By Khairie Hisyam
While the plantations division has shown some improvement, it still lags behind industry leaders in terms of yield. Meantime, the overall risk profile is increased by a massive inroad into Liberia. KiniBiz examines why Sime Darby Plantation should be listed on its own.
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Every year, Sime Darby plantations produce 5% of the world’s crude palm oil output. Of the 2.47 million tonnes — or thereabouts — it produces annually, 82% is certified sustainable, which means Sime Darby is the world’s largest producer of sustainable palm oil.
This production comes from its 204 estates worldwide, encompassing 858,879 hectares across Malaysia, Indonesia and Liberia, although its estates in Liberia have yet to see output.
At a glance, one objective of the Synergy Drive merger — to create the world’s largest listed plantations group by planted land area and leverage from economies of scale and cost synergies that result — seems to have been accomplished.
But is it? And what does having such a behemoth as a division means to the collective conglomerate’s performance?
Group performance tied to Plantation
An examination of the plantation division’s contribution to overall group earnings in the years after the merger shows that plantations has always formed the bulk of Sime Darby’s earnings (see tables).
Following the Synergy Drive merger, earnings from plantations comprised as much as 70.2% of Sime Darby’s group earnings in FY08. While the percentage has reduced in the following financial years, up to FY12 plantation still provided slightly more than half of the group’s earnings at 52.1%.
Last year was the first time Sime Darby’s plantation division contributed less than half of the group’s earnings at 41.3%.
Notably, major movements in Sime Darby Plantation’s earnings mirror that of the Sime Darby Group.
In FY09, for example, Plantation’s operating profit dropped 55% from the previous financial year mainly due to lower crude palm oil (CPO) prices — 24.5% lower than FY08 at RM2,177 per tonne — as well as biological tree stress and unfavourable weather conditions. The group saw 41% less pre-tax profit that year at RM3.1 billion compared to RM5.2 billion in FY08.
Similarly when Plantation recorded a 55% operating profit surge in FY11, group pre-tax profit jumped 212.9% as Plantation’s earnings improvement coincided with strong showing by the Industrial and Motors divisions.
However, one mismatch had been when Plantations posted 23% higher operating profit in FY10 at RM2.11 billion whereas the group saw its pre-tax earnings drop 43.3% to RM1.7 billion, but it is worth noting that during this financial year Sime Darby’s Energy & Utilities division posted an operating loss of RM1.75 billion, dragging down overall results.
The emerging picture is Sime Darby group’s earnings are invariably tied to how its Plantation division is doing. With generally half of the conglomerate’s earnings coming from a single division, Plantation essentially overshadows the performance of the remaining divisions.
This effectively negates the benefits of diversification. The point of being a diversified conglomerate — as pointed out by Sime Darby president and group chief executive Mohd Bakke Salleh in the previous part of this series — is that it reduces risk in overall terms for the conglomerate.
However this does not appear to be the case given how much Sime Darby depends on one division in terms of earnings, especially one that is inherently unstable and cyclical.
Instability in plantations
The plantation business involves an element of instability given how it is dependent on weather conditions, which is beyond human technology to fully control.
While Sime Darby has rubber plantations under its Plantation division, for the purpose of this analysis KiniBiz will focus on palm oil which is the division’s main crop.
A look at the reasoning behind year-on-year fluctuations of Sime Darby Plantation’s full-year earnings reveals the strong effects of weather on the division’s performance.
Weather played a pivotal role in the earnings dips seen in FY09 (-55%) and FY12 (-2%), when effects from unfavourable weather conditions and tree stress ultimately hurt total production figures.
In contrast, year-on-year (y-o-y) profit improvements in FY10 (+23%) and FY11 (+55%) was on the back of improved production, implying that weather conditions were favourable.
For FY14 which ends June 30 this year, Sime Darby expects 2% lower fresh fruit bunches (FFB) output due to dry weather conditions. This is based on the expectation of improved production in 2H14 as the first half of the financial year saw production decline by 14.2% from 1H13.
Admittedly weather, while an essential influencing factor in Sime Darby Plantation’s performance, is not the be-all and end-all. CPO prices are also a pivotal factor.
This is seen in FY13, when Plantation recorded operating profit of RM2 billion, 37% lower than the previous financial year. While FFB production for the year was 3.8% higher, average CPO price realised for the year fell 20.8% to RM2,317 per tonne compared to RM2,825 tonne in FY12.
An important consideration here is that average CPO selling prices are subject to market supply and demand — price goes up whenever demand outstrips supply and vice versa. CPO prices are by nature cyclical as the balance continuously shifts back and forth from the state of undersupply to oversupply.
This means unstable earnings is inherent in the plantation industry, an unfortunate circumstance for a division contributing the bulk of Sime Darby conglomerate’s earnings when the group was formed to gain earnings stability in the first place.
Cost and revenue efficiencies?
In the Synergy Drive merger prospectus, the group said that the merger would allow its Plantation division to gain better cost and revenue efficiencies as most of the group’s plantations were adjacent or close to each other.
“The consolidation of such estates will generate revenue and cost synergies through lower overheads, mill optimisation (where FFB can be routed to the nearest mill and surplus mills can process FFB from third parties) and sharing of best estate management practices and R&D findings to further raise FFB yields,” said the group in the prospectus.
Six years on, has Sime Darby achieved this? KiniBiz compares its plantation division’s yield and CPO extraction figures against Kuala Lumpur Kepong Bhd (KLK) and IOI Corporation Bhd, two other major listed planters, as well against the industry average (see Table 4).
Going by the numbers, Sime Darby Plantation’s FFB yield per mature hectare has declined over the last six full financial years, going from 21.77 metric tonne (MT) per mature hectare in FY08 to 21.52 MT in FY13 — 1.14% lower. However the industry average has declined 5.74% over the same period, hitting 19.02 MT last year.
In terms of CPO extraction rates (or OER), Sime Darby has improved on its 21.19% in FY08 to reach 21.79% in FY13, 0.6% higher, during which period the industry average increased at a lower quantum of 0.02% to record 20.24% last year.
Notably, while Sime Darby’s OER for FY13 is higher than both the industry average and the two other planters being considered, IOI Corp boasts higher FFB yield per mature hectare at 24.46 MT in FY13.
Over the same period, Sime Darby’s production cost per MT of palm product has risen from RM811 in FY08 to RM1,002 in FY13. In comparison, the industry average cost is between RM1,400 and RM1,600 for listed planters, said an analyst KiniBiz spoke to.
From this simple analysis, Sime Darby Plantation appears to have achieved some measure of efficiency compared to the industry average, although it is not the leader in terms of FFB yield per mature hectare.
Increasing risk profile
Going forward, however, Sime Darby Plantation’s re-entry into Liberia in 2008 poses concern for several reasons.
Prior to the merger, Guthrie was already in Liberia with a 20,000-acre plantation area for rubber, but operations were suspended between 1989-1996 and 2001-2003 following civil war in the country.
In November 2007 however the newly formed Sime Darby group successfully renewed the old concession agreement with the Liberian government for a 63-year duration. Under the agreement, Sime Darby Plantation (Liberia) Inc would develop 220,000 hectares of land into oil palm and plantations.
Sime Darby’s expansion is certainly understandable from a business perspective, given the size limitations of Malaysia and Indonesia’s move to limit new plantations in the country to 100,000 hectares.
However going into a new country always carries some risk, and going into Liberia, where civil war ended just a decade ago, has increased Sime Darby’s risk profile.
“It does,” agreed an analyst KiniBiz spoke to, adding that while Liberia presents an opportunity for Sime Darby to expand, there is also greater risk involved.
Among the issues is investment cost in putting up infrastructure and other essentials given Liberia is less developed. In addition Sime Darby’s entry has also seen opposition from locals who, due to the cost of obtaining land ownership deeds, are seeing some of their lands given to multinationals by their government as said land are technically public land.
The foremost risk, however, is security. Liberia’s last civil war, which saw between 250,000 and 520,000 people dead, only ended in 2003.
In terms of production, it is not certain whether Sime Darby’s Liberian venture will see yield and OER figures comparable to its current numbers for Malaysian and Indonesian plantations.
“We can only see how the investment turns out after we start seeing output in another two years,” said an analyst to KiniBiz.
This lends weight to the argument that Sime Darby Plantation should be listed separately so as to give a clearer view of its risk profile, reduce the risk factor for other divisions and ultimately prevent it from overshadowing the performances of other divisions.
Yesterday: How to break up Sime Darby
Tomorrow: Creating a property behemoth
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