Indofood Agri Resources Ltd - What will it do to cut profit killing costs?

12/5/2013 – CIMB has cut its recommendation on Indofood Agri Resources (IndoAgri), after the palm oil, rubber and sugar producer warned slowing economic growth in China and Europe, and lower biodiesel demand in Europe, were putting commodity prices under pressure.

After hitting a 2-year low of US$776 per tonne in December 2012, crude palm oil (CPO) prices recovered slightly to US$845 in Q1 FY13 but remained significantly lower than 2012’s level of US$1,006.

Also, a bumper soybean crop in South America has put significant pressure on prices.

On a positive note, Indonesia has now become one of the largest consumers of palm oil, together with China and India.

It also expects Indonesia's growing food and beverage industry to sustain domestic demand for palm oil products.

Similarly, rubber prices also remained soft in Q1 at US$3,156 per tonne compared to an average of US$3,384 in 2012 because of lower demand from major rubber consuming countries such as China, the US and Europe.

But the long-term outlook for rubber remains upbeat because of healthy demand from tyre makers, automotive industries and rubber goods manufacturers in developing markets.

In the medium term rubber demand growth will be driven by global GDP growth.

Sugar prices in Indonesia are relatively shielded from global fluctuations because government policies are aimed at protecting the domestic industry, in particular smallholders.

Currently the domestic sugar price in Indonesia is above the international market because of strict import quotas, restricting imports when domestic prices fall below the government mandated floor price of IDR8,100 per kilogram.

In the near term, Indonesia will continue to rely heavily on sugar imports, despite the government’s intentions for Indonesia to be self-sufficient.

This detailed commentary was part of the company's Q1 FY13 earnings report, which looked like this:

Revenue: -3.2% YoY to IDR3,097 bln
Gross profit: -41.9% to IDR637 bln
Gross margin: 20.6% vs 34.3%
EBITDA: -51% to IDR450 bln
EBITDA margin: 15% vs 29%
Profit: -71.7% to IDR107 bln
Cash flow from operations: IDR260 bln vs IDR173 bln

Revenue declined mainly due to lower selling prices of key plantation crops, reflecting the broader decline in commodity prices, as well as lower edible oils sales.

Gross profit declined because the cost of production was higher, partly arising from newly matured plantations.

CIMB Research downgraded the stock from NEUTRAL to UNDERPERFORM with a target price of S$1.02.

It says the main surprise was Q1 core net profit plunging 69% YoY, largely because of lower CPO prices and increased production costs.

The analyst scaled back earnings targets, which lead to a 16% cut in the target price.

Although the stock has underperformed the market, it may stay weak unless it is able to contain the rise in its cost of production and beat earnings expectations.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1. Why did it not issue a profit warning?

The market hates surprises.

Why didn't the company forewarn investors how big the drop was going to be?

Looking to the future, can it be more specific about the following:

Question

2. How much more will costs rise?

Unit production cost for the group’s palm products rose 19% YoY.

The higher costs were due mainly to lower fresh fruit bunches (FFB) yields from the 18,000 hectares (ha) that came into maturity in the previous year.

Also, the group applied more fertiliser in Q1 due to favourable weather.

But fertiliser prices that had been locked in were 10% higher than before.

It also indicated labour costs will be 15% higher following its recent wage negotiation with its workers.

Question

3. What is the budgeted cost of new plantings?

Indofood Agri planted 1,500 ha of oil palm estates in Q1, double Q1 FY12’s 699 ha.

It maintains its plans to increase its planted oil palm estates by 10,000 to 15,000 ha in 2013 and its sugarcane estates by 2,000-3,000 ha.

Question

4. Will volumes compensate for lower revenue from the edible oil & fats division?

Sales volume of edible oils & fats fell 12% in Q1 as the group sold less refined edible oils because the refining margins for this segment were thin.

This was the key reason behind the 12% drop in edible oils & fats volumes in 1Q.

Its branded cooking oil business in Indonesia remains unaffected.

However, the group has lowered its cooking oil prices by 10% and margarine prices by 4% in April 2013.

Question

5. What is the expected average CPO price in Q2?

Group guided that the near-term concern for CPO prices lies in the higher South American soybean supplies, which may dampen soybean oil prices and put pressure on CPO price.

But this is partially offset by higher biodiesel demand in Indonesia and recent drawdown of CPO stocks.

Question

6. What does the group plan to plant on the acquired land by its subsidiaries?

Group’s subsidiaries, SIMP and LSIP recently acquired a 79.7% interest in PT Mentari Pertiwi Makmur (MSM) for IDR330 mln or US$34 mln.

MPM owns SAL group, which holds three industrial forest plantation concessions totalling 73.330 ha in East Kalimantan.

The group plans to plant other agriculture crops through intercropping on this land.

This also leads to our next question:

Question

7. What is the expected capital expenditure for this venture?

We have sent these questions to the company to invite them for an on-camera interview, and/or seek their written response.

Sofar, we have not had a reply (which is why you are seeing this message).


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