Written by Chain Reaction Research and authored by Milena Levicharova, Profundo; Tim Steinweg, Aidenvironment; and Gabriel Thoumi, CFA, FRM, Climate Advisers, this report analyzes the financial risks for the 10 largest Indonesian listed palm oil companies. The report builds upon the outcomes of the Chain Reaction Research report 2016 Sustainability Benchmark: Indonesian Palm Oil Growers, published in December 2016. It adds a financial risk assessment of each company’s revenues calculating revenue at risk in consideration of its No Deforestation, No Peat, No Exploitation (NDPE) compliance. Analysis shows that an improved sustainability performance might lead to better share price returns and lower valuation risks versus a non-NDPE compliant peer.
- Companies with higher sustainability scores, such as Sinar Mas Agro Resources and Technology, Astra Agro Lestari and Dharma Satya Nusantara, generally have a more diversified buyer base but have a weak total return performance over the last two years of -12 percent in USD vs. Jakarta Stock Exchange Agricultural Index (JAKAGRI or JKAGRI depending on data source) -14 percent return over the same period.
- As shown in Figure 1 (below), companies with higher sustainability scores appear to have lower revenue at risk. Average valuation is lower and the net debt/EBITDA ratio is safer. These companies may face less volatile revenue movements because their supply chains are more NDPE-compliant. Further, any revenue impacts they may experience could have a below-average impact on profits due to increased cost structure flexibility. Thus, lower valuation plus lower risk, may signal higher upside potential, i.e. better returns than for the companies with lower sustainability scores.
- Companies with lower sustainability scores appear to have mixed financial performance. Tunas Baru Lampung and Sampoerna Agro showed above-average share price performances compared to the JAKAGRI with a stable buyer-base. They however experienced mixed impact on profits due to revenue impacts and NDPE. Other companies with low scores performed poorly like Bakrie Sumatera Plantations, Eagle High Plantations and Sawit Sumbermas Sarana. The last two were confronted with major loss of customers due to NDPE non-compliance. The average USD total return of the group was -17 percent.
- As shown in Figure 1 (below), companies with lower sustainability scores appear to exhibit higher quarterly revenue at risk. The potential impact from this risk on net profits is unclear. Considering that these equities may be valued at a premium (higher PE ratios), while also having higher net debt/EBITDA ratios, the companies may be facing a valuation risk if the market continues to pursue NDPE-compliance.
|August 8, 2017||Total stock return July 2017 to August 2017||Revenue-at-risk||Potential net profit impact||P/E 17 (X)||EV/EBITDA 17 (X)|
|High sustainability score||-12%||33%||Below average||12.7||8.2|
|Low sustainability score||-17%||46%||Mixed||14.1||12.7|
Figure 1: Sector rankings. Source: Profundo, Bloomberg. High score group: Sinar Mas Agro Resources and Technology, Astra Agro, Salim Ivomas Pratama, Dharma Satya Nusantara, Austindo Nusantara. Low score group: Sampoerna Agro, Eagle High Plantations, Sawit Sumbermas Sarana, Tunas Baru, Bakrie Sumatera Plantations; equity total return in USD.
Since 2013, palm oil growers in Indonesia have begun to make No Deforestation, No Peat, No Exploitation (NDPE) commitments. During the same period, many palm oil buyers have also made NDPE commitments, resulting in incenting growers to transparently execute upon their NDPE commitments. As a result, some companies in the Indonesian palm oil sector are moving towards zero-deforestation supply chains that prohibit clearing carbon sinks such as peatlands and primary forest. This prevents releasing carbon pollution into the atmosphere. Some companies are also making material labor commitments. NDPE compliance means that these companies adhere to the such commitments in practice, even without having a formal NDPE policy.
Some companies have adjusted quickly to NDPE-compliant supply chains. At the same time, non-NDPE compliant firms have exhibited negative financial impacts. In June 2017, Sawit Sumbermas Sarana lost eight percent of its Q1 2017 revenue when Unilever publicly stated it would cease purchasing from SSMS. This may result in further revenue loss, decrease in profit margins and shareholder value loss.
This report analyzes the financial risks for the ten largest Indonesian publicly-listed palm oil companies by market capitalization. It builds on the Chain Reaction Research report 2016 Sustainability Benchmark: Indonesian Palm Oil Growers and adds financial risk assessment of the revenues for each company. Further, the report analyses whether an improved sustainability performance, namely adoption of NDPE policies, has had an impact on the share price performance and whether the current valuation still contains risks.
Each company’s quarterly revenues, customer base, profitability margins, and liquidity ratios over the last eight quarters were also analyzed. Material changes in these metrics linked to NDPE-compliance were traced. Each company’s share price was compared to the Jakarta Stock Exchange Agricultural Index (JAKAGRI).
Subsequently, this report applies a Monte Carlo simulation technique to determine the quarterly revenue at risk for each of the palm oil companies. Note that in the event of non-NDPE compliance, any grower has a risk of losing revenue to growers that are NDPE-compliant.
The scenarios differ for each company, depending on the degree of the diversification of the company’s customers, the existence of buyers responsible for more than 10 percent of revenue on quarterly basis, and the flexibility of the grower to quickly replace lost buyers. Companies who have a more diversified client base likely exhibit lower risk, as they are not contingent on one or two single large buyers. After running 1,000 iterations, the Monte Carlo analysis presents a 5 percent probability of revenue at risk (see the Appendix for methodology).
Finally, based on the results from these Monte Carlo simulations, the analysis continues net profit impact with future equity price forecasts. This analysis enables investors to distinguish Indonesian palm oil growers for compliance with NDPE policies, their sustainability scores, and potential valuation and revenue impacts.
Main Benchmark Findings and Conclusions
Figure 2 (below) shows each company’s sustainability score and various financial metrics. The scoring rubric includes each company’s dependence on one to two large buyers, whether they lost a material buyer greater than 10 percent of sales, and these actions’ potential financial impacts. It also includes the share price development of the last two-year period to enable a broader conclusion on shareholders’ value creation versus sustainability performance.
|CRR sustainability score||1 to 2 large buyers||Material change in buyer base||Impact margin||Direct share price impact||Total return 1/7/15-8/8/17|
|Astra Agro Lestari||8||No||No||No||(30%)|
|Austindo Nusantara Jaya||6||Yes||Yes||Yes||Unkn||33%|
|Bakrie Sumatera Plantations||5||No||No||Yes||No||(66%)|
|Dharma Satya Nusantara||7||Mid||No||No||Yes||(26%)|
|Eagle High Plantations||4||Yes||Yes||Yes||Yes||(48%)|
|Salim Ivomas Pratama||6||No||No||No||Yes||(14%)|
|Sawit Sumbermas Sarana||2||Mid||Yes||No||Yes||(23%)|
|Sinar Mas Agro Resources and Technology||10||No||No||Yes||Yes||(21%)|
|Tunas Baru Lampung||0||Mid||No||No||No||193%*|
|Average excluding high and low||(14%)|
Figure 2: Benchmark findings. Source: Profundo, Chain Reaction Research, Bloomberg; total return stocks in USD; * this is largely related to the company’s starting a new sugar mill.
- The companies with a high sustainability score such as Sinar Mas Agro Resources and Technology, Astra Agro Lestari and Dharma Satya Nusantara have a diversified buyer base but end up but a weak total return performance over the last two years. They have clearly not been rewarded for their changes. Austindo Nusantara Jaya and Salim Ivomas Pratama have a score above average, and they have performed better than average. The average total return of the top five in the sustainability score was -12 percent in USD, above the -14 percent of the JAKAGRI.
- The companies with a below-average sustainability score show a mixed performance. Tunas Baru Lampung and