Friday, 14 November 2008

Palm Oil Predicament

Palm Oil Predicament

Ioannis Gatsiounis, 11.24.08,

Sime Darby's Ahmad Zubir Murshid copes with the plunging price of palm oil.

A year ago three Malaysian palm oil producers--Sime Darby, Golden Hope Plantations and Kumpulan Guthrie--merged to form the world's biggest listed palm plantation company in terms of landholdings. That was just in time for the crash in palm oil prices.

The price of the benchmark Malaysian futures contract has fallen by nearly two-thirds since March. That has Sime Darby--as the new company is called--and other palm oil producers scrambling to cut costs and improve yields on their plantations.

The Malaysian government is so alarmed at the sudden downturn that it's kicking in $56 million to encourage producers to replant their land with young, higher-yielding palms.

In this tough environment Sime Darby faces a more serious test than most of its rivals. It may have the biggest land bank, but it's far from being the most efficient producer, and its management controls need improvement. This makes the task of Chief Executive Ahmad Zubir Murshid all the more urgent: to streamline an unwieldy conglomerate--in which the government owns just over 50%--and reap the cost savings that the megamerger promised.

He relishes the job. When reminded of the tightening competition and the volatile market, his face lights up: "That's the challenge."

Despite the turmoil, Ahmad Zubir is sticking to the ambitious goal he set after completing the merger: double palm oil production within ten years, giving Sime Darby control of 10% to 15% of global output. "I still believe we can get there," he says at Sime Darby's recently built public convention center, overlooking a golf course flecked with tropical flora. "That's what this merger's always been about."

Sime Darby first annual results after the merger were sterling. Net profit jumped 40% to $1.2 billion for the year ended June 30. Revenue reached $10.4 billion, 21% higher than in fiscal 2007.

But that was before palm prices really nosedived, hitting $373 a metric ton last month after peaking at $1,420 in March; recently it's edged back to $467. At the same time, the price of fertilizer has doubled in a year and now accounts for 40% of Sime Darby's plantation costs.

That's pushed up the cost of palm-oil production to $345 a ton, from $270. With palm oil accounting for roughly three-quarters of the company earnings--its other core businesses are property, car dealerships, energy and utilities, and heavy equipment--the market capitalization has taken a pounding, losing $11 billion since January. Its stock closed recently at $1.78, down 53% this year.

Crude palm oil prices track crude oil prices, so they've followed as oil prices have fallen. The reasons are similar: a slowing world economy, a world supply glut and the rise in the dollar. As the price falls, defaults rise among buyers of futures contracts at higher prices, which accelerates the price spiral.

Defaults are expected to jump over the next three months, leading to delays in palm oil shipments and the renegotiation of import deals, particularly with China and India. Biodiesel accounts for 5% of palm oil sales, and that demand is slipping because of a backlash in Europe over the environmental damage sometimes caused by new plantations.

Ivy Ng, an analyst at CIMB in Kuala Lumpur, notes that most commodities are suffering now as hedge funds unwind their positions. "It's not cause for panic," she says. "The industry has seen windfall profits the last three years. We're likely to see companies become more cautious about costs. But I've seen this type of cycle many times."

Sime Darby is certainly focused on costs--it aims to reach $115 million a year in merger savings within two years. Meanwhile, it's sticking with its long-term goal of 10% growth in revenue each year. "Remember that before this boom in palm oil prices two years ago, we were all very happy at [$520] per ton," says Ahmad Zubir. In any event, he sees the low price as temporary and expects it to return to $575 in the long term.

One reason Ahmad Zubir is optimistic is that there's room for Sime Darby to improve its palm yields. It owns 560,000 hectares across Indonesia and Malaysia, and he wants to boost yields by 5% a year over the next three to four years.

Doing so, he says, would allow the company to catch industry leader IOI in terms of yield. Sime Darby averaged 22 metric tons per hectare in fiscal 2008 while IOI racked up 29 tons. IOI, also headquartered in Malaysia, is so efficient and profitable that it's spending its third straight year on FORBES ASIA's Fab 50 best listed companies in the Asia-Pacific region.