Should FELDA ‘Hold’ or ‘Fold’ FGV

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FGV - Should Felda Hold or Fold?

Felda Global Ventures , one of the world’s largest vertically integrated plantation companies, is also at the moment the most politically important company in Malaysia. Felda settlers, who control over 60 parliamentary seats, grumble that they have been forced to sustain losses due to the collapse in FGV’s share price from its IPO price of RM 4.55 to RM 2.00 The question that has not been answered is whether or not the Company is capable to turn around its performance and consequently support a much higher share price.

Let us first start by providing all the positive conclusions to our in-depth analysis of FGV.

  • As a vertically integrated palm oil plantation company, FGV is in the right business as demand is sustainable and FGV can achieve economies of scale through its huge operations. FGV’s is very well positioned in terms of its current corporate structure and has benefitted from synergistic acquisitions, namely of Felda Holding Berhad, which was acquired at a very attractive price.
  • FGV has numerous corporate assets such as effective ownership of a sizeable land bank, vast downstream operations and tertiary high technology palm derivative manufacturing operations through investment in Twin River Technologies (TRT), which has begun to show strong progress.
  • FGV has access to major markets, such as North American, Middle East, Indian sub-continent and should benefit from the growing rapprochement between Malaysia and China, largely on the back of efforts by Prime Minister, Dato Seri Najib.
  • FGV has a very manageable debt burden profile relative to its cashflow generating capabilities.
  • Felda has addressed a key leadership issue by appointing  Dato’ Zakaria Arshad as FGV’s new CEO. The Rembau Times is also supportive of Dato’ Zakaria Arshad as he hails from Felda Palong, in Gemas, and can be considered as a “son of Rembau.” Dato Zakaria has also instituted new measures to address the poor profits inherited from previous management.
Rembau Times supports FGV's new CEO Data Zakaria Arshad
Rembau Times supports FGV’s new CEO Data Zakaria Arshad

However, the question politicians are most concerned with is whether or not they can promise Felda settlers that FGV’s share price will recover to its pre-IPO level of RM 4.55. The short answer is that this is very unlikely in the short term, unless the Government sells Felda to a Chinese buyer. FGV’s net profit has declined sharply by over 90% steadily from 22 sen per share in 2012 to 0.8 sen per share in 2016. The production yield from its estates has declined by 30% from 19.1 MT/Ha to 14.5 MT/Ha. Over the same period, Its CPO production has declined 20% from 3.3 million MT in 2012 to 2.66 million MT. The Trading, Marketing and Logistics segment, which used to generate RM 300m in profits when managed by Felda Holdings Berhad now barely makes a profit.

Replace Isa with Shahrir
Under Tan Sri Shahrir Felda is now asking tough questions of FGV

With so much potential asset generating capabilities, why is FGV still struggling to make a profit? Why is its share price languishing 50% below its IPO price?  Felda itself is seen to be losing patience and recently, there have been news report indicating Felda’s intention to seek the return of its land currently leased out to and managed by FGV because it feels that it could extract higher returns.

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The Rembau Times is unafraid to state that the idea to terminate the Land Lease Agreement does not make sense financially. Not only will it lead to negative consequences for FGV, its creditors and the market as a whole, it exposes Felda to ownership of an upstream asset without any supporting downstream facilities. Felda will not be better off having the plantation managed internally as the key downstream and logistics assets are now owned by FGV. In fact, it will create yet another issue which can be capitalized by the Opposition.

Current management may have inherited legacy cost and operational issues
FGV’s current Chairman, Tan Sri Isa alongside  previous CEO, Emir Mavani.

However, Felda should move to replace FGV’s current Chairman, Tan Sri Isa with Tan Sri Shahrir Samad. This seems sensible as Felda is the major shareholder of FGV, with a shareholding of 33.7% and Tan Sri Isa has been associated with the poorly conceived idea of acquiring a minority stake in PT Eagle High at an inflated price. This was viewed as a political decision and roundly criticized by the market and led to a collapse in the share price and eventual exit of blue chip investors like KWSP.   Tan Sri Shahrir has a generally better aura than his predecessor and has a reputation of telling it as it is.  A no-nonsense Chairman will also ensure that Management is kept to task to deliver its targets and profits.

There are some issues that should be tackled by FGV’s management immediately.

The first has to do with its cost structure.

FGV's administrative cost cuts into profits
FGV’s administrative cost cuts into profits

Since its listing, FGV’s Selling, General and Administrative (SGA) expenses as a percentage of sales has risen from 0.80% to 4.20% in 2016.  In absolute terms, FGV’s SG&A was RM 110m in 2012 but has now increased to RM 727m. Whilst part of this was a result of the acquisition of FHB, there was still an increase of RM 300m in SGA costs from RM 448m in 2014. This increase in cost has cut deeply into FGV’s profits. In this regard, the new CEO has promised improvement on this matter and has reduced administrative costs by RM 127m and targeted to reduce CPO production costs by 9% to RM 1,451 per mt.

CPO Spiraled out of control in 2016

The second issue relates to internal controls and risk management capabilities. This issue was evidenced by the fraud losses discovered in 2016 at FGV’s overseas joint venture subsidiary in Felda Iffco Gida Sanayi (“FIGS”) and losses in the Trading Marketing and Logistics (“TMLO” segment), which FGV’s attributed to poor market positioning in the futures market. FGV needs to strengthen its internal controls as its inventories and receivables have increased to RM 4b, which has consequently lengthened the cash conversion cycle and at the same time increased the risk of further losses due to fraud or credit.

FGV's Yield Per Mature Ha lags far behind peers
FGV’s Yield Per Mature Ha lags far behind peers

The third related issue is the lack of productivity, as the FFB yield per mature hectare of FGV operated estates dropped to 14.9 MT/Ha in 2016. Whilst Management has blamed this on an unfavorable age profile and the effects of the El Nino, this performance compared poorly with the performance from Sime Darby’s Malaysian plantations, which recorded a yield of 20.3 MT/Ha in the preceding year. For its part, FGV’s 2017 performance is expected to be better as MPOB’s data has revealed a 20% increase in FFB production over the first four months of the year.

Management has attempted to address these challenges through several ways.  For its Upstream cluster, the replanting initiative which is expected to increase production by 30% to 5.2 mil MT of FFB by 2020. For its Downstream cluster, FGV’s management is aiming to produce high-margin consumer goods such as premium shortening in the FMCG sector. The TMLO sector, which has been restructured to the Logistics and Others sector, will focus on other supply chains such as the minerals supply chain in Perak through a tie-up with Lhoist S.A, a global leader in global leader in lime, dolime and minerals, and entering new markets through the construction of warehouses in Tanjung Langsat Johor to serve Oil and Gas clientele.  However, The Rembau Times is not totally convinced that an Agribusiness provider venture out to manage other supply chains when it cannot even efficiently manage its own supply chain and deliver profits. After all, FHB used to run the downstream and logistics segment profitably but FGV has been unable to replicate the performance.

Whilst The Rembau Times is supportive of the CEO, we reserve our comment on the Management Team in place. FGV has yet to show meaningful improvement in Operational Return metrics, which is explored in-depth in  following articles. But, in the short time since he has taken over, the new CEO Dato Zakaria Arshad has inspired more confidence than his predecessor.  The new CEO should forge ahead with his plans and ensure that the management team he has in place is capable of delivering the results.  And a new Chairman should be there to hold management to these results or replace them with a better group.

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