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Astra Agro Lestari (AALI) is of the second largest palm oil plantation and processing in Indonesia, its 36 years of experience in palm oil industry has made AALI as a role model for many palm oil companies in Indonesia. AALI was established October 3rd 1988 with the name PT Suryaraya Cakrawala, which was changed to PT Astra Agro Niaga in August 4th 1989. The company was merged with PT Suryaraya Bahtera in June 30th 1997, and then named PT Astro Agro Lestari. After the merger, company capital was raised from Rp 250 billion to Rp 2 trillion, derived from 4 billion shares with Rp 500 nominal each. On November 21st 1997, 125.8 million shares with offering price of Rp 1550/shares were offered to the public through Initial Public Offering (IPO).
AALI is attractive to be scrutinized further due to its position as Astra subsidiaries, which is famous for the work ethics, but is operating in a risky industry. A sustainability report proves that AALI plays a role in deforestation, peat land conversion, and biodiversity and land disputes. AALI is the largest private palm oil company that is not member of Roundtable on Sustainable Palm Oil (RSPO), even though three of its largest customers have policies requiring responsible production and sourcing policies. In 2011, Norwegian Government Pension Fund Global dropped AALI from its portfolio due to the severe environmental damage AALI caused.
Apart from the position of having highly regarded parent company and operating in a controversial industry, AALI also conduct several corporate actions in the past and recently in May 2016. AALI corporate actions include share dividend amounting 251.6 million shares in May 10th 1999 and employee stock option amounting 75.48 million shares in May 10th 2000. Recently, in May 30th 2016, AALI did a right issue amounting 349.94 million shares with Rp 500/share nominal value, the offering price was Rp 11425/share. AALI has also acquire small plantation in 2014 and pays dividend for almost every year with payout ratio ranging from 45%-65% in the last five years.
Palm oil plantation is part of agriculture industry operating only in several regions of the world, particularly in Asia, Africa, and South America due to the need of warm temperatures, sunshine, and plenty of rain. However, the industry is criticized because of the negative impact to environment and people surrounding the plantations. Indonesia and Malaysia dominated the world palm oil production, accounting 90% of total world production. Palm oil production and export in Indonesia has been robust for the last 15 years, as signified by figure 1.3.
Production has been increasing at a steady pace, supporting the growth in export volume to China, India, Malaysia, Singapore, and Netherlands. Palm oil business itself is a key industry to Indonesian economy through the export value and employment of millions Indonesian. Plantations are mostly concentrated in Sumatera (70%) and Kalimantan (30%). In 2016, total area of palm oil plantations in Indonesia amounts to 8 million hectares, twice the number in 2000. It is expected to grow further to 13 million hectares by 2020, producing 40 million tons of CPO. Half of the production comes from private enterprises (Wilmar, Sinar Mas), 35% from small farmers, and the rest from state-owned plantations.
Apart from focusing on the plantation and mills, palm oil companies has also expanded to develop refinery for CPO, producing derivatives of palm oil such as RBDPO, Olein, Stearin, and PFAD. The initiative is in-line with government goal of extracting more export value from value added resources. In the past, export was mainly dominated by raw palm oil, but today the priority has shifted to refined products. In the downstream product, government has cut the export tax to boost growth. Meanwhile, crude palm oil export tax range from 0%-22.5% depending on international palm oil price. As long as price is below $750/metric ton, export tax is 0%, which has been the condition since October 2014. However, in May 2015 government introduce palm oil export levies, imposing $50/metric ton on CPO and $30/metric ton on processed products. The attractiveness of processed products cause the increase in oil refining capacity from 21.3 million tons in 2012 to 45 million tons in 2014.
On demand side, domestic consumption is expected to be stronger on the back of government requirement of 20% palm oil content in biodiesel, from previously 15% in 2015 and 10% in 2014. Fitch Ratings expect CPO price in 2016 to increase as global demands stagnate but lower supply from Indonesia and Malaysia due to El Nino. Malaysia production has been declining significantly in the last one year, while Indonesian production has also started to fall in the first half of 2016. In 2015, palm oil industry suffers from the slowdown in growth of importing countries such as China, India, and Pakistan, and the fall in CPO price related to oil price. Strengthening of USDIDR also push costs upward.
From the outline above we can see that palm oil industry prospect is stable, even positive should the CPO price increase further. There are few potential problems from politic and economic point of view. The drawback lies in the social and environmental point of view, where palm oil companies often destroy the area surrounding the plantations and impair the living of the communities through deforestation and destruction of carbon-rich peat lands. Many international companies have made policies to only purchase palm oil derived from companies with sustainable and responsible practice, usually based on the Roundtable on Sustainable Palm Oil. Western countries are also putting stricter regulation of imported palm oil, pushing the need for companies to join RSPO.
In 2011, Indonesia established Indonesian Sustainable Palm Oil (ISPO) to enhance the global competitiveness and bring companies to operate under stricter environmental regulation. All palm oil companies in Indonesia have to adhere to the regulation. Despite the push for companies to adhere to sustainable palm oil criteria, many Indonesian plantations failed to operate with no deforestation, no peat, and no exploitation policy. The Indonesian government also signed a two-year primary forest moratorium in 2011, implying a temporary stop to the granting of new permits to clear rain forests and peat lands. After the expiration in 2013, the president extended the moratorium for two years in exchange for $1 bilion package from Norway. The moratorium has limited the expansion of palm plantations in Indonesia, although it was said that the government had grant nine million hectares before the implementation. In May 2015, President Joko Widodo extended the moratorium for another two years.
Nevertheless, Indonesian palm oil business is still going to be lucrative due to the thick profit margin and increasing international demand. Indonesian CPO production cost is the lowest worldwide; it also has higher productivity rates compared to other edible oil products.
Company Strategic Analysis
Astra Agro Lestari main products are crude palm oil and palm kernel, derived from plantations across Sumatera, Kalimantan, and Sulawesi. It controls 297862 hectares of developed plantations consist of 235432 hectares nucleus plantation and 62430 hectares plasma plantation. The plantations are located in Kalimantan (46.7%), Sumatera (35.8%), and Sulawesi (17.5%). As of December 2015, 86.8% of the plantations are mature plantations, as seen in figure 1.4.
AALI main customers are Kuala Lumpur Kepong (KLK), Musim Mas, Wilmar, and Golden-Agri Resources. These companies contribute 71% of AALI revenue. Domestic market accounts for 98.5% of AALI CPO sales, while derivative products are all exported to China, Philippines, South Korea, and Pakistan. There are 29 mills with 1435 tons/hour capacity and two refinery located in West Sulawesi and Riau owned by AALI. Production of CPO has decreased in 2015 due to El Nino, but intensification program has helped the production of Tandan Buah Segar (TBS). In 2015, AALI produced 5.6 million tons, increasing slightly from 5.56 million tons in 2014. Those figures translate to 1.74 million tons of CPO, 24.93 thousands of RBDPO, 428.72 thousand tons of Olein, 114.17 thousand tons of Stearin, and 27.64 thousand tons of PFAD. To adhere to the environmental regulation, management has met the sustainability laws applicable. By the end of 2015 it has obtained 16 ISPO certificates, and also waiting for other certificates currently processed.
Currently, there are limited options for AALI to grow its business due to the moratorium; palm oil companies including AALI are facing the issue of constraint expansion through clearing new land. The only way to keep the business growing is to improve productivity in each step of operation, starting from fertilizing, in-field activities, and transporting the fruits by mechanization of the process. For example, mechanization in fertilizing and transporting the fruits have increase the effectiveness in harvesting and shipping the fruits to mills. This is logical for a commodity business, where volume, price, and cost are the significant variables. Due to the limitation of plantation fields’ organic expansion and inability to control market price, AALI’s only way is to acquire other plantation and reduce the cost as small as possible. This mean reducing not only the cost of planting and maintenance, but also the cost of fine from environmental damage and cost incurred by hazards such as fire, failed harvest, etc. In July 2014, AALI acquire all the shares of PT Palma Plantasindo, a palm oil plantation in East Kalimantan for Rp 308.726 billion. Despite the difficulty to expand, AALI has the opportunity to increase its production through optimization of their current plantation.
Capital Structure Analysis
Balance sheet structure and capital structure of AALI is robust, in 2011 the company has very low debt level and low level of liabilities in the balance sheet, signified by 0% of debt and 17.4% liabilities/asset. Starting in 2012, the company started to borrow and its debt increase to 7.8% assets. AALI increase its debt level at a stable pace onward, as figure 1.6 shows. As the business expands AALI working capital also increase, causing the stable increase in liabilities/ asset from 2012 to 2015.
AALI debt/asset ratio currently is healthy at 36% and its interest coverage ratio is excellent at 14.73x.
Breaking down the equity composition further, we see that in 2015 there are 1.574.745.000 shares outstanding, with 79.68% owned by PT Astra International Tbk and 20.32% owned by public shareholders. In May 2016, AALI did a right issue amounting 349.94 million shares, increasing the number of shares outstanding to 1.924.688.333 and nominal equity value to 962.344 million. The right issue goal is to strengthen the robust capital structure further and balance the debt/equity ratio.
AALI relies solely on bank loans to finance its debt, it could be broken down into short-term and long-term debt, since AALI doesn’t issue bond during the period. At the end of 2015, AALI debt was dominated by long-term debt to Oversea-Chinese Banking Corporation, Mizuho Bank, and United Overseas Bank. We appreciate the management decision to take a loan and improve the return to equity.
From liquidity perspective, AALI should decrease its short-term debt or increase its cash to boost current ratio above 1 (healthy level). But at good times, management may be reluctant to increase its cash due to the ability to borrow from bank’s committed line of credit.
Valuation of the Company
In valuing the enterprise and equity value, first we have to project the revenue and costs in the future to arrive at either free cash flow or dividend. The valuation method we use for AALI is discounted cash flow based on free cash flow to the firm (enterprise value), then adjusted with debt outstanding to determine the equity value. Based on the industry analysis and company strategy outlined above, we expect AALI’s profit margin to increase back to the level similar to 2013. In 2015, AALI suffers from rising COGS, operating expenses, and forex loss due to rupiah depreciation. We expect profit margin to normalize in the next couple years starting in 2016, backed by stable commodity price and improve efficiency as the management guidance stated. Details of the number could be found in figure 1.11 and 1.12.
The valuation is using several key assumptions; first production volume is expected to decline further as in figure 1.13 shows. The decrease in production volume is expected to drive up CPO price higher on the back of higher demand and lower supply worldwide. CPO price used in the assumptions is charted on figure 1.14. We use risk-free rate of 6.9% (government 10 year bond), return market of 10.53% (average IHSG return), and Beta of 1.041 (Pefindo). Terminal growth of 5.67% is derived from retention rate and ROE.
Based on the projection and key assumptions outlined above, we derived the firm value of Rp 45.412.964 million, equivalent to Rp 23.595/share. Deducting the outstanding debt, we arrived at the equity value of Rp 19.544/share, or 29.86% above the current market price. Details of the calculation are in the excel file attached.
We issue a BUY recommendation for AALI with Target Price Rp 19.550/share, equivalent to 30% upside potential. The most potential downside risks are decline in CPO price, legal issue of plantations managed, change in policy regarding palm oil industry, and litigation from community or NGO.
We outlined suggestion to management in term of the risk involved in the business. There are several risks that also have to be managed:
- Commodity Price Risks
Management could pursue greater stability in revenue growth by setting a long-term contract (forward) to customers fixing the volume and/or price agreed upon by forgoing the upside potential of some percentage of its production. However, we expect that CPO price will be higher in the next few years, therefore leaving AALI exposure un-hedged would results in greater revenue and profit should the prediction comes true. Management could also hedge their exposure by selling CPO futures or buying put options on CPO price.
- Financial Risks
As we have suggests in company capital structure section, AALI may want to reduce its short-term debt and shift it to long-term debt instead. Such action would improve the liquidity and better match the long-term nature of the business. Liquidity and bank’s funding may be scarce during recession, hampering AALI ability to finance its operation or refinancing its debt. As a palm oil producer, AALI is also exposed to the Malaysian Ringgit in determining the CPO price; weaker Ringgit is good for foreigner buying CPO, driving the price higher. There is a negative correlation between MYR and CPO price, therefore hedging the risk may prove to be difficult and introduce basis risk. However, management may want to be cautious in monitoring those variables.
- Operational Risks
Due to the moratorium that limits AALI expansion option, management should focus on improving efficiency and reducing the cost of production. The biggest cost driver are fertilizer and labor cost, therefore management should automate the process possible. Labor should be sourced from local community to enhance participation and sense of belonging to the company, in addition of reducing labor cost. Risks such as fire and other natural disaster should also be mitigated by proper Standard Operating Procedure.
- Legal and Policy Risks
Legality of the plantations managed by AALI could be mitigated by auditing the legal document to ensure the strong standing of the company in the eye of law. Policies of national and local government could also be influenced through association of Indonesian palm oil industry. AALI may want to join RSPO in the future to improve its image in the eye of international importer.