Stock Code: 9059
Price: MYR2.45
12-Month Target Price: MYR2.70
Date: July 25, 2008
HOLD S&P
GICS: Consumer Staples/Agricultural Products
Market Value - Total: MYR1,011.7 mln
Summary: TSH Resources (TSH) is an integrated plantation group, with oil palm plantations and palm oil mills in Sabah and Indonesia, a refinery and bio-energy power plants. The group is also involved in the manufacturing of engineered hardwood flooring and cocoa products.
Analyst: Siti Rudziah Salikin
Highlights
TSH is a small oil palm planter in Sabah with about 4,500 ha of planted oil palm but having expanded its plantations in Indonesia, it now holds a total land bank of 80,000 ha. The planted area, totaling 20,000 ha, is still young (11,500 ha consist of immature palms), and will support double-digit production growth over the next 3-4 years. Longer-term growth will hinge on the progress of new plantings in Indonesia.
Downstream, TSH has palm oil mills, a refinery and bio-energy power plants, which use solid and liquid wastes from the mills as raw materials. The additional benefit is that bio-energy project allows TSH to apply for carbon credits, which are tradable.
In spite of the current downward pressure on the price of CPO, we believe the downside will be supported by the strong underlying demand for and the tight global supplies of other edible oils.
TSH, via 65%-owned Ekowood International (EKO MK, MYR0.50, Not Ranked), produces hardwood flooring but we are cautious on its prospects due to the uncertain outlook of the property markets in Europe and the U.S., its main export markets.
Investment Risks
Risks to our recommendation and target price include a continued downtrend in CPO price and slow progress of its new plantings. A significant economic downturn in Europe and the U.S. would also hurt prospects for its flooring business.
Recommendation
We initiate coverage on TSH with a Hold recommendation and a 12- month target price of MYR2.70 per share.
Despite the potential long-term growth prospects from the plantations in Indonesia, we prefer to be less aggressive in our valuation due to execution risks with the new plantings. A less promising earnings outlook for the wood flooring division will also place additional bearing on its valuation, in our opinion.
The target price is derived from a PER-based sum-of-parts valuation and includes our projected dividend. We assign a PER of 10x to 2009 earnings for the palm and bio-integration operations. The PER is within the range of our target multiples of 8x-10x for medium-sized plantation stocks. We accord a PER of between 6x and 7x for the wood-based and cocoa manufacturing divisions, in line with the singledigit forward PER for timber and food-based stocks.
We project a higher dividend of 7.5 sen for 2008. The projected payout of about 26% is slightly lower than TSH’s policy of 30% due to its high capex requirements mostly to fund the new plantings in Indonesia. We project net gearing to increase to between 40% and 50% (at group level) in 2009 from 29.3% at end 2007.
Corporate Social Responsibility (CSR) issues were addressed in TSH’s 2007 annual report, which reviewed the group’s CSR initiatives pertaining to human resources, workplace and community.
Background
Founded in 1979, TSH was initially involved in the marketing and distribution of cocoa products. TSH started its oil palm plantations in Sabah in the late 1980s. Today, it has integrated palm oil operations (plantations, milling and a refinery) that include bio-energy generation as its core business while its cocoa business is a secondary activity. It also owns 65.1% of Ekowood International which is a leading manufacturer of hardwood flooring in the country.
The group is helmed by founder, Tan Soon Hong (Executive Chairman) and his sons, Dato’ Kelvin Tan and Tan Aik Sim, who are Managing Director and Chief Executive Officer, respectively for both TSH and Ekowood. Mr Tan’s two other sons, Tan Aik Kiong and Tan Aik Yong also sit on the board as Executive Director and alternate Director, respectively.
Organization structure
Palm and bio-integration operations
Oil palm plantations
TSH is a small planter in Sabah with about 4,500 ha of planted oil palms. Nevertheless, since venturing into Indonesia in 2003, it has since acquired several companies with plantation land in Indonesia and increased its total land bank to about 80,000 ha. About 20,000 ha of the land are planted with oil palms (including the estates in Sabah). On the unplanted land in Indonesia, the plan is to develop about 10,000-15,000 ha p.a. but progress has been delayed by localized land issues, which are still being addressed. About 2,000-3,000 ha are expected to be planted in 2008 but TSH anticipates the planting pace to pick up in 2009.
The planted palms are very young with 11,500 ha immature (less than three years old) and 8,500 ha between the ages of four and 16 years. The estates in Sabah are already at the prime production age, thus growth prospects will be limited, in our opinion. The estates produced a comparatively high fresh fruit bunches (FFB) yield of 28 tons/ha in 2006 and 29 tons/ha in 2007. Future growth in FFB production will come from the estates in Indonesia. The immature estates are expected to come into harvesting in stages and the yield is expected to gradually improve as young palms reach peak maturity. This will support a double-digit growth in FFB production over the next 3-4 years. The new plantings will sustain the growth in the longer term.
Downstream, TSH has three palm oil mills in Sabah and one in Sumatera, Indonesia with a combined processing capacity of 1.5 mln tons of FFB p.a.. The mills currently operate at about 70%-75% capacity. Presently, about 15%-20% of the FFB processed come at the mills from TSH’s own plantations but the in-house supply will gradually increase along with the growth in FFB production. TSH plans to add one new mill in Indonesia in 2009 and another mill in 2010 to cater for the projected increase in FFB output.
TSH also owns palm oil refinery and palm kernel crushing plants (in Sabah), which are set up via a 50:50 joint venture with Wilmar International (WIL SP, SGD4.30, Not Ranked). Wilmar is a welldiversified agribusiness group with an extensive distribution network to undertake the marketing of the palm products. The refinery commenced operations in January 2007 and currently runs at about half of its annual capacity of 750,000 tons. The ramping up of production will be gradual with the full utilization expected in 4-5 years. The venture contributed MYR13.1 mln to TSH’s pre-tax profit in 2007.
Palm bio-integration
The bio-integration operations involve recycling the wastes from palm oil millings into energy and paper.
Presently, TSH has two bio-mass power plants, which use empty fruit bunches (EFB), and a biogas power plant, which uses palm oil mill effluent or waste water, to generate electricity and industrial steam. The first bio-mass power plant (14MW) sells the electricity to Sabah Electricity Board (SEB). TSH has a 21-year renewable energy purchase agreement with SEB to sell up to 10MW of the electricity to SEB at 21.25 sen per kwh from the date of the plant becoming operational, which was in 2005. The other plant (9.8MW) is 50%-owned and was set up in a similar joint venture with Wilmar to power the refinery. The biogas power plant (2.5MW) is currently on a trial run and will supply the electricity and steam to TSH’s new pulp and paper (Ekopaper) plant.
TSH is setting up a 30,000 tons p.a. Ekopaper plant to process EFB into pulp and paper. The plant is targeted for operational in mid-2009.
The bio-integration operations allow TSH to extract more value from its palm oil operations while at the same time contribute to the conservation of the environment. As an additional benefit, the project allows TSH to apply for carbon credits, which can either be: (i) sold to other companies or governments to meet their greenhouse gas emission requirements under the Kyoto Protocol; or (ii) traded at a climate exchange. TSH’s biogas power plant qualifies as a Kyoto’s Clean Development Mechanism project and is entitled to carbon credits, while the applications for its two bio-mass power plants are still awaiting approval. TSH is looking at generating 30,000 tons of carbon credits in 2008 and 80,000 tons in 2009 and has committed to sell half of its carbon credits output to a European purchaser at EUR$12/ton. Altogether, TSH expects to generate up to 200,000 tons of carbon credits from its bio-energy plants.
Other businesses
Cocoa and vegetable fat manufacturing
TSH’s cocoa processing factories are located in Port Klang and housed under CocoaHouse Industries Sdn Bhd and TSH Industries Sdn Bhd. CocoaHouse produces cocoa butter, cocoa cake and cocoa powder. The products are exported to bakeries, confectioneries, beverages and chocolate manufacturers in the U.S., Australia, New Zealand, Korea, Egypt, Russia, Iran, the Philippines and India. TSH Industries processes low grade cocoa beans and illipe nuts into deodorized expeller cocoa butter, deodorized extracted cocoa butter, neutralized and bleached illipe butter. The operations generated a decent operating profit of MYR21.6 mln (17.1% of group profit) in 2007.
Wood-based manufacturing and reforestation
The division contributed MYR19.9 mln or 15.7% to group operating profit for 2007. Ekowood manufactures engineered solid hardwood flooring using local and imported wood species at its factory in Gopeng, Perak. The products cater to the export market, mainly to Europe (which accounted for 57% of Ekowood’s revenue for 2007). Ekowood has gained some ground in the domestic market, thanks to the robust high-end property market, and has increased domestic sales to 17% of revenue in 2007 from 9.2% in 2005. Ekowood invested about MYR20 mln in 2007 to upgrade the ESHF plant and expand the capacity to 25 mln sq. ft. from 14 mln-15 mln sq. ft.. However, we understand that the performance of the new machinery has not been up to specifications, and this will delay the commissioning to 2009.
TSH also has 100-year rights, which was awarded in 1997, to undertake forest rehabilitation, conservation and planting activities on 123,000 ha of forestry land in Ulu Tungud, Sabah. The forest plantation program involves an area of 11,000 ha and is funded by British American Tobacco (BAT MK, MYR41.00, Hold). The planting began in 2004 and to-date, about 5,000 ha have been planted. Although the return involves a long gestation period as it requires at least 10 years for the trees to mature, the project reflects TSH’s strong commitment towards the protection of the environment.
Earnings Outlook
The palm and bio-integration operations, which contributed 67.2% to group operating profit for 2007, will continue to lead the group’s performance going forward, in our opinion. We project a 26% YoY growth in net profit for 2008 to MYR119.6 mln driven by increased production from TSH’s own plantations in Indonesia and higher palm oil price. We assume a lower CPO price for 2009 and expect net profit for the year to slid 2.3% YoY to MYR116.9 mln.
The recent crude oil price slide, the high inventory of palm oil in Malaysia and the review of the biofuel target (of 10% of all transport fuel from renewable sources by 2020) by the European Union, are factors that have put downward pressure on the price of CPO of late. However, we still maintain our view that the downside will be supported by the strong underlying demand for and the tight global supplies of other edible oils, including soybean oil. We are keeping our forecasted CPO price of MYR3,200/ton for 2008 and MYR3,000/ton for 2009.
We expect the lower CPO price for 2009 to be partly made up by our projected double-digit growth in production and better margins for the refinery. The 14MW biomass power plant is expected to achieve its optimal efficiency in 2008 and contribute MYR7 mln–MYR8 mln p.a. in operating profit from the electricity sale. Profit contributions from carbon credits are not expected to be significant in 2008-2009.
We are cautious on the prospect of the wood flooring business. While the capacity increase may support volume growth, the uncertain outlook of the property markets in Europe and the U.S. and the volatility of raw material prices could affect pricing and profitability. We also believe the local highend properties have peaked, which is likely to put a brake on demand growth from the domestic market. Similarly, price inflation and weaker consumer spending may slow down the demand for cocoa products while the high prices of cocoa beans are likely to put pressure on margins.
Valuation
TSH’s share price has corrected 25.7% over the past two months, lowering the stock’s PER to a more reasonable level of 8.5x (based on projected earnings for 2008). Although the plantations in Indonesia will provide strong growth prospects for a long-term period, there are execution risks due to the local land issues, which could further delay the rate of new plantings. A less promising earnings prospect for the wood flooring division will place additional bearing on valuation, in our opinion. Thus, we prefer to be less aggressive in our valuation for the stock.
We value the stock using a PER-based sum-of-parts and add on our projected DPS to arrive at a value of MYR2.70 per share for the stock. We assign a PER of 10x to projected 2009 net EPS for the palm and biointegration operations. The assigned PER is within the range of our target multiples for medium-sized plantation stocks of 8x-10x. We accord a PER of between 6x and 7x to earnings for the wood-based and cocoa manufacturing divisions, taking into consideration the low single-digit forward multiples for Ekowood (and other downstream timber producers) and food-based manufacturers.
TSH has a long-term dividend payout policy of 30%. We project a dividend of 7.5 sen per share or a payout of about 26% for 2008 as we expect TSH to conserve part of the cash for its new plantings, palm oil mills and Ekopaper plant. At an estimated planting cost of MYR12,000/ha, TSH will need over MYR600 mln – MYR700 mln to develop the unplanted areas of 60,000 ha in Indonesia over the next 6-7 years. Net gearing is projected to increase but should remain at a comfortable level of between 40% and 50% (at group level) in 2009 from 29.3% at end-2007.
Recent Development
June 2008: TSH entered into a sale and purchase agreement to acquire a 100% interest in Martinique Cove Pte Ltd for USD5.7 mln. Martinique holds a 90% stake in PT Mitra Jaya Cemerlang, which 15,000 ha of land with izin lokasi (location permit) status in Central Kalimantan.
June 2007: TSH proposed to acquire 100% stake in Elaeis Oversea Pte Ltd for USD4.7 mln. Elaeis holds a 90% interest in PT Farinda, which owns 15,000 ha of land with izin lokasi status in East Kalimantan. The completion time for the proposed acquisition has been extended to Sep. 30, 2008.
Recommendation and Target Price History
Date/Recommendation/Target Price
New/Hold/2.70
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