From loggers to planters

Malaysian Business, Mar 16, 2008 by James S

WHILE MANY PEOPLE THINK that all loggers do is chop down trees, this may not be true, at least partly for local timber players in the last few years. In fact, a number of these players have been planting trees instead. Well, if you think that perhaps these timber operators could have suddenly developed a soft spot for the environment, given all the greenhouse gases plaguing planet Earth, think again.

The reality is that timber entities are in business and like any other profit-making entity, these players have, in the last few years, been attracted by a different type of tree. Yes, with crude palm oil (CPO) prices hitting record highs (prices broke above RM4,000/tonne recently from slightly above RM1,000 a few years back), Malaysian timber players have been increasingly making their presence felt in the oil palm business as well.

For one, WTK Holdings Bhd (WTK) recently announced its intention to plant about 2,000ha of oil palm trees per year at the initial stage, and this could be expanded to at least 5,000ha per year by 2010, says RHB Research Institute in an investment report on the company. This move is not surprising as other timber companies such as Ta Ann Holdings Bhd, Jaya Tiasa Holdings Bhd, Lingui Developments Bhd and Leweko Resources Bhd have already previously made their foray into the palm oil business. With the strong run-up in CPO prices over the last two years, their plantation divisions are now starting to make significant profit and cash flow contributions to the overall earnings of these companies.

Generally speaking, Malaysian timber companies started planting oil palm when they became involved in forest reforestation programmes under the government initiative. As forest reforestation requires massive investment outlays and a long gestation period before any meaningful contribution from harvesting can be obtained, the government actually allowed timber companies to utilise 20% of their reforestation areas to plant any crop that would give them short-term cash flows.

Most timber companies, therefore, opted to plant oil palm trees which would provide returns within four years of planting. This was particularly useful as banks were reluctant to provide funds to timber companies to finance the reforestation programme given the long gestation period.

Among the listed timber companies, Jaya Tiasa is believed to have the biggest plantation land bank (67,767ha) followed by Ta Ann Holdings (45,000ha) and WTK Holdings (23,000ha). In terms of planted land bank, Jaya Tiasa is also the largest player (25,349ha as at October 2007) followed by Ta Ann (17,000ha as at September 2007) and WTK (3,000ha as at December 2007). However, note that as Jaya Tiasa only started its planting in 2002, only 2,800ha of the planted crop is matured currently.

Ta Ann, meanwhile, has the largest matured hectarage of 7,000 as at December 2007 while none of WTK's trees have matured as yet, as it only started planting oil palm trees last year, says RHB Research.

Will there be a major change in the earnings profile of these timber players in the future, given their increasing foray into the palm oil business? In this story, we look into the rising earnings contributions from CPO to timber companies like Ta Ann Holdings, Jaya Tiasa Holdings, Lingui Development and Leweko Resources since WTK is still a new kid to the business. We also look at how the `golden oil' is mitigating the impact of the current cyclical weak timber business, especially in the plywood segment of these players.

Ta Ann Holdings

The commissioning of the company's first CPO mill at Naman, Sibu in August 2005 has been a good investment, as it has brought positive cash contribution to the group till today. The mill is supplied by fresh fruit bunches (FFB) from the Naman estate (which has a planted area of 10,000 hectares) and neighbouring oil palm estates.

Meanwhile, the group's second joint venture with the Land Custody Development Authority (LCDA) at its Pelita Igan estate covering an area of 11,673 hectares has seen its first planting. Oil palm plantings here, which started in March last year, will be carried out in phases. The objectives are to cultivate superior seedlings that are healthy, with the potential to produce high FFB yields and superior quality oil.

Analysts say that increasing revenue contribution is likely from the CPO mill and the new oil palm estates of the company given:

(i) the growing mature hectarage of its estate, and

(ii) current attractive CPO prices.

With the encouraging outlook of the industry, most expect the company's diversification into the palm oil business to bring promising returns ahead.

In fact, RHB Research believes that Ta Ann Holdings will have the greatest exposure to plantations in terms of profit contribution among timber companies going forward. Ta Ann Holdings completed its first 30t/hr (convertible to 60t/hr) CPO mill in August 2006 and this has improved the profit margin of the division to an estimated 27% in FY07 from 14% in FY06, it says.

Meanwhile, Ta Ann Holdings intends to set up a second CPO mill (30t/hr) which will be operational by 2011 to cater to its increasing mature areas. The company intends to plant about 5,000- 6,000 ha of land per year and based on this planting schedule, RHB Research expects Ta Ann Holdings to finish planting all its oil palm land bank in the next five years. Given this schedule, the company's matured hectarage is expected to increase to 9,500ha by FY08 and 14,000ha by FY09 from just 7,000ha last year.

Based on a revised CPO price assumption of RM2,500/t for 2007, RM2,900/t for 2008 and RM2,800/t for 2009 (from earlier assumptions of RM2,300/t for 2007, RM2,600/t for 2008 and RM2,500/t for 2009 respectively), RHB Research has recently raised its FY07-FY09 earnings forecasts for the company by 3%-6% per annum. It expects the company's plantation division to contribute 60%-65% of the group's net profit in FY08/09 from about 25% in FY07 and just only 4% in FY06.

Jaya Tiasa Holdings

Jaya Tiasa Holdings had 713,211 hectares of forest concession area in FY07. As for oil palm plantation areas, it has 69,055 hectares of plantable area, of which some 24,525 hectares have been planted with 2,788 hectares having matured to date.

The company intends to plant about 10,000ha of land per year and based on this planting schedule, RHB Research expects Jaya Tiasa Holdings to finish planting all of its plantable land bank in the next four years. Hence, it expects the company's matured hectarage to increase to 7,780ha in FY09 and 11,325ha in FY10 from an estimated 4,195ha in FY08.

Although the contribution of the oil palm division to the total revenue of the group still remained relatively insignificant in FY07, revenue from the sales of the group's FFB has increased remarkably by 280.8% to RM9.9 million from RM2.6 million as a result of an increase in the FFB harvest and its average selling price. FFB harvested in FY07 for Jaya Tiasa Holdings was 31,864 tonnes, representing an increase of 191.8% from 10,919 tonnes in FY06. These FFB also fetched a higher average selling price of RM312 per tonne as compared to RM242 per tonne in the previous financial year due to rising CPO prices.

With more of the planted area coming into maturity in time to come, the group's oil palm division is expected to contribute significantly to the overall group's earnings in the future. RHB Research expects the earnings from the plantation division to contribute 18% to Jaya Tiasa Holdings' group profit in FY08, 40% in FY09 and 60% in FY10 (as compared to just 4% in FY07).

Lingui Development

While Lingui Development has no direct exposure to the plantation business, it nonetheless has some indirect exposure to the CPO business via its 36.4%-owned associate company - Glenealy Plantations (Malaya). However, it would seem that this associated company has not really brought any significant profit contribution to the group as yet. While the profit from this associate increased by 64.4% from FY06 to FY07, its contribution to Lingui Development's operating profit was however at a lower 7.1% share in FY07 vis-a- vis the 20.9% share in FY06.

Leweko Resources

It was reported previously that Leweko Resources plans to expand its oil palm plantations either in Malaysia or Indonesia apart from continuously looking for new potential mergers and acquisitions (M&As) in the sector to strengthen its core timber related operations. Management was quoted as saying that the group's oil palm activities serve to cushion the company from the earnings volatility in the timber business. At present, Leweko Resources has oil palm trees ranging from 10-15 years old and produces about 2,500 tonnes of FFB per month. With its production cost of about RM800 per tonne, higher CPO prices would directly translate into additional profit here for the group.

From Chart 3, it is clearly seen that Leweko Resources' oil palm plantation division has contributed meaningfully to the group's revenue and pre-tax profit. Plantation accounted for a 10% and 50% share of the group's revenue and pre-tax profit in FY07 vis-a-vis the previous year's 5.7% and 12.9% share respectively. The quantum leap was due mainly to the increase in FFB prices and output in FY07. In FY06, the group achieved an average selling price of RM1,490/tonne for its CPO but this jumped to RM2,400/tone in FY07. With the CPO price now being close to RM4,000/tonne, it is believed that the profit contribution from this segment could be even more significant this year for the company.

So will there be a re-rating?

Apart from smoothing out the timber companies' profits and cash flows, could there be a re-rating of the prospects of these companies by investors given their rising plantations earnings? Well, according to a timber sector report from RHB Research recently, given that the increase in CPO prices has sent share prices of most plantation stocks to record highs, it has prompted the research house to also evaluate the profit contributions of the plantation division of timber companies in order to include the embedded values of this division into their valuation calculation.

Out of the three timber stocks that it follows, the research house says that Ta Ann Holdings has the greatest exposure to plantations in terms of profit contribution, given its sizeable mature land bank as compared to Jaya Tiasa Holdings and WTK Holdings. Based on its revised CPO and FFB price assumptions, RHB Research says that it has raised Ta Ann Holdings' FY07-FY09 forecasts by 3%-6% and Jaya Tiasa's FY08-FY10 forecasts by 12%- 105% while keeping its WTK Holdings' earnings projections unchanged.

With the earnings upgrade, the research house has also raised its fair value target for Ta Ann Holdings to RM7.00 from RM6.64 based on the sum of parts (SOP) valuation methodology, while Jaya Tiasa Holdings' fair value has been upgraded to RM4.03 from RM3.47. It, however, keeps WTK Holdings' fair value unchanged at RM2.07. On the back of these upgrades, RHB Research has also raised its rating on Ta Ann Holdings to an `outperform' (from `underperform') and Jaya Tiasa Holdings to `market perform' (from `underperform'). It has also upgraded its timber sector rating to `neutral' from `underweight'.

Conclusion
The oil palm plantation segment has certainly proved helpful in sustaining timber companies' profitability at current times when their main timber business is weak, given lacklustre plywood prices and demand. With the run-up in CPO prices recently, plantations may well account for as high as 50% of the overall pre-tax profits of some of these timber companies.

However, it is unclear whether investors will re-rate the timber sector under this scenario, as most will probably prefer to get direct exposure into pure or actual plantation companies rather than seek indirect exposure via timber companies. Still, timber companies may well find solace that without plantation earnings, their share prices may well see more downside than where they are at now.

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