Anglo Eastern Plantations AEP
June 11, 2012 - 1:25am EST by
Den1200
2012 2013
Price: 7.10 EPS $0.00 $0.00
Shares Out. (in M): 40 P/E 0.0x 0.0x
Market Cap (in $M): 281 P/FCF 0.0x 0.0x
Net Debt (in $M): -84 EBIT 0 0
TEV ($): 197 TEV/EBIT 0.0x 0.0x

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  • Indonesia
  • Discount to Liquidation Value
  • replacement value
 

Description

Anglo Eastern Plantations (AEP) is a UK listed company that owns palm oil plantations, mostly in Indonesia. The company is attractively priced at a price per Ha between $4,200 and $5,200. Significantly cheaper than the replacement value per Ha of $8,000 and far below the private transaction prices per Ha of between $15,000 and $20,000.

In addition buying AEP at between $4,200 and $5,200 per Ha provides one with a great post tax ROIC of plus 20% based on conservative estimates and 30% on average estimates. But most importantly, there is also the upside from increased investment at high ROICs.

Lastly the future economics, meaning increased demand and limited supply, of the palm oil business look attractive which over time will allow for an improvement of those ROICs and continued growth.

 

Before I get going, I’d like to share with you two quotes by Jeremy Grantham, both which touch on relevant issues related AEP

 

“As the population continues to grow, we will be stressed by recurrent shortages of hydrocarbons, metal, water, and, especially, fertilizer. Our global agriculture, though, will clearly bear the greatest stresses. It may have the responsibility for feeding an extra two to three billion mouths, a 30% to 40% increase in just 40 years … Encouraged by higher prices, we will become more frugal and more sensible and stretch out our resources, buying us more time for a natural decline in population to eventually bring us into balance … Farming will be a satisfying and enriching experience if, on a global basis, we rise to the long-term agricultural challenges. And, if good old short-term profit maximizing continues as it did for the Syrian, Greek and Roman farmers before us, then at least today’s farm owners will go down with the ship, but travelling in first class.” Jeremy Grantham

 

I am in agreement with Mr. Grantham. The only thing he doesn't mention is that there will also be increased demand for food per capita. Over the years, the impact of the per capita demand is twice that of population growth.

 

What is Palm Oil?

Palm oil and Palm kernel oil are the vegetable oils extracted from the fruit from the Oil Palm tree. In the industry this fruit is called Fresh Fruit Bunch or FFB, the product removed from the tree from which they extract both oils. Palm oil is found in the fleshy portion of the fruit (mesocarp), whereas palm kernel oil is found in the kernel or the seed of the fruit. These two oils have very different compositions. Crude palm oil (CPO) is by far the largest revenue stream. In addition, the palm oils aren’t just used for edible purposes, but the last decade a large demand has developed for biodiesel made from palm oil.

 

MP Evans keeps an update graph of the CPO price per ton on its website at http://www.mpevans.co.uk/mpevans/en/operations/com.

 

Palm oil is the most widely consumed vegetable oil with a 33% market share. Competitors are soy bean oil (29%), rapeseed (17%), sunflower (8%), peanut (4%), coconut (3%), cotton (3%) and olive oil (2%). Soy used to have the largest market share, being 40% in 1970, while CPO was only at 10% at that time.

 

 

Market Shares Palm Oil Vegetable Oil Market

Market Shares Palm Kernel Oil Vegetable Oil Market

1997

23.5%

 

1998

22.7%

 

1999

22.8%

 

2000

24.8%

 

2001

27.2%

 

2002

26.8%

 

2003

29.0%

3.5%

2004

29.2%

3.6%

2005

30.1%

3.5%

2006

30.7%

3.5%

2007

30.3%

3.6%

2008

31.6%

3.6%

2009

32.5%

3.8%

2010

32.4%

3.7%

2011

32.7%

3.5%

4/1/2012 TTM

33.0%

3.6%

 

Market share gains are the result of CPO and Palm Kernel Oil being the cheapest vegetable oils on the market, which has a large impact in the price sensitive developing countries where most of the growth in demand has taken place. This does not mean it is the lowest quality product out there. Actually it is the better alternative as it is the only vegetable oil that does not require hydrogenation which causes transfatti acids, which increase the risk of coronary heart disease.

Both palm oils also are the lowest cost producers in the industry. The reasons are that palm oil production does not require continuous planting, can be harvested more regularly and the output per professionally managed Ha is multiples of that of its competitors. Here are the differences in yield per Ha.

 

Palm Oil Indonesia – 3.9 Tons/Ha (Total of between 5 and 6 tons for professionally managed properties like those of AEP.)

Palm Oil Malaysia – 4.5 Tons/Ha

Soy USA – 0.53 Tons/Ha

Soy Brazil – 0.51 Tons/Ha

Rapeseed Oil EU – 1.3 Tons/Ha

Rapeseed Oil Germany – 1.6 Tons/Ha

Sunflower – 0.8 Tons/Ha

 

Palm oil has the benefit on not requiring continuous planting. The oil palm tree cycle is about 25 years. After planting for the first 2 years there is no FFB yield. Then it slowly starts in year 3 improving each year to year 7 where the tree reaches maximum FFB productivity. It stays at that level until about year 16 after which the FFB yield slowly declines until year 25 at which time one replants. Only in year 5 does the palm oil extraction rate get close to 20% increasing a full maturity to around 24%.

 

Market Dynamics – Before getting to AEP I believe it relevant to discuss industry dynamics.

 

Demand for vegetable oils, and palm oil, continues to increase each year driven by increased consumption per capita as well as by a continued increase of the world’s population. All this against a background of limited availability of arable land.

 

Lets start on the demand side:

 

The two drivers of increased aggregate demand are increased demand per capita as well as an increase in the world’s population, both have been growing for some time and are expected to continue to do so. Here are some historical numbers.

 

 

Consumption Per Capita Vegetable Oils (Kg)

Consumption Per Capita Palm Oil (Kg)

Consumption Per Capita Palm Kernel Oil (Kg)

Population (MM)

Total Demand Vegetable Oil (MM mt)

Total Demand Palm Oil (MM mt)

Total Demand Palm Kernel Oil (MM mt)

1997

12.5

              2.93

 

          5,847

             72.87

    17.13

 

1998

12.4

              2.82

 

          5,926

             73.72

    16.73

 

1999

13.1

              2.99

 

          6,003

             78.54

    17.92

 

2000

13.6

              3.37

 

          6,081

             82.68

    20.50

 

2001

14.4

              3.91

 

          6,157

             88.58

    24.07

 

2002

14.6

              3.91

 

          6,234

             91.04

    24.36

 

2003

15.1

              4.39

               0.53

          6,310

             95.51

    27.69

3.36

2004

15.7

              4.59

               0.57

          6,386

           100.40

    29.29

3.61

2005

16.7

              5.03

               0.58

          6,462

           107.96

    32.50

3.78

2006

17.6

              5.41

               0.62

          6,537

           115.21

    35.35

4.04

2007

18.3

              5.54

               0.66

          6,613

           120.93

    36.61

4.34

2008

18.8

              5.93

               0.68

          6,688

           125.49

    39.68

4.57

2009

19.3

              6.26

               0.73

          6,764

           130.22

    42.33

4.94

2010

20.2

              6.56

               0.74

          6,840

           138.38

    44.86

5.07

2011

21.0

              6.87

               0.72

          6,916

           145.18

    47.54

5.01

4/1/2012 TTM

21.6

              7.13

               0.77

7,019

           150.83

    49.82

5.41

CAGR

3.79%

6.28%

3.92%

1.21%

5.05%

7.56%

5.12%

 

As you can see, most of the demand growth has come from the increase in consumption per capita, rather than population growth, especially when it comes to palm oil. Most of that growth is driven by the developing world.

 

To continue on the consumption per capita, following is a table listing per capita consumption for different countries, with the average consumption per capita in the developing world being 20.02 Kg, less than half of the number consumed in the US and the EU. The gap is large enough to allow for a significant increase in per capita consumption in the developing world, without a need to get to the 40 Kg plus consumed in the US and EU. This is important. If the average consumption of vegetable oils was already 40Kg globally, there’d be not much need for more vegetable oil per capita.

 

Vegetable Oil Consumption By Country

Kg/Capita

China

        21.53

EU-27

        49.18

India

        14.07

United States

        40.75

Pakistan

        19.59

Russia

        22.99

Egypt

        27.03

Mexico

        19.58

Nigeria

        11.14

Turkey

        24.09

 

The correlation between GDP growth per capita and consumption per capita is strong with an R Squared that is high, so assuming continued economic progress and population growth in the developing world there will be significantly more demand for vegetable oils going forward.

 

I would like to address population growth. While it has been the smaller part of the equation, its still important. To me it seems there is a very high likelihood that the world’s population will continue to grow at a reasonable clip to the 9 billion people number. Actually, the current layout of the global population pyramid and the math behind that pretty much guarantee it, except if we see massive changes in the dynamics behind population growth. The replacement rate would have to collapse by more than half quickly we’d need to average life expectancy to come down too.

What makes this happen? Increased GDP and healthcare are inversely correlated with the replacement rate. A richer and healthier world will mean less children. The problem is that those changes happen gradually over a generation. Also lack of food and other resources can have an impact. How much is doubtful, just look at Africa where the population continues to expand despite significant food instability. Or worse something like H5N1 which since 2003 out of 566 confirmed human cases has resulted in the deaths of 332 people. Currently H5N1 is not able to transmit easily between human. Actually, from what I found out only one case was ever suspected of doing so. If H5N1 ever finds a way to have easy transmission from human to human it would be bad for us all. The whole system could get bent out of shape pretty badly.

If you’d like to play around a little with the population pyramid over time, there’s a great site http://www.worldlifeexpectancy.com/world-population-pyramid. Spain’s pyramid looks interesting as birthrates collapsed pretty severely 3 decades ago. The pyramid looks like a Christmas tree and looking at it on first sight I thought Spain’s population should start shrinking soon, but it turns out that the Spanish population will continue to grow from 45 million now to 52 million in 2050. Only once the Spanish Baby Boomer bulge works its way through the system is the population expected to shrink, which is post 2050.

So the 9 billion global population number is a pretty high probability. By the way, this number already includes a fairly significant decline in the birthrate.

 

So the three elements for increased demand are available:

  1. The large existing gap between developing and developed country consumption.
  2. The growth in consumption per capita. Given the state of the developing world I find it hard to assume GDP growth coming to a halt soon. Even 2.5% to 3% global growth will continue to drive increased consumption per capita, although at a slower rate.
  3. The growth in global population, which is a high probability outcome.

 

Besides the above there are other factors driving increased demand, like transfats and biodiesel.

 

Lets start with bio diesel/bio fuels.

 

In 2000 production of bio fuel was 15,200 barrels a day which did increase to 294,690 barrels a day in 2010. Current global mandates by governments provide for a need of 3.77 million barrels of bio fuel a day in 2022. The mandates do exist, although there is doubt about their achievability. Biofuels are either ethanol or biodiesel. Palm oil is used to make biodiesel.

Ex input costs, palm oil is the most competitive vegetable oil to be turned into biodiesel. It takes about $150 to $200 to make one ton of palm oil based biodiesel while it costs between €500 and €600 to make a similar quantity of rapeseed oil into biodiesel.

 

Yield Bio Diesel Per Ha

 

 

 

Source

Yield (Liters/Ha)

Yield (Gallons/Ha)

Comparison Yields

Palm

5950

1572

100%

Coconut

2689

710

45%

Jatropha

1818

480

31%

Rapeseed

1190

314

20%

Soybean

446

118

7%

 

Biodiesel at this time is the marginal demand for palm oil which can be seen clearly as the price of 1 ton of CPO tends to track the price of oil at about 10 times the price of a barrel of Brent, despite the fact that 1 ton of CPO produces about 7.3 barrels of biodiesel. Now biodiesel is a finished product while that barrel of Brent still needs refining. So I guess that explains the difference.

 

The cost of producing biodiesel depends on the input cost of the palm oil, but assuming we pay $1,000 per ton and assuming a $100 per barrel fossil oil price. The average professionally managed plantation generates about 5 tons per Ha. That gets us a cost of $5,000 per Ha. That gets us 1,572 gallons per Ha or $3.18 per gallon. The average diesel tax in the US is 50 cents  and the average distribution cost is about 50 cents too. This give one a retail cost of about 4.18 per gallon. Now bio diesel tends to get tax breaks so the cost is going to be lower overall. So in general one can assume that palm oil based biodiesel is competitive.

 

The price of oil tends to be very volatile. I don’t see that coming to an end, so in the short-term the same volatility can be expected from the price of CPO. But I believe the long-term trend in fossil oil price to be up and at least higher than $75 per barrel, which represents a CPO price of $750 which still provides us with a great ROIC.

Currently according to Bernstein the cost par marginal fossil oil barrel (90th percentile) is $92, resulting from a 14% CAGR increase since 2001. The median unit costs ($35.88/barrel) and cash cost ($39.65/barrel) per barrel have seen a CAGR of increased costs respectively of 17% and 15% since 2001. There is no denying that the cost per barrel of new oil is increasing fast. I knew the costs were going up, but I had not idea how high that CAGR has been. Except if we see a hard fall off in demand, due to the high marginal cost the oil price can be expected to stay high over time. Still to give myself a margin of safety, instead of $90 I use $75 per barrel for the medium term, meaning that the oil price can go below $75 per barrel, but that it will have difficulty staying below that as the marginal cost is higher.

 

Some other arguments for higher oil prices are

  • ·GDP growth and population growth: There is a strong correlation (with a high R Squared) between GDP and population growth and oil consumption.
  • ·According to BP, the US has 800 vehicles per 1,000 people, Germany has 600 per 1,000, Chine about 50 per thousand and India has about 20 per thousand. China’s fleet is expected to increase to 140 per 1,000 (5.7% per annum) by  2030 and India’s to 65 per 1,000 (6.7% per annum). Increased demand in the developing world should drive vehicle demand up from 1 billion vehicles now to about 1.6 billion in 2030. This does not include the increased use of oil for commercial transportation purposes. According to a BP study this should result in demand of about 103 million barrels per day by 2030 from around 90 million barrels per day today. A CAGR of 0.75%. Although the rate of transportation demand growth will be higher BP expects that average car mileage will increase measurably due to consistently high prices.
  • ·According to Boone Pickens, the Saudis need $94 per barrel to pay the bills in order to buy themselves social peace and they are the main suppliers with excess capacity.

 

Now here are some arguments against high oil prices and biodiesel

  • ·Asia has been the real driver of demand for oil as the consumption of barrels per day went from 2.5 million barrels per day to 24.5 million barrels a day. If that growth slow it would impact demand severely.
  • ·Won’t GDP growth slow because of high prices? Probably, but the transportation fuel market is many times larger than the edible oil market and will easily absorb the biodiesel that will be available. What we want is high prices irregarding of available supply.
  • ·What about alternatives to palm oil biodiesel, mostly being algae and Jatropha. Algae looks promising as it has all the elements for success, being high oil content extraction and concentrated land use. The problem with Algae is that they also release a higher level of CO2. Jatropha is a poisonous shrub that begins that produces nuts that can be used to make bio diesel. The main benefit is that the plant needs very little water and can be grow on low quality dessert like land. The problem is that its poisonous which in case of large scale planting will make the soil poisonous too. Remember though, current bio fuel mandates are for 3.7 million barrels a day in 2022 from 0.3 million being produced right now. We are going to need every inch of productive capacity to achieve that number.
  • ·Palm Oil Biodiesel and Europe: The Europeans are complaining about forests being cut down for palm oil biodiesel, but that issue is being addressed by RSPO (more on that later). And the global fuel market is fluid. I guess then they’ll sell more to Asia if need be.

 

A last factor that will drive demand is transfats. The consumption of trans fats increases the risk of coronary heart disease by raising levels of “bad” LDL cholesterol and lowering levels of “good” HDL cholesterol. Health authorities worldwide recommend that consumption of trans fat be reduced to minimal amounts. Contrary to other vegetable oils, palm oil is the only vegetable oil that does not require hydrogenation, what causes TFA. Transfatti acids have been a major reason for growth in demand of palm oil in the developed world, especially demand in the US has increased because of this. Countries like Denmark and Switzerland, as well as a number of counties in the US have banned the use of trans-fats in restaurants. Other countries like the UK, Canada and Brazil have implemented policies aimed at reducing the use of trans-fats in commercial food production.

 

So now lets get to the supply dynamics:

 

Palm Oil is a tropical crop which for best results requires to be planted within 10 degrees, but for ideal results within 5 degrees, of the equator. For best results, the plants also require an average temperature of 24-33 degree Celsius, needs evenly distributed rainfall of about 2000 mm a year, a well drained alluvial soil with a general pH of between 4 and 7 and extensive root development. I know this might be a little too much detail, but it is of importance. What this means is that there aren’t many places in the world that have these optimal high yield conditions and once you take palm trees out of their optimal conditions the palm oil yield falls by about 50%. This is why 87% of all palm oil is produced in Malaysia, Indonesia and Papua New Guinea, globally the area with the best growing conditions. The other 13% of market share is mainly divided up by Thailand, Colombia and Nigeria and is reflective of the quantity of quality high yield land they have available.

 

The most important supply issue long-term is … we’re running out of arable land. Actually, that isn’t exactly correctly. The amount of available arable land hasn’t changed much over the last 100 year. But what has changed is the amount of people that are fed using that land all the while that the per capita calorie intake continues to increase.

Here are some interesting stats:

  • ·The arable Ha per capita has gone from 0.4 Ha in 1961 to 0.2 Ha today. And given that we expect a continued annual growth in population that number is expected to decline even more. For example if we take the world’s population up from 7 to 9 billion, that would decrease the available Ha per capita by 22.5%.
  • ·The average annual growth in crop yields has gone from 3.5% in 1971 to about 1% now. At the same time the amount of fertilizer used per sq km of land has gone from 2 tons in 1961 to around 11 tons nowadays.
  • ·The per capita consumption of food continues to increase. For example: Around 1997 average consumption of vegetable oils per capita was 12.5 Kg, now it is 21.6 Kg. In addition people in the developing world are starting to eat more meat as well as meat that requires more calorie inputs. Where 1 Kg of chicken requires 2 Kg of grains, 1 Kg of beef requires 7 Kg of grains.
  • ·Erosion is a serious problem long-term. Most arable land is eroding at rates much faster than their replacement rate. In Australia about 70% of arable land is considered severely degraded. Since colonial times the US has lost between one-third to one-half of all its productive topsoil. No till farming is a solution but that is currently used on only 5% of the world’s arable land.

 

So what does all this mean? Let me give you an example? Lets assume that the per capita use of vegetable oil goes up by 10Kg keeping the world’s population constant. I think over the next two decades that looks like an achievable number given that current average developing county consumption is 20 Kg where the average of Europe and the US is 45 Kg per capita. By the way, just the expected population increase represents a 2 Kg increase per capita using current global population numbers. Well there are currently about 5.5 billion people in the developing world. An increase in 10Kg per capita consumption would mean an need for a lot more land. If we just use palm oil we’d need an additional 11 million Ha. If we want to achieve the same number using soybean, that would require an additional 103 million Ha. Using rapeseed that would be an additional 37 million Ha and using sunflower seeds would mean another 74 million Ha. Let me put those numbers in perspective. According to the USDA, the total size of the US is 930 million Ha. Of that 496 million Ha is off limits or not usable, 255 million Ha is of low quality and used as grassland and only 179 million Ha is arable land. Or let me put that in perspective on a global basis. The earth’s land area is 12.972 billion Ha. Of that 10.6% (1.375 billion Ha) is arable and permanent crop land is 1.2% (0.155 billion Ha) of the earth’s land area. So finding an additional 37 to 103 million Ha if we decide to go with Soy, Rapeseed or Sunflower will not be easy. Finding another 11 million Ha for Palm Oil would not be easy either, but because of the lack of available land a focus on palm oil does become the logical choice.

Now this example just focused on vegetable oil and did not address the need for arable and permanent crop land needed for other crops. For example 80% of all soybean production is used in meals and only 20% goes to vegetable oil. Given the expected population growth and continued global growth one would assume that we’d also need an increase in other foods. This would be the case even if the CAGR of both population and GDP growth slows down.

So how difficult is it to increase the amount of arable land? Well despite high crop prices, since 2007 the amount of US arable land has increased by about 0.35 million Ha out of a total of 179 million. The main issue is that there are huge gaps in productivity between A grade and B and C grade land. The difference between A and C grade can be multiples of production.

Now I am not saying we are about to run into a hard stop, what I am saying is that in order to get more food we’ll need to change the way we are going to consume and grow food. We’ll need higher prices in order to incentivize consumers to eat higher calories versus cost foods. For example, protein provided by soy cost 1/4th of the same amount of protein provided by beef. In addition we’ll have to expand the use of arable land into lower quality and yield areas which will result in higher costs/price. This increased marginal unit cost will drive up prices, including the price of palm oil. Now do I have an idea by how much? Actually no. But that’s not my point. A $2,000 price per ton CPO would be awesome and possible, but I don’t need that. The only thing I need for this investment to work is a price per ton of CPO in the $750 to $1,250 range. At the current price we are paying for AEP, we’d get a great ROIC (20% plus) per planted assets per Ha and we’d get a decent ROIC (15%) for the newly planted assets. At a $1,000 per ton of CPO, we’d start also doing great on the newly planted assets (19.4%) and at $1,250 the ROIC on newly planted assets would be great at 24.5%.

 

So how much more land for oil palm is available? When thinking about available oil palm land there are four categories to think of. A. Primary forest, being considered valuable habitat that is off limits to professional agriculture. B. Secondary forest that is available under certain circumstances. There is about 36 million Ha of secondary forest. Of that 18 to 20 million Ha is not suitable. 10 million Ha is available, but only at a much higher cost so that leaves about 6 million Ha available for planting now if all the permits can be obtained. C. Imperata grassland in Indonesia, 8 million Ha of it. The problem is that it will have a lower yield and be more expensive to build out. D. Degraded secondary forest. There is about 5 to 6 million Ha of degraded old forest land in Indonesia that the government offered up. The problems are huge though. Most of the land is in really bad shape. About half is considered severely or very severely degraded. After all, if the degraded land was still productive, the farmer wouldn’t have abandoned it. Also building out degraded land would be expensive. For one, when using forest land, the product from the deforestation is sold providing cash and second, the degraded land would require a lot of work to bring it back up to par if that’s even possible in the first place. It seems this idea is more of a political gimmick than a real opportunity. Concluding, there really isn’t that much land available for oil palm as commonly thought.

Most of the land available and expansion will take place in Indonesia for two reasons. A. Malaysia is having trouble paying for the labor. The GDP per capital of rural Malaysia is multiples of that of rural Indonesia, meaning salaries in Malaysia are multiples that of Indonesia. High labor cost in Malaysia currently is considered a serious issue to the point plantation owners in Malaysia point it out in their annual reports as an issue. By the way, of the 48.8K net Ha owned by AEP, only 2,000 is in Malaysia. B. Papua New Guinea has high quality land, but the issue there is a severe lack of infrastructure. Overtime PNG will be explored more actively, but the low hanging fruit to be found is currently in Indonesia.

 

A few more supply issues

 

Recently RSPO, the Roundtable For Sustainable Palm Oil, came into being. Which was recently followed by the ISPO which stands for Indonesian Sustainable Palm Oil. The goal of both is to move to a model of sustainable development of the palm oil industry. The main goals are to limit to amount of deforestation and the CO2 it causes. The main gist of it is that the forest is being divided in primary and secondary forest, where the primary forest has become off limits for deforestation and oil palm plantations. The main result is that the available land from plantations has shrunk making it harder to find land to expand.

One important side effect of RSPO has been that certainly in the developed world it has become a standard requirement for the investibility of a company. The last thing a pension fund manager wants is to have a Green Peace accusing him of destroying the rain forest. RSPO provides cover from that. This is especially the case in Europe where palm oil driven deforestation has become a big issue.

AEP is working on getting the RSPO certification, which should not take much longer.

 

There is also the issue of small holders. On land purchased post 2007 companies wanting to expand have to provide 20% of the land to local communities at cost as part of obtaining a permit. Here is how it works, the plantation owner builds out the 100% and then sells 20% at full cost to the local small holder. It has to provide the loan to the small holders. On that loan, the company is allowed to charge market interest rates. Once the plantation is finished, the owner will manage the whole plantation including the 20% owned by the small holder. For that management the plantation owner gets a 5% management. The plantation owner also makes money from the extraction of the palm oil. So while it isn’t as profitable as owning the land outright, it isn’t that they have to give the land away. The plantation owner just sells the land at cost and receives interest, a management and a palm oil processing fee. The plantation owner controls the entire revenue of the 20% held by the small holder and takes all payments due upfront before handing over the rest of the money.

 

There is a severe productivity gap between yields achieve by local farmers and large plantation owners. A large professional plantation can yield about 2 tons more, as they employ agricultural specialists that can monitor every aspect of the cycle. This difference has existed for many years and just doesn’t seem to close. Many efforts have been made to get that productivity gap to close, but it seems too complex with too many parties involved.

 

Lastly the cost to build a new plantation per Ha is about $8,000. That includes clearing, preparation of the land and planting as well as PP&E and interest.

 

So now, lets get to AEP.

AEP at the end of 2011 owned net to common equity holders 31,744 Ha of mature and 16,464 Ha of immature oil palm plantations. On page 9 of the 2011 annual you can see the actual Ha and percentage ownership. In addition AEP has a net Ha ownership of 506 Ha mature and 170 Ha that was immature. Rubber plantations tend to be more profitable than oil palm. In 2010 and 2011 a rubber Ha was about 2 to 2.5 times as profitable as a Ha of oil palm. In addition rubber is not hindered by export taxes. I will discuss the export tax issue later. So in order to give it the right valuation, I assume that each Ha of rubber was worth 2 Ha of oil palm. So the 506 mature Ha of rubber is adjusted in the valuation as 1,012 mature Ha of oil palm and the 170 Ha of rubber of immature is considered 340 Ha of immature palm oil.

In addition on a net basis AEP also owns 47,571 Ha of plantable land. This is a valuable asset. Assuming a $750 CPO price per ton the after tax ROIC is 15.3% once built out. At $1,000 it is 20.3% and at $1,250 it is 25.7%. AEP planted gross 4,800 Ha in 2011 and the plan is to add another 9,000 planted Ha over the next two years. Given all this investment opportunity with pretty good ROICs one should not expect the company to buy back shares or increase the dividend much. Basically AEP understands the opportunity to grab land at attractive prices and the focus will stay on buying more land and turning it into productive plantations.

 

AEP is majority owned by Genton International, which in its turns is controlled by Madam Lim Siew Kim, a Malaysian person of Chinese decent. Looking back over the years, I see a company that is well managed with a clear and simple strategy. There have been no accounting issues, no insider dealing and the board paid itself $194K in 2011.

 

Before I get to the valuation I want to first lay out the Indonesian export tax and ROIC of this business.

 

The table below shows you the export tax and profitability of a Ha of oil palm using the $8,000 in cost to build a new Ha. In column two one can see the actual export taxes based on the CPO price at the time of sale. The main reason for these import taxes is the government wanting to capture the whole value add in the supply chain. In the second table you will see that compared the upstream export taxes, the export taxes after the CPO has been down streamed are much lower.

 

Profitability*

 

 

 

 

 

 

Price per Ha

$8,000

 

 

 

 

 

 

CPO Sales Price

Upstream CPO Export Tax

Net CPO Price Ex Export Tax

Cost CPO CIF Rotterdam

Net Income Per Ton CIF Rotterdam

Operating Profit 5 Ton Per Ha

Operating Profit 5 Ton Per Ha After Tax (30%

ROIC 5 Ton Using Cost Per Ha After Tax

750

0.0%

           750

            400

                  350

         1,750

                1,225

15.3%

800

7.5%

           740

            400

                  340

         1,700

                1,190

14.9%

850

9.0%

           774

            400

                  374

         1,868

                1,307

16.3%

900

10.5%

           806

            400

                  406

         2,028

                1,419

17.7%

950

12.0%

           836

            400

                  436

         2,180

                1,526

19.1%

1000

13.5%

           865

            400

                  465

         2,325

                1,628

20.3%

1050

15.0%

           893

            400

                  493

         2,463

                1,724

21.5%

1100

16.5%

           919

            400

                  519

         2,593

                1,815

22.7%

1150

18.0%

           943

            400

                  543

         2,715

                1,901

23.8%

1200

19.5%

           966

            400

                  566

         2,830

                1,981

24.8%

1250

21.0%

           988

            400

                  588

         2,938

                2,056

25.7%

1300

22.5%

        1,008

            400

                  608

         3,038

                2,126

26.6%

* I did use 30% in net tax. If you check, you will see that the actual tax is 25%, but in order to adjust for SG&A I added 5%, which seems to be a decent approximation.

 

Indonesia downstream export tax (% of gross market price)

USD

RBD Palm Oil

RBD Palm Stearin

RBD Palm Kernel Oil

Palm Fatty Acid Distillate

Bio Diesel

<750

0

0

0

0

0

750-800

0

0

0

3

0

800-850

0

0

0

4

0

850-900

2

2

2

5

0

900-950

3

3

3

6

0

950-1000

4

4

4

7

2

1000-1050

5

5

5

8

2

1050-1100

6

6

6

9

2

1100-1150

7

7

7

10.5

2

1150-1200

8

8

8

12

5

1200-1250

9

9

9

13.5

5

>1250

10

10

10

15

7.5

 

Ok, so how much is this thing worth?

 

Let me first comment on the following:

 

Net Cash: I use $90 million in net cash. I know that doesn’t include the $6.5 million in debt. Let me explain: First, it assumes this business needs little cash to run itself, which is correct. The receivables at the end of 2011 were $1.5 million, payables $20.8 million. In addition we are almost halfway through 2012, 6 months during which AEP has probably made at least another $30 million in operating profit or about $22.5 million after tax. So I feel confident to assume at this time there is enough cash on the balance sheet to cover the $6.5 million in debt and enough cash to run the business.

 

Value of unplanted land: While the current sale value of a plantable Ha is $1,000, and climbing fast, I think there is a real argument to be made that the value of the plantable land is at least $2,000 per Ha. Lets just look at the comps for arable land in the UK and US. In the UK around the middle of 2011, an acre of prime arable land was fetching £8,500 per acre or about £21,003 per Ha, more than thirty times what we are currently paying in Indonesia. Or look at the US in the following table. As you can see there is quite the delta between oil palm land and US based arable land. So it seems to be reasonable to assume AEP’s land’s IV is worth at least $2,000 per Ha, especially if one assumes the ROICs that are available from planting a Ha of oil palm. For one, I have never heard farming in the UK or US to be a double digit ROIC affair. Interesting too is that a doubling of the cost of oil palm land to $2,000 increases the total cost of per Ha built out by only 12.5% from $8,000 to $9,000.

 

Value Land US 2011

Acre

Ha

Northeast

 $5,190

 $12,824

Lake

 $3,450

 $8,525

Corn Belt

$4,920

$12,157

Northern Plains

$1,700

 $4,201

Appalachian

$3,590

 $8,871

Southeast

$3,650

$9,019

Delta

$2,050

$5,066

Southern Plains

$1,520

$3,756

Mountain

$1,550

$3,830

Pacific

$5,150

$12,726

 

Private market sales value of planted land: Currently the private market sales price per Ha is between $15,000 and $20,000 per Ha. I am using $15,000 as a conservative number. $15,000 still gets us a ROIC of 8.2% at $750 per ton CPO. I consider $750 CPO per ton to be the lower end price over the medium term.

 

Comp values: I choose First Resources Limited as it has a similar asset profile as AEP. AEP has about 34% of its planted area as immature. First Resources Limited has 35%. Currently First Resources Limited trades at $14,264 per Ha. In April it was still selling for more than $18,000 per Ha.

 

Rubber Ha: Remember that as Rubber is about twice as profitable, I doubled the amount of rubber Ha in order to equalize it with oil palm.

 

Price per Ha Planted AEP

$1,000 per plantable Ha

$2,000 per plantable Ha

LSE:AEP

£7.10

£7.10

Market Cap

£280,734,000

   £280,734,000

USDGBP (Exchange rate)

1.54

1.54

Market Cap in USD

 $432,931,131

 $432,931,131

Anglo Eastern Net Cash Dec 2011

 $90,000,000

 $90,000,000

Value Unplanted Ha

$1,000

$2,000

Value Unplanted Assets

 $47,570,850

 $95,141,700

Value of Mills

 $40,000,000

 $40,000,000

Ex Value

 $255,360,281

 $207,789,431

# Ha

               48,883

               48,883

Price per Ha Planted

$5,224

$4,251

 

 

IV AEP using $15K per Ha

 

 

TOTAL Ha End 2011

   48,883

               48,883

Value of average Ha

$15,000

$15,000

Total Ha Value End Dec 2012

$733,244,250

$733,244,250

Anglo Eastern Net Cash Dec 2011

$90,000,000

$90,000,000

Value Unplanted Land Per Ha

$1,000

$2,000

Plantable Direct Ownership Ha

$47,571

$47,571

Value Unplanted Assets

$47,570,850

$95,141,700

Value Mills

$40,000,000

$40,000,000

Sum of Parts

$910,878,671

$958,450,521

# shares

39,539,000

        39,539,000

IV per share in $

$23.04

$24.24

USDGBP (Exchange Rate)

1.54

1.54

IV per share in GBP

£14.94

£15.72

LSE:AEP

£7.10

£7.10

Upside

110.40%

121.39%

 

Now this IV valuation does not include the value that will be generated by turning the unplanted assets into producing plantations. At a $750 per ton CPO price, the annual after tax income is $1,225 per Ha annually. At $1,000 per ton CPO the after tax income is $1,628 per Ha annually. At $1,250 per ton CPO it is $2,056 per Ha after tax annually. Btw. I am using a 5 ton per Ha CPO yield, while the real number is somewhere between 5 and 6 ton.

 

So what are reasons why AEP might be so much cheaper than its competitors, which tend to trade in the $14,000 to $18,000 per Ha. The main reason is that AEP being listed in London given the recent mostly European based environmental/deforestation issues around palm oil and the lack of RSPO accreditation of AEP have made AEP uninvestable for most European institutions. AEP will be receiving RSPO accreditation soon which will fix this overhang.

 

The main two risks are:

  • ·Lack of population and GDP growth.
  • ·Demand from biodiesel going away.

Catalyst

RSPO accreditation
    sort by    

    Description

    Anglo Eastern Plantations (AEP) is a UK listed company that owns palm oil plantations, mostly in Indonesia. The company is attractively priced at a price per Ha between $4,200 and $5,200. Significantly cheaper than the replacement value per Ha of $8,000 and far below the private transaction prices per Ha of between $15,000 and $20,000.

    In addition buying AEP at between $4,200 and $5,200 per Ha provides one with a great post tax ROIC of plus 20% based on conservative estimates and 30% on average estimates. But most importantly, there is also the upside from increased investment at high ROICs.

    Lastly the future economics, meaning increased demand and limited supply, of the palm oil business look attractive which over time will allow for an improvement of those ROICs and continued growth.

     

    Before I get going, I’d like to share with you two quotes by Jeremy Grantham, both which touch on relevant issues related AEP

     

    “As the population continues to grow, we will be stressed by recurrent shortages of hydrocarbons, metal, water, and, especially, fertilizer. Our global agriculture, though, will clearly bear the greatest stresses. It may have the responsibility for feeding an extra two to three billion mouths, a 30% to 40% increase in just 40 years … Encouraged by higher prices, we will become more frugal and more sensible and stretch out our resources, buying us more time for a natural decline in population to eventually bring us into balance … Farming will be a satisfying and enriching experience if, on a global basis, we rise to the long-term agricultural challenges. And, if good old short-term profit maximizing continues as it did for the Syrian, Greek and Roman farmers before us, then at least today’s farm owners will go down with the ship, but travelling in first class.” Jeremy Grantham

     

    I am in agreement with Mr. Grantham. The only thing he doesn't mention is that there will also be increased demand for food per capita. Over the years, the impact of the per capita demand is twice that of population growth.

     

    What is Palm Oil?

    Palm oil and Palm kernel oil are the vegetable oils extracted from the fruit from the Oil Palm tree. In the industry this fruit is called Fresh Fruit Bunch or FFB, the product removed from the tree from which they extract both oils. Palm oil is found in the fleshy portion of the fruit (mesocarp), whereas palm kernel oil is found in the kernel or the seed of the fruit. These two oils have very different compositions. Crude palm oil (CPO) is by far the largest revenue stream. In addition, the palm oils aren’t just used for edible purposes, but the last decade a large demand has developed for biodiesel made from palm oil.

     

    MP Evans keeps an update graph of the CPO price per ton on its website at http://www.mpevans.co.uk/mpevans/en/operations/com.

     

    Palm oil is the most widely consumed vegetable oil with a 33% market share. Competitors are soy bean oil (29%), rapeseed (17%), sunflower (8%), peanut (4%), coconut (3%), cotton (3%) and olive oil (2%). Soy used to have the largest market share, being 40% in 1970, while CPO was only at 10% at that time.

     

     

    Market Shares Palm Oil Vegetable Oil Market

    Market Shares Palm Kernel Oil Vegetable Oil Market

    1997

    23.5%

     

    1998

    22.7%

     

    1999

    22.8%

     

    2000

    24.8%

     

    2001

    27.2%

     

    2002

    26.8%

     

    2003

    29.0%

    3.5%

    2004

    29.2%

    3.6%

    2005

    30.1%

    3.5%

    2006

    30.7%

    3.5%

    2007

    30.3%

    3.6%

    2008

    31.6%

    3.6%

    2009

    32.5%

    3.8%

    2010

    32.4%

    3.7%

    2011

    32.7%

    3.5%

    4/1/2012 TTM

    33.0%

    3.6%

     

    Market share gains are the result of CPO and Palm Kernel Oil being the cheapest vegetable oils on the market, which has a large impact in the price sensitive developing countries where most of the growth in demand has taken place. This does not mean it is the lowest quality product out there. Actually it is the better alternative as it is the only vegetable oil that does not require hydrogenation which causes transfatti acids, which increase the risk of coronary heart disease.

    Both palm oils also are the lowest cost producers in the industry. The reasons are that palm oil production does not require continuous planting, can be harvested more regularly and the output per professionally managed Ha is multiples of that of its competitors. Here are the differences in yield per Ha.

     

    Palm Oil Indonesia – 3.9 Tons/Ha (Total of between 5 and 6 tons for professionally managed properties like those of AEP.)

    Palm Oil Malaysia – 4.5 Tons/Ha

    Soy USA – 0.53 Tons/Ha

    Soy Brazil – 0.51 Tons/Ha

    Rapeseed Oil EU – 1.3 Tons/Ha

    Rapeseed Oil Germany – 1.6 Tons/Ha

    Sunflower – 0.8 Tons/Ha

     

    Palm oil has the benefit on not requiring continuous planting. The oil palm tree cycle is about 25 years. After planting for the first 2 years there is no FFB yield. Then it slowly starts in year 3 improving each year to year 7 where the tree reaches maximum FFB productivity. It stays at that level until about year 16 after which the FFB yield slowly declines until year 25 at which time one replants. Only in year 5 does the palm oil extraction rate get close to 20% increasing a full maturity to around 24%.

     

    Market Dynamics – Before getting to AEP I believe it relevant to discuss industry dynamics.

     

    Demand for vegetable oils, and palm oil, continues to increase each year driven by increased consumption per capita as well as by a continued increase of the world’s population. All this against a background of limited availability of arable land.

     

    Lets start on the demand side:

     

    The two drivers of increased aggregate demand are increased demand per capita as well as an increase in the world’s population, both have been growing for some time and are expected to continue to do so. Here are some historical numbers.

     

     

    Consumption Per Capita Vegetable Oils (Kg)

    Consumption Per Capita Palm Oil (Kg)

    Consumption Per Capita Palm Kernel Oil (Kg)

    Population (MM)

    Total Demand Vegetable Oil (MM mt)

    Total Demand Palm Oil (MM mt)

    Total Demand Palm Kernel Oil (MM mt)

    1997

    12.5

                  2.93

     

              5,847

                 72.87

        17.13

     

    1998

    12.4

                  2.82

     

              5,926

                 73.72

        16.73

     

    1999

    13.1

                  2.99

     

              6,003

                 78.54

        17.92

     

    2000

    13.6

                  3.37

     

              6,081

                 82.68

        20.50

     

    2001

    14.4

                  3.91

     

              6,157

                 88.58

        24.07

     

    2002

    14.6

                  3.91

     

              6,234

                 91.04

        24.36

     

    2003

    15.1

                  4.39

                   0.53

              6,310

                 95.51

        27.69

    3.36

    2004

    15.7

                  4.59

                   0.57

              6,386

               100.40

        29.29

    3.61

    2005

    16.7

                  5.03

                   0.58

              6,462

               107.96

        32.50

    3.78

    2006

    17.6

                  5.41

                   0.62

              6,537

               115.21

        35.35

    4.04

    2007

    18.3

                  5.54

                   0.66

              6,613

               120.93

        36.61

    4.34

    2008

    18.8

                  5.93

                   0.68

              6,688

               125.49

        39.68

    4.57

    2009

    19.3

                  6.26

                   0.73

              6,764

               130.22

        42.33

    4.94

    2010

    20.2

                  6.56

                   0.74

              6,840

               138.38

        44.86

    5.07

    2011

    21.0

                  6.87

                   0.72

              6,916

               145.18

        47.54

    5.01

    4/1/2012 TTM

    21.6

                  7.13

                   0.77

    7,019

               150.83

        49.82

    5.41

    CAGR

    3.79%

    6.28%

    3.92%

    1.21%

    5.05%

    7.56%

    5.12%

     

    As you can see, most of the demand growth has come from the increase in consumption per capita, rather than population growth, especially when it comes to palm oil. Most of that growth is driven by the developing world.

     

    To continue on the consumption per capita, following is a table listing per capita consumption for different countries, with the average consumption per capita in the developing world being 20.02 Kg, less than half of the number consumed in the US and the EU. The gap is large enough to allow for a significant increase in per capita consumption in the developing world, without a need to get to the 40 Kg plus consumed in the US and EU. This is important. If the average consumption of vegetable oils was already 40Kg globally, there’d be not much need for more vegetable oil per capita.

     

    Vegetable Oil Consumption By Country

    Kg/Capita

    China

            21.53

    EU-27

            49.18

    India

            14.07

    United States

            40.75

    Pakistan

            19.59

    Russia

            22.99

    Egypt

            27.03

    Mexico

            19.58

    Nigeria

            11.14

    Turkey

            24.09

     

    The correlation between GDP growth per capita and consumption per capita is strong with an R Squared that is high, so assuming continued economic progress and population growth in the developing world there will be significantly more demand for vegetable oils going forward.

     

    I would like to address population growth. While it has been the smaller part of the equation, its still important. To me it seems there is a very high likelihood that the world’s population will continue to grow at a reasonable clip to the 9 billion people number. Actually, the current layout of the global population pyramid and the math behind that pretty much guarantee it, except if we see massive changes in the dynamics behind population growth. The replacement rate would have to collapse by more than half quickly we’d need to average life expectancy to come down too.

    What makes this happen? Increased GDP and healthcare are inversely correlated with the replacement rate. A richer and healthier world will mean less children. The problem is that those changes happen gradually over a generation. Also lack of food and other resources can have an impact. How much is doubtful, just look at Africa where the population continues to expand despite significant food instability. Or worse something like H5N1 which since 2003 out of 566 confirmed human cases has resulted in the deaths of 332 people. Currently H5N1 is not able to transmit easily between human. Actually, from what I found out only one case was ever suspected of doing so. If H5N1 ever finds a way to have easy transmission from human to human it would be bad for us all. The whole system could get bent out of shape pretty badly.

    If you’d like to play around a little with the population pyramid over time, there’s a great site http://www.worldlifeexpectancy.com/world-population-pyramid. Spain’s pyramid looks interesting as birthrates collapsed pretty severely 3 decades ago. The pyramid looks like a Christmas tree and looking at it on first sight I thought Spain’s population should start shrinking soon, but it turns out that the Spanish population will continue to grow from 45 million now to 52 million in 2050. Only once the Spanish Baby Boomer bulge works its way through the system is the population expected to shrink, which is post 2050.

    So the 9 billion global population number is a pretty high probability. By the way, this number already includes a fairly significant decline in the birthrate.

     

    So the three elements for increased demand are available:

    1. The large existing gap between developing and developed country consumption.
    2. The growth in consumption per capita. Given the state of the developing world I find it hard to assume GDP growth coming to a halt soon. Even 2.5% to 3% global growth will continue to drive increased consumption per capita, although at a slower rate.
    3. The growth in global population, which is a high probability outcome.

     

    Besides the above there are other factors driving increased demand, like transfats and biodiesel.

     

    Lets start with bio diesel/bio fuels.

     

    In 2000 production of bio fuel was 15,200 barrels a day which did increase to 294,690 barrels a day in 2010. Current global mandates by governments provide for a need of 3.77 million barrels of bio fuel a day in 2022. The mandates do exist, although there is doubt about their achievability. Biofuels are either ethanol or biodiesel. Palm oil is used to make biodiesel.

    Ex input costs, palm oil is the most competitive vegetable oil to be turned into biodiesel. It takes about $150 to $200 to make one ton of palm oil based biodiesel while it costs between €500 and €600 to make a similar quantity of rapeseed oil into biodiesel.

     

    Yield Bio Diesel Per Ha

     

     

     

    Source

    Yield (Liters/Ha)

    Yield (Gallons/Ha)

    Comparison Yields

    Palm

    5950

    1572

    100%

    Coconut

    2689

    710

    45%

    Jatropha

    1818

    480

    31%

    Rapeseed

    1190

    314

    20%

    Soybean

    446

    118

    7%

     

    Biodiesel at this time is the marginal demand for palm oil which can be seen clearly as the price of 1 ton of CPO tends to track the price of oil at about 10 times the price of a barrel of Brent, despite the fact that 1 ton of CPO produces about 7.3 barrels of biodiesel. Now biodiesel is a finished product while that barrel of Brent still needs refining. So I guess that explains the difference.

     

    The cost of producing biodiesel depends on the input cost of the palm oil, but assuming we pay $1,000 per ton and assuming a $100 per barrel fossil oil price. The average professionally managed plantation generates about 5 tons per Ha. That gets us a cost of $5,000 per Ha. That gets us 1,572 gallons per Ha or $3.18 per gallon. The average diesel tax in the US is 50 cents  and the average distribution cost is about 50 cents too. This give one a retail cost of about 4.18 per gallon. Now bio diesel tends to get tax breaks so the cost is going to be lower overall. So in general one can assume that palm oil based biodiesel is competitive.

     

    The price of oil tends to be very volatile. I don’t see that coming to an end, so in the short-term the same volatility can be expected from the price of CPO. But I believe the long-term trend in fossil oil price to be up and at least higher than $75 per barrel, which represents a CPO price of $750 which still provides us with a great ROIC.

    Currently according to Bernstein the cost par marginal fossil oil barrel (90th percentile) is $92, resulting from a 14% CAGR increase since 2001. The median unit costs ($35.88/barrel) and cash cost ($39.65/barrel) per barrel have seen a CAGR of increased costs respectively of 17% and 15% since 2001. There is no denying that the cost per barrel of new oil is increasing fast. I knew the costs were going up, but I had not idea how high that CAGR has been. Except if we see a hard fall off in demand, due to the high marginal cost the oil price can be expected to stay high over time. Still to give myself a margin of safety, instead of $90 I use $75 per barrel for the medium term, meaning that the oil price can go below $75 per barrel, but that it will have difficulty staying below that as the marginal cost is higher.

     

    Some other arguments for higher oil prices are

    • ·GDP growth and population growth: There is a strong correlation (with a high R Squared) between GDP and population growth and oil consumption.
    • ·According to BP, the US has 800 vehicles per 1,000 people, Germany has 600 per 1,000, Chine about 50 per thousand and India has about 20 per thousand. China’s fleet is expected to increase to 140 per 1,000 (5.7% per annum) by  2030 and India’s to 65 per 1,000 (6.7% per annum). Increased demand in the developing world should drive vehicle demand up from 1 billion vehicles now to about 1.6 billion in 2030. This does not include the increased use of oil for commercial transportation purposes. According to a BP study this should result in demand of about 103 million barrels per day by 2030 from around 90 million barrels per day today. A CAGR of 0.75%. Although the rate of transportation demand growth will be higher BP expects that average car mileage will increase measurably due to consistently high prices.
    • ·According to Boone Pickens, the Saudis need $94 per barrel to pay the bills in order to buy themselves social peace and they are the main suppliers with excess capacity.

     

    Now here are some arguments against high oil prices and biodiesel

    • ·Asia has been the real driver of demand for oil as the consumption of barrels per day went from 2.5 million barrels per day to 24.5 million barrels a day. If that growth slow it would impact demand severely.
    • ·Won’t GDP growth slow because of high prices? Probably, but the transportation fuel market is many times larger than the edible oil market and will easily absorb the biodiesel that will be available. What we want is high prices irregarding of available supply.
    • ·What about alternatives to palm oil biodiesel, mostly being algae and Jatropha. Algae looks promising as it has all the elements for success, being high oil content extraction and concentrated land use. The problem with Algae is that they also release a higher level of CO2. Jatropha is a poisonous shrub that begins that produces nuts that can be used to make bio diesel. The main benefit is that the plant needs very little water and can be grow on low quality dessert like land. The problem is that its poisonous which in case of large scale planting will make the soil poisonous too. Remember though, current bio fuel mandates are for 3.7 million barrels a day in 2022 from 0.3 million being produced right now. We are going to need every inch of productive capacity to achieve that number.
    • ·Palm Oil Biodiesel and Europe: The Europeans are complaining about forests being cut down for palm oil biodiesel, but that issue is being addressed by RSPO (more on that later). And the global fuel market is fluid. I guess then they’ll sell more to Asia if need be.

     

    A last factor that will drive demand is transfats. The consumption of trans fats increases the risk of coronary heart disease by raising levels of “bad” LDL cholesterol and lowering levels of “good” HDL cholesterol. Health authorities worldwide recommend that consumption of trans fat be reduced to minimal amounts. Contrary to other vegetable oils, palm oil is the only vegetable oil that does not require hydrogenation, what causes TFA. Transfatti acids have been a major reason for growth in demand of palm oil in the developed world, especially demand in the US has increased because of this. Countries like Denmark and Switzerland, as well as a number of counties in the US have banned the use of trans-fats in restaurants. Other countries like the UK, Canada and Brazil have implemented policies aimed at reducing the use of trans-fats in commercial food production.

     

    So now lets get to the supply dynamics:

     

    Palm Oil is a tropical crop which for best results requires to be planted within 10 degrees, but for ideal results within 5 degrees, of the equator. For best results, the plants also require an average temperature of 24-33 degree Celsius, needs evenly distributed rainfall of about 2000 mm a year, a well drained alluvial soil with a general pH of between 4 and 7 and extensive root development. I know this might be a little too much detail, but it is of importance. What this means is that there aren’t many places in the world that have these optimal high yield conditions and once you take palm trees out of their optimal conditions the palm oil yield falls by about 50%. This is why 87% of all palm oil is produced in Malaysia, Indonesia and Papua New Guinea, globally the area with the best growing conditions. The other 13% of market share is mainly divided up by Thailand, Colombia and Nigeria and is reflective of the quantity of quality high yield land they have available.

     

    The most important supply issue long-term is … we’re running out of arable land. Actually, that isn’t exactly correctly. The amount of available arable land hasn’t changed much over the last 100 year. But what has changed is the amount of people that are fed using that land all the while that the per capita calorie intake continues to increase.

    Here are some interesting stats:

    • ·The arable Ha per capita has gone from 0.4 Ha in 1961 to 0.2 Ha today. And given that we expect a continued annual growth in population that number is expected to decline even more. For example if we take the world’s population up from 7 to 9 billion, that would decrease the available Ha per capita by 22.5%.
    • ·The average annual growth in crop yields has gone from 3.5% in 1971 to about 1% now. At the same time the amount of fertilizer used per sq km of land has gone from 2 tons in 1961 to around 11 tons nowadays.
    • ·The per capita consumption of food continues to increase. For example: Around 1997 average consumption of vegetable oils per capita was 12.5 Kg, now it is 21.6 Kg. In addition people in the developing world are starting to eat more meat as well as meat that requires more calorie inputs. Where 1 Kg of chicken requires 2 Kg of grains, 1 Kg of beef requires 7 Kg of grains.
    • ·Erosion is a serious problem long-term. Most arable land is eroding at rates much faster than their replacement rate. In Australia about 70% of arable land is considered severely degraded. Since colonial times the US has lost between one-third to one-half of all its productive topsoil. No till farming is a solution but that is currently used on only 5% of the world’s arable land.

     

    So what does all this mean? Let me give you an example? Lets assume that the per capita use of vegetable oil goes up by 10Kg keeping the world’s population constant. I think over the next two decades that looks like an achievable number given that current average developing county consumption is 20 Kg where the average of Europe and the US is 45 Kg per capita. By the way, just the expected population increase represents a 2 Kg increase per capita using current global population numbers. Well there are currently about 5.5 billion people in the developing world. An increase in 10Kg per capita consumption would mean an need for a lot more land. If we just use palm oil we’d need an additional 11 million Ha. If we want to achieve the same number using soybean, that would require an additional 103 million Ha. Using rapeseed that would be an additional 37 million Ha and using sunflower seeds would mean another 74 million Ha. Let me put those numbers in perspective. According to the USDA, the total size of the US is 930 million Ha. Of that 496 million Ha is off limits or not usable, 255 million Ha is of low quality and used as grassland and only 179 million Ha is arable land. Or let me put that in perspective on a global basis. The earth’s land area is 12.972 billion Ha. Of that 10.6% (1.375 billion Ha) is arable and permanent crop land is 1.2% (0.155 billion Ha) of the earth’s land area. So finding an additional 37 to 103 million Ha if we decide to go with Soy, Rapeseed or Sunflower will not be easy. Finding another 11 million Ha for Palm Oil would not be easy either, but because of the lack of available land a focus on palm oil does become the logical choice.

    Now this example just focused on vegetable oil and did not address the need for arable and permanent crop land needed for other crops. For example 80% of all soybean production is used in meals and only 20% goes to vegetable oil. Given the expected population growth and continued global growth one would assume that we’d also need an increase in other foods. This would be the case even if the CAGR of both population and GDP growth slows down.

    So how difficult is it to increase the amount of arable land? Well despite high crop prices, since 2007 the amount of US arable land has increased by about 0.35 million Ha out of a total of 179 million. The main issue is that there are huge gaps in productivity between A grade and B and C grade land. The difference between A and C grade can be multiples of production.

    Now I am not saying we are about to run into a hard stop, what I am saying is that in order to get more food we’ll need to change the way we are going to consume and grow food. We’ll need higher prices in order to incentivize consumers to eat higher calories versus cost foods. For example, protein provided by soy cost 1/4th of the same amount of protein provided by beef. In addition we’ll have to expand the use of arable land into lower quality and yield areas which will result in higher costs/price. This increased marginal unit cost will drive up prices, including the price of palm oil. Now do I have an idea by how much? Actually no. But that’s not my point. A $2,000 price per ton CPO would be awesome and possible, but I don’t need that. The only thing I need for this investment to work is a price per ton of CPO in the $750 to $1,250 range. At the current price we are paying for AEP, we’d get a great ROIC (20% plus) per planted assets per Ha and we’d get a decent ROIC (15%) for the newly planted assets. At a $1,000 per ton of CPO, we’d start also doing great on the newly planted assets (19.4%) and at $1,250 the ROIC on newly planted assets would be great at 24.5%.

     

    So how much more land for oil palm is available? When thinking about available oil palm land there are four categories to think of. A. Primary forest, being considered valuable habitat that is off limits to professional agriculture. B. Secondary forest that is available under certain circumstances. There is about 36 million Ha of secondary forest. Of that 18 to 20 million Ha is not suitable. 10 million Ha is available, but only at a much higher cost so that leaves about 6 million Ha available for planting now if all the permits can be obtained. C. Imperata grassland in Indonesia, 8 million Ha of it. The problem is that it will have a lower yield and be more expensive to build out. D. Degraded secondary forest. There is about 5 to 6 million Ha of degraded old forest land in Indonesia that the government offered up. The problems are huge though. Most of the land is in really bad shape. About half is considered severely or very severely degraded. After all, if the degraded land was still productive, the farmer wouldn’t have abandoned it. Also building out degraded land would be expensive. For one, when using forest land, the product from the deforestation is sold providing cash and second, the degraded land would require a lot of work to bring it back up to par if that’s even possible in the first place. It seems this idea is more of a political gimmick than a real opportunity. Concluding, there really isn’t that much land available for oil palm as commonly thought.

    Most of the land available and expansion will take place in Indonesia for two reasons. A. Malaysia is having trouble paying for the labor. The GDP per capital of rural Malaysia is multiples of that of rural Indonesia, meaning salaries in Malaysia are multiples that of Indonesia. High labor cost in Malaysia currently is considered a serious issue to the point plantation owners in Malaysia point it out in their annual reports as an issue. By the way, of the 48.8K net Ha owned by AEP, only 2,000 is in Malaysia. B. Papua New Guinea has high quality land, but the issue there is a severe lack of infrastructure. Overtime PNG will be explored more actively, but the low hanging fruit to be found is currently in Indonesia.

     

    A few more supply issues

     

    Recently RSPO, the Roundtable For Sustainable Palm Oil, came into being. Which was recently followed by the ISPO which stands for Indonesian Sustainable Palm Oil. The goal of both is to move to a model of sustainable development of the palm oil industry. The main goals are to limit to amount of deforestation and the CO2 it causes. The main gist of it is that the forest is being divided in primary and secondary forest, where the primary forest has become off limits for deforestation and oil palm plantations. The main result is that the available land from plantations has shrunk making it harder to find land to expand.

    One important side effect of RSPO has been that certainly in the developed world it has become a standard requirement for the investibility of a company. The last thing a pension fund manager wants is to have a Green Peace accusing him of destroying the rain forest. RSPO provides cover from that. This is especially the case in Europe where palm oil driven deforestation has become a big issue.

    AEP is working on getting the RSPO certification, which should not take much longer.

     

    There is also the issue of small holders. On land purchased post 2007 companies wanting to expand have to provide 20% of the land to local communities at cost as part of obtaining a permit. Here is how it works, the plantation owner builds out the 100% and then sells 20% at full cost to the local small holder. It has to provide the loan to the small holders. On that loan, the company is allowed to charge market interest rates. Once the plantation is finished, the owner will manage the whole plantation including the 20% owned by the small holder. For that management the plantation owner gets a 5% management. The plantation owner also makes money from the extraction of the palm oil. So while it isn’t as profitable as owning the land outright, it isn’t that they have to give the land away. The plantation owner just sells the land at cost and receives interest, a management and a palm oil processing fee. The plantation owner controls the entire revenue of the 20% held by the small holder and takes all payments due upfront before handing over the rest of the money.

     

    There is a severe productivity gap between yields achieve by local farmers and large plantation owners. A large professional plantation can yield about 2 tons more, as they employ agricultural specialists that can monitor every aspect of the cycle. This difference has existed for many years and just doesn’t seem to close. Many efforts have been made to get that productivity gap to close, but it seems too complex with too many parties involved.

     

    Lastly the cost to build a new plantation per Ha is about $8,000. That includes clearing, preparation of the land and planting as well as PP&E and interest.

     

    So now, lets get to AEP.

    AEP at the end of 2011 owned net to common equity holders 31,744 Ha of mature and 16,464 Ha of immature oil palm plantations. On page 9 of the 2011 annual you can see the actual Ha and percentage ownership. In addition AEP has a net Ha ownership of 506 Ha mature and 170 Ha that was immature. Rubber plantations tend to be more profitable than oil palm. In 2010 and 2011 a rubber Ha was about 2 to 2.5 times as profitable as a Ha of oil palm. In addition rubber is not hindered by export taxes. I will discuss the export tax issue later. So in order to give it the right valuation, I assume that each Ha of rubber was worth 2 Ha of oil palm. So the 506 mature Ha of rubber is adjusted in the valuation as 1,012 mature Ha of oil palm and the 170 Ha of rubber of immature is considered 340 Ha of immature palm oil.

    In addition on a net basis AEP also owns 47,571 Ha of plantable land. This is a valuable asset. Assuming a $750 CPO price per ton the after tax ROIC is 15.3% once built out. At $1,000 it is 20.3% and at $1,250 it is 25.7%. AEP planted gross 4,800 Ha in 2011 and the plan is to add another 9,000 planted Ha over the next two years. Given all this investment opportunity with pretty good ROICs one should not expect the company to buy back shares or increase the dividend much. Basically AEP understands the opportunity to grab land at attractive prices and the focus will stay on buying more land and turning it into productive plantations.

     

    AEP is majority owned by Genton International, which in its turns is controlled by Madam Lim Siew Kim, a Malaysian person of Chinese decent. Looking back over the years, I see a company that is well managed with a clear and simple strategy. There have been no accounting issues, no insider dealing and the board paid itself $194K in 2011.

     

    Before I get to the valuation I want to first lay out the Indonesian export tax and ROIC of this business.

     

    The table below shows you the export tax and profitability of a Ha of oil palm using the $8,000 in cost to build a new Ha. In column two one can see the actual export taxes based on the CPO price at the time of sale. The main reason for these import taxes is the government wanting to capture the whole value add in the supply chain. In the second table you will see that compared the upstream export taxes, the export taxes after the CPO has been down streamed are much lower.

     

    Profitability*

     

     

     

     

     

     

    Price per Ha

    $8,000

     

     

     

     

     

     

    CPO Sales Price

    Upstream CPO Export Tax

    Net CPO Price Ex Export Tax

    Cost CPO CIF Rotterdam

    Net Income Per Ton CIF Rotterdam

    Operating Profit 5 Ton Per Ha

    Operating Profit 5 Ton Per Ha After Tax (30%

    ROIC 5 Ton Using Cost Per Ha After Tax

    750

    0.0%

               750

                400

                      350

             1,750

                    1,225

    15.3%

    800

    7.5%

               740

                400

                      340

             1,700

                    1,190

    14.9%

    850

    9.0%

               774

                400

                      374

             1,868

                    1,307

    16.3%

    900

    10.5%

               806

                400

                      406

             2,028

                    1,419

    17.7%

    950

    12.0%

               836

                400

                      436

             2,180

                    1,526

    19.1%

    1000

    13.5%

               865

                400

                      465

             2,325

                    1,628

    20.3%

    1050

    15.0%

               893

                400

                      493

             2,463

                    1,724

    21.5%

    1100

    16.5%

               919

                400

                      519

             2,593

                    1,815

    22.7%

    1150

    18.0%

               943

                400

                      543

             2,715

                    1,901

    23.8%

    1200

    19.5%

               966

                400

                      566

             2,830

                    1,981

    24.8%

    1250

    21.0%

               988

                400

                      588

             2,938

                    2,056

    25.7%

    1300

    22.5%

            1,008

                400

                      608

             3,038

                    2,126

    26.6%

    * I did use 30% in net tax. If you check, you will see that the actual tax is 25%, but in order to adjust for SG&A I added 5%, which seems to be a decent approximation.

     

    Indonesia downstream export tax (% of gross market price)

    USD

    RBD Palm Oil

    RBD Palm Stearin

    RBD Palm Kernel Oil

    Palm Fatty Acid Distillate

    Bio Diesel

    <750

    0

    0

    0

    0

    0

    750-800

    0

    0

    0

    3

    0

    800-850

    0

    0

    0

    4

    0

    850-900

    2

    2

    2

    5

    0

    900-950

    3

    3

    3

    6

    0

    950-1000

    4

    4

    4

    7

    2

    1000-1050

    5

    5

    5

    8

    2

    1050-1100

    6

    6

    6

    9

    2

    1100-1150

    7

    7

    7

    10.5

    2

    1150-1200

    8

    8

    8

    12

    5

    1200-1250

    9

    9

    9

    13.5

    5

    >1250

    10

    10

    10

    15

    7.5

     

    Ok, so how much is this thing worth?

     

    Let me first comment on the following:

     

    Net Cash: I use $90 million in net cash. I know that doesn’t include the $6.5 million in debt. Let me explain: First, it assumes this business needs little cash to run itself, which is correct. The receivables at the end of 2011 were $1.5 million, payables $20.8 million. In addition we are almost halfway through 2012, 6 months during which AEP has probably made at least another $30 million in operating profit or about $22.5 million after tax. So I feel confident to assume at this time there is enough cash on the balance sheet to cover the $6.5 million in debt and enough cash to run the business.

     

    Value of unplanted land: While the current sale value of a plantable Ha is $1,000, and climbing fast, I think there is a real argument to be made that the value of the plantable land is at least $2,000 per Ha. Lets just look at the comps for arable land in the UK and US. In the UK around the middle of 2011, an acre of prime arable land was fetching £8,500 per acre or about £21,003 per Ha, more than thirty times what we are currently paying in Indonesia. Or look at the US in the following table. As you can see there is quite the delta between oil palm land and US based arable land. So it seems to be reasonable to assume AEP’s land’s IV is worth at least $2,000 per Ha, especially if one assumes the ROICs that are available from planting a Ha of oil palm. For one, I have never heard farming in the UK or US to be a double digit ROIC affair. Interesting too is that a doubling of the cost of oil palm land to $2,000 increases the total cost of per Ha built out by only 12.5% from $8,000 to $9,000.

     

    Value Land US 2011

    Acre

    Ha

    Northeast

     $5,190

     $12,824

    Lake

     $3,450

     $8,525

    Corn Belt

    $4,920

    $12,157

    Northern Plains

    $1,700

     $4,201

    Appalachian

    $3,590

     $8,871

    Southeast

    $3,650

    $9,019

    Delta

    $2,050

    $5,066

    Southern Plains

    $1,520

    $3,756

    Mountain

    $1,550

    $3,830

    Pacific

    $5,150

    $12,726

     

    Private market sales value of planted land: Currently the private market sales price per Ha is between $15,000 and $20,000 per Ha. I am using $15,000 as a conservative number. $15,000 still gets us a ROIC of 8.2% at $750 per ton CPO. I consider $750 CPO per ton to be the lower end price over the medium term.

     

    Comp values: I choose First Resources Limited as it has a similar asset profile as AEP. AEP has about 34% of its planted area as immature. First Resources Limited has 35%. Currently First Resources Limited trades at $14,264 per Ha. In April it was still selling for more than $18,000 per Ha.

     

    Rubber Ha: Remember that as Rubber is about twice as profitable, I doubled the amount of rubber Ha in order to equalize it with oil palm.

     

    Price per Ha Planted AEP

    $1,000 per plantable Ha

    $2,000 per plantable Ha

    LSE:AEP

    £7.10

    £7.10

    Market Cap

    £280,734,000

       £280,734,000

    USDGBP (Exchange rate)

    1.54

    1.54

    Market Cap in USD

     $432,931,131

     $432,931,131

    Anglo Eastern Net Cash Dec 2011

     $90,000,000

     $90,000,000

    Value Unplanted Ha

    $1,000

    $2,000

    Value Unplanted Assets

     $47,570,850

     $95,141,700

    Value of Mills

     $40,000,000

     $40,000,000

    Ex Value

     $255,360,281

     $207,789,431

    # Ha

                   48,883

                   48,883

    Price per Ha Planted

    $5,224

    $4,251

     

     

    IV AEP using $15K per Ha

     

     

    TOTAL Ha End 2011

       48,883

                   48,883

    Value of average Ha

    $15,000

    $15,000

    Total Ha Value End Dec 2012

    $733,244,250

    $733,244,250

    Anglo Eastern Net Cash Dec 2011

    $90,000,000

    $90,000,000

    Value Unplanted Land Per Ha

    $1,000

    $2,000

    Plantable Direct Ownership Ha

    $47,571

    $47,571

    Value Unplanted Assets

    $47,570,850

    $95,141,700

    Value Mills

    $40,000,000

    $40,000,000

    Sum of Parts

    $910,878,671

    $958,450,521

    # shares

    39,539,000

            39,539,000

    IV per share in $

    $23.04

    $24.24

    USDGBP (Exchange Rate)

    1.54

    1.54

    IV per share in GBP

    £14.94

    £15.72

    LSE:AEP

    £7.10

    £7.10

    Upside

    110.40%

    121.39%

     

    Now this IV valuation does not include the value that will be generated by turning the unplanted assets into producing plantations. At a $750 per ton CPO price, the annual after tax income is $1,225 per Ha annually. At $1,000 per ton CPO the after tax income is $1,628 per Ha annually. At $1,250 per ton CPO it is $2,056 per Ha after tax annually. Btw. I am using a 5 ton per Ha CPO yield, while the real number is somewhere between 5 and 6 ton.

     

    So what are reasons why AEP might be so much cheaper than its competitors, which tend to trade in the $14,000 to $18,000 per Ha. The main reason is that AEP being listed in London given the recent mostly European based environmental/deforestation issues around palm oil and the lack of RSPO accreditation of AEP have made AEP uninvestable for most European institutions. AEP will be receiving RSPO accreditation soon which will fix this overhang.

     

    The main two risks are:

    • ·Lack of population and GDP growth.
    • ·Demand from biodiesel going away.

    Catalyst

    RSPO accreditation

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