Still fertile - Chemical Company of Malaysia has been enjoying a fine run of late. Will the good times last?

AsiaViews, Edition: 52/V/Jan/2009

IT HAS BEEN A GOOD YEAR THUS far for Chemical Company of Malaysia Bhd (CCM), driven by strong growth from its fertilizer division. However, will the good times last? With 80% of its fertiliser products driven by the oil palm sector, the health of this sector going forward is crucial to the division and the prospect of the group as a whole. The oil palm sector is now going through challenging times as crude palm oil (CPO) prices are now in a cyclical downturn. However, analysts say that the adverse impact to CCM is still expected to be manageable, given the well-diversified business model of the group.

A leading industrial conglomerate

The group has been in business for a long time, to say the least. CCM was incorporated as Chemical Company of Malaysia in 1963 by Imperial Chemical Company Plc (ICI) of the United Kingdom. It was initially set up to manufacture chlor-alkali products and high-grade compound fertilizers. In 1995, the company broadened its horizon to include pharmaceuticals and hospital services. At present, its main core businesses are categorized into three main divisions, namely,

(i) fertilisers,
(ii) chemicals, and
(iii) pharmaceuticals


CCM’s involvement in chemicals is via its 80%-owned subsidiary CCM Chemicals Sdn Bhd (CCMC). The division’s principal activities include the manufacture and marketing of chlor-alkali and other chemical products with three manufacturing facilities located in Shah Alam, Port Klang and Pasir Gudang, producing and formulating various chemical products. The two major products produced by CCMC are chlorine and caustic soda.

Chlorine products are typically used for water treatment and in plastic manufacturing while caustic soda is used in the manufacture of soap powder, alumina, detergents and bleaching products as well as in the pulp and paper industry. In 2007, the chemicals division contributed around 32.7% of group revenue. Riding on its established position in Malaysia, CCMC is progressively penetrating the Asean market by setting up offices in Singapore, Indonesia, Vietnam, Thailand and the Philippines.

The group’s pharmaceuticals division, on the other hand, comprises several subsidiaries such as CCM Pharma Sdn Bhd, UPHA Pharmaceutical Manufacturing Sdn Bhd and CCM Duopharma. This division is mainly involved in manufacturing and marketing pharmaceutical and healthcare products. Around 80% of its pharmaceutical products are ethical products and the remaining 20%, OTC products. Currently, the division exports to more than 20 countries worldwide, with Asian countries such as Cambodia, Indonesia, Hong Kong and Singapore being the major export markets. In 2007, the pharmaceutical division contributed 15.6% to group revenue.

The fertilizer division, which is CCM’s biggest revenue contributor, contributed around 51.9% of the group’s revenue in 2007. It is involved in this business segment via its 50.1%-owned CCM Fertilizers Sdn Bhd (CCMF), which is the largest manufacturer and trader of fertilizers in Malaysia with a 30% share of the local market. It has been reported that CCMF is the only manufacturer of compound fertilizers in the country. At present, CCMF has only one fully operated plant in Shah Alam with an annual rated capacity of 280,000 tons. However, it has three plants under construction currently in Bintulu, Medan and Lahad Datu. Upon completion, CCMF will have a combined manufacturing capacity of 670,000 tons of fertilizers per annum, making it one of the largest producers of compound fertilizers in Asean.

Prospects generally bright

According to the Department of Statistics, between 2003 and 2007, the sales value of chemicals in the country increased at an average annual rate of 20.5% to RM157.9 billion in 2007. Over the same period, the annual export value of chemicals rose 15.3% to RM36.4 billion in 2007. CCM’s pharmaceutical division is expected to grow steadily, supported by rising healthcare expenditure and growing awareness of healthcare and disease prevention among the population. The prospect of fertilizer usage is said to be sustainable.

According to the International Fertilizer Industry Association (IFA), Malaysia is ranked as the world’s 10th largest fertilizer consumer, accounting for around 1.1% of the world’s total consumption in 2006. Not surprisingly, around 72% of the fertilizer consumption in Malaysia is used by the oil palm sector followed by other agriculture sectors such as rice and fruits and vegetable crops, which accounted for around 8% and 2.8% of total consumption respectively. In 2006, potassium fertilizer was the most commonly used fertilizer in Malaysia, making up around 56% of the total consumption followed by nitrogen and phosphate fertilizer, which made up another 30% and 13.6% of the total consumption respectively. Based on the latest data, fertilizer consumption in Malaysia grew at around 8.4% p.a. between 1997 and 2006.

Given that all its divisions are one of the largest players in their respective segments with a dominant market share, local research house OSK Research believes that CCM will remain a market leader in its businesses given its strong competitive advantage and vast experience and in-depth knowledge. It adds that a strong market position means CCM has strong bargaining power in terms of securing raw materials, selling prices and economies of scale. The emergence of Permodalan Nasional Bhd (PNB) as the group’s largest shareholder has also strengthened its profile, particularly its fertilizer division, given PNB’s substantial shareholdings in plantation estates in Malaysia.

… but affected now by CPO price down-cycle

However, its profitable fertilizer division is under threat from the downtrend in CPO prices at the moment. OSK Research says that farmers generally buy fertilizers on credit and repay only when their harvest is sold. Hence, the price those farmers expect to receive for their harvest influences their decision to invest in fertilizers to increase yield and improve crop quality. Studies have apparently shown that the prices of agricultural commodities have a greater influence on farmers’ decision to spend on fertilizers than do the price of fertilizers themselves.

The rising market price of agricultural commodities tends to push up fertilizer prices rather than the contrary (refer Chart 5) where fertilizer prices move in tandem with agricultural commodity prices but with a time lag. This has been proven by the recent rise in food/soft commodities prices due to a global food shortage, which has pushed fertilizer prices to an all-time high. Falling CPO prices mean oil palm planters are likely to scale back their purchases of fertilizers going forward.

Expecting lower growth going forward

In Malaysia, firm CPO prices have been the main driver for the demand of premium fertilisers, namely, compound fertilizers, as smallholders and oil palm plantations attempt to raise yields to capitalize on the crop’s high prices. As a result, compound fertilizer sales in Malaysia generally move in tandem with CPO price movements, although with some time lag. In contrast, oil palm planters tend to switch to cheaper and lower quality fertilizer, such as straight and mixed fertilizer, when CPO prices are low, as a cost-cutting measure, considering that fertilizer cost accounts for around 30% to 40% of total planting and maintenance cost. In a worst-case scenario, OSK Research says it does not rule out the likelihood that oil palm planters will either defer or cancel their fertilizer purchases, which would hurt CCM’s earnings.

Note that although timely application of the right fertilizer is still important for yield, the research house believes that planters are still likely to cut their fertilizer application for the next few quarters based on the following two possible reasons.

Firstly, the dramatic drop in CPO prices over a very short period is considered the worst the players have seen, catching them unprepared in adjusting their production costs and maintaining margins. Although the current CPO price of around RM1,500/ton is still well above the lowest price in 2001 of RM750/ton, production costs have over the years increased significantly as well. This has caused planters to opt to cut their fertilizer cost by reducing fertilizer application since this is seen as the easier way to cut production cost.

Secondly, given the strong CPO prices from 2006 up to earlier this year, planters have increased their fertilizer application quite significantly over this period to capitalize on the high CPO prices, which has resulted in nutrient-rich soil. In the event the planters decide to cut their fertilizer application significantly for the next few quarters, the nutrients in the soil are still seen as sufficient to sustain the growth of oil palm trees for the next few months with a minimal impact on yield.

Under such circumstances, OSK Research has reduced its average compound fertilizer prices for 2009 from RM1,800 per ton to RM1,400 per ton. The research house has also lowered its forecast capacity utilization rate assumption for CCM in 2009 from 100% to 80% after factoring in a slowdown in demand for compound fertilizer. It was reported that fertilizer consumption in Malaysia dropped by around 23% from 1998 to 2001 during the previous down-cycle in CPO prices.

Still solid nonetheless

Even if the immediate outlook of its fertilizer division seems gloomy, OSK Research believes that CCM group’s earnings as a whole will still be cushioned by its chemicals division, mainly driven by a newly acquired subsidiary, Innovative Group. It also expects the group’s pharmaceutical division to remain resilient despite the economic slowdown, given the nature of its business even though the division’s 2008 earnings has been somewhat disappointing due to margins contraction driven by higher material and production costs. However, the division’s margins are expected to recover in 1QFY09 as most of its raw material prices have come down from their peak in tandem with receding oil prices.

Conclusion

Although there might be some concerns over the liquidity of CCM shares, OSK Research believes that CCM is still a good choice for long-term investors. It adds that the group has an attractive dividend payout guideline of 75% of its net profit, which is sustainable given that it had historically managed to pay its dividends as guided. The research house has a ‘BUY’ rating on CCM with a fair value of RM2.78.




Malaysian Business, 01 January 2009


blogger remark : the target price was downgraded to RM2.24 (neutral) ,on February 26, 2009