Soft CPO prices boost M&As in plantation sector

Under pressure: A file picture showing a villager harvesting oil palm fresh fruit bunches. CPO prices are expected to be under pressure from rising palm oil output from Malaysia and Indonesia.

Latest one is between two Sabah-based oil palm plantation firms

THE softening in crude palm oil (CPO) prices has increased the appetite for merger and acquisition (M&A) exercises among the local plantation companies.

The latest one is between two Sabah-based oil palm plantation companies with Hap Seng Plantations Holdings Bhd proposing to buy a controlling stake in Kretam Holdings Bhd in a deal worth RM1.18bil or priced at 92 sen a share of the latter.

This would see Hap Seng Plantations acquiring 55% of Kretam Holdings. This will trigger a mandatory general offer (MGO) for the remaining shares of Kretam.

Also, recall in January this year, Ta Ann Holdings Bhd had proposed to buy a 30.4% stake in Sarawak Plantation Bhd for RM169.9mil in cash.

Ta Ann, quoting its group managing director and CEO Datuk Wong Kuo Hea, had also indicated its interest to take up more shares in Sarawak Plantation following that stake buy.

CPO prices are expected to be under pressure this year on rising palm oil output from the world’s top two producing countries namely Malaysia and Indonesia. This follows a recovery of the sector from the El Nino dry weather phenomenon in 2017.

Prices have declined more than 23% since its peak in February last year, from RM3,306 per tonne to RM2.493.67 per tonne.

Output in top producer Indonesia is forecast to rise to 37.8 million tonnes, while Malaysian output is expected to increase to 20.5 million tonnes, according to a Reuters poll.

Benchmark prices are forecast to average RM2,620 a tonne this year, versus RM2,807 in 2017, according to the poll which is based on the median estimate from 14 traders, planters and analysts.

“The operating environment for palm oil companies in Malaysia will be more challenging this year as CPO prices remain under pressure and coupled with the labour shortage issue,”

“As such, we would see more consolidation among medium to small plantation companies this year,” said an analyst.

It is worth noting that going by the share price movement of Ta Ann and Hap Seng Plantations, the market seems not so excited about their proposed corporate exercises.

Shares in Hap Seng Plantations closed one sen lower to RM2.57 yesterday. Its share price has been trading sideways in the past few years, ranging between RM2.50 and RM2.70 a piece.

Meanwhile, shares in Ta Ann have been on the downtrend since the announcement of its proposed stake purchase in Sarawak Plantation.

Mixed view by analysts

Several research houses were not so positive on the proposed Hap Seng Plantation-Kretam deal, raising the issues of valuation and potential earnings dilution of the former.

“At first glance, we are negative on this deal,” said CGS CIMB Research in a report.

It calculated that Hap Seng Plantations in paying around RM97,000 per ha for Kretam’s estates. The research house pointed out that this figure was “significantly higher” than the value of RM53,000 per ha which they ascribed to Hap Seng Plantations estates.

“We estimate the acquisition could dilute Hap Seng Plantations’ earnings by 44% for FY19 and will raise the group’s gearing ratio to 0.97 times from a net cash position.

“This could in turn affect the future dividend payout of the group, which has supported its share price,” CGS CIMB said.

Meanwhile, Kenanga Research said it is “short-term negative” on the deal, due to “stretched valuations” and a potential core net profit dilution (of Hap Seng Plantation).

“The incremental earnings contribution (to Hap Seng Plantation) of RM45mil a year from the stake buy would fail to offset additional interest cost of RM50mil to RM100mil a year, depending on the final acquired stake,” it said in a note.

Kenanga Research pointed out that the proposed purchase price implied “a huge” forward price-earnings ratio (PE) of 77 times, far exceeding the smallcap average of 18 times.

Additionally, the research house said Hap Seng Plantations’ net gearing post-acquisition could go up to 0.5-1.0 times, which would “severely” limiting expansion capabilities.

The proposed acquisition is expected to be completed in the third quarter of this year.

Meanwhile, it is noteworthy that Hap Seng Plantations’ acquisition price appears higher than the recent acquisition by Ta Ann of Sarawak Plantation.

According to Maybank IB Research, the acquisition price paid by Ta Ann for Sarawak Plantation appears cheap on enterprise value (EV) per ha of between RM16,667 and RM21,679.

Nonetheless, Hap Seng Plantations said the acquisition price of 92 sen per share for Kretam is justifiable because it is at a 5% discount to Kretam’s adjusted consolidated net assets of RM2.25bil or 97 sen, as well as the scarcity of sizeable oil palm plantation land in the vicinity of Hap Seng Plantations’ existing operations.

In search of growth

Market observers said that Hap Seng Plantations may reach a stage where growth has hit a plateau. Of the research firms polled by Bloomberg on Hap Seng Plantations, four have a “hold” call on the stock, signalling that the market is possibly waiting for a re-rating catalyst.

Earnings wise, Hap Seng Plantations have been reporting a choppy performances in the past five years.

Currently, Hap Seng Plantations owns 40,279 ha of land, making it one of the largest oil palm planters in Sabah. About 90% of that or 36,145 ha is planted with an average tree age profile of 15.3 years.

It has a total of 16 estates and four oil mills, all located in Sabah – notably in the Lahad Datu, Tawau, and Kota Marudu regions.

Hap Seng Plantations said in its 2016 annual report that the group’s long-term strategy is to increase its estate size.

In 2016, it acquired 476 ha of estate land, adjacent to its present contiguous plot at Lahad Datu.

Under the proposed exercise to buy into Kretam, Hap Seng Plantations would see an immediate increase in its landbank, as well as exposure in the downstream sector of the edible oil and biodiesel segment.

“Upon completion of the proposed acquisition, the total plantation landbank and planted area of the group is expected to increase to 23,865ha or 59.2% and 19,623ha or 54.3%, respectively,” said Hap Seng Plantations.

As at Dec 31, 2016, Kretam has a total land bank of 23,865 ha located in Sandakan, Lahad Datu and Tawau, out of which 19,623 ha. Out of that 18,423 ha is considered mature.

“The estates of Kretam and its subsidiaries in Sandakan, Lahad Datu and Tawau are also strategically located close to Hap Seng Plantations’ existing estates.

“Hap Seng Plantations’ familiarity with these areas will facilitate the integration, management, and operations of Kretam’s estates after the completion of the proposed acquisition, and thus potentially achieve greater economies of scale,” it said.

The proposed acquisition is also expected to improve the age profile of Hap Seng group’s oil palm estates, as the plantation land of the Kretam group comprises mainly of oil palm estates that are within the prime age of between 11 and 19 years.

Affin Hwang Capital reckoned the move by Hap Seng to buy the controlling stake in Kretam is a good long-term move.

“Taking into account the scarcity of sizeable and suitable palm oil plantation land, particularly in Sabah, the proposed acquisition is considered a strategic investment for Hap Seng Plantations.

“We believe the acquisition could contribute positively to the group as Hap Seng Plantations’ expertise in estate management could further improve Kretam’s operations,” it said.

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