 3 of its plantations and their associated milling facilities. As an Indonesian producer, DSN is also committed to meeting the standards of the Indonesian Sustainable Palm Oil initiative (ISPO). One DSN mill has gained ISPO certification. Additionally, the company has received International Sustainability and Carbon Certification (ISCC) certification for two of its mills, thus enabling sale of the CPO output of those mills for the production of biofuels for European markets.
Efficiencies
DSN is one of the most efficient producers in Indonesia with top quartile FFB yields per hectare and upper level extraction rates.
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Company Name FFB Yield (mt/ha) Oil Extraction Rate
(%) Anglo‐Eastern Plantations 17.7 21.20% Astra Agro Lestari 21.7 21.58% Austindo Nusantara Jaya Plantation 20.3 21.70% Bakrie Sumatera Plantations 14.0 na Dharma Satya Nusantara Plantations 26.2 23.90% Eagle High (BW Plantation) 14.2 23.50% First Resources 18.7 22.80% Global Palm 15.8 21.04% Golden Agri 22.1 22.93% Indofood Agri Resources 18.2 22.20% London Sumatra Indo 17.5 23.20% MP Evans 16.2 24.40% Provident Agro 15.0 22.93% R.E.A. Holdings 20.8 22.50% Salim Ivomas Pratama 17.6 22.40% Sampoerna agro 19.7 21.70% Sawit Sumbermas Sarana na 23.30%
Sipef (Brussel) 22.4 21.81% Source: Company Reports
The company reports that it has “consistently achieved or surpassed the laboratory standard FFB yields” within 6 of its estates and that yields have also being recorded at high levels on the company’s Plasma operations.
Ethos&AmbitionDSN’s ambition is to tap into Indonesian growth and to build a world class business focused on the creation of value from Indonesian natural resources. From our conversations with the company’s management, it appears that the palm oil operations are to be the primary platform for growth. Having accumulated a significant land bank, the company is ambitious to develop the operations progressively through both organic growth and acquisition activity to become one of the top 10 producers of palm oil within Indonesia in the course of the next five to ten years. While currently focused on the production of crude palm oil and crude palm kernel oil, DSN has not ruled out developing an integrated business including upstream production and downstream fractionation, including possibly production of oleo‐chemicals and or biodiesel. With the production of REAK included, a combined DSN/REAK would currently be able to produce circa 567,000 mt of CPO. Both DSN and REAK have significant land banks for further development. In REAK’s case, circa 20,000 ha and for DSN, we understand that in the region of 100,000 ha of the current unplanted land bank of 130,000 ha, may be available for palm oil cultivation. With a further 120,000 ha of combined production capacity, the DSN/REAK combine would be capable of producing perhaps 1.35m mt of CPO annually from nucleus plantations only. Adding in another 70,000 mt CPO produced from 3rd party suppliers of FFB would push the combined group above 1.4m metric tonnes CPO annually, putting the grouping into contention with the current output of Golden Agri (Sinar Mas), Indofood Agri Resources and Astra Agro Lestari. Seen in this context, the REAK transaction has very significant strategic value to DSN.
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Conclusion
Above $550/mt FOB, or $770 CIF Rotterdam, the production of palm oil is a profitable business for commercially scaled and efficient Indonesian producers. At higher prices, palm oil production businesses are quite literally ‘money pumps’. The KLK bid for MP Evans will have jolted the investment community to take note that many quality names, like MP Evans, are or have been trading below replacement value. At the offer price for MP Evans (adjusted for the estimated value of the non‐palm oil related activities and estimated net cash), KLK could expect to earn a return of up to 16.5% on every hectare purchased. In an era of negative bond rates, considering that the megatrend of human population may push beyond 9bn to 12bn by the end of this century, noting that although slowing, the Chinese economy is now by some measures the largest in the world and still young, palm oil assets across the sector look anomalously cheap.
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