Dear Mr Lee,

With regards to your bullishness in FGVB in your expectation of the rise of palm oil price in the near future, here I will give you my opinion as requested by you.

When I buy something, I want to buy something which is good and cheap. Similarly when investing, I always look for good companies selling at cheap price in relation to its earnings, assets and prospect of its future growth in earnings.

My major criterion of a good company is one which provides a high return of capital, not one which has high growth expectation as professed by you. A $100 of additional capital created by a business employing $200 of capital is more impressive than a business B employing $1000 creating an additional capital of $300.

FGVB deployed a total capital of 13b and earned a net profit of 500m (exclude extra-ordinary gains) for the financial year ending 31 December 2013, or 4% return of capital. This is definitely not my kind of definition of a good company.

Other complementary attributes of a good company are good cash flows and free cash flow, and a healthy balance sheet as a prudent risk management. FGVB certainly meets the requirement of cash flow, but just. Yes, it is cash rich. Why not, it just got so much cash from the IPO a couple of years ago. It is not because they got so much cash retained from its operations.

FGVB is not a good company in my book according to my criterion of a good return of capital above. However a not-so-good company can be good investment. Why? Yes, if it is selling cheap.

FGVB had whopping revenue of RM12.6 billion and makes a net profit of 27 sen per share last year. At RM4.14, the PE ratio is about 15, not really expensive. It can even be cheap if one thinks the palm oil price will spike in the near future. But is the net profit of 1.1 billion or EPS of 27 sen really the “true” earnings? It doesn’t appear to me as 328m was booked as “profit” arising from the acquisition of FHB, and 495m “profit” in fair value change in Land Lease Agreement Liability (LLA). So 823m, or 22.5 sen per share is just one-off and non-cash item. So how much is the “true” EPS? 5 sen? What will be the PE ratio then?  

I know investment is not about the past, it is about the future. FGVB is the largest palm oil producer in the world with a land bank of 450,000 hectares. It has the upstream, mid stream and downstream activities in this agriculture business. If palm oil price spikes, FGVB may gain tremendously increase in earnings. But how much and how much will it be translated to EPS? How much can an already big elephant grows? How much expectation has already been built into its share price of RM4.14 now?

I read that the industry experts and analysts forecast that palm oil prices will average around RM2,600 per tonne, which is only RM200, or less than 10% higher than 2013 prices. Actually academic research has shown that nobody has ever predicted the commodity prices correctly and consistently. Nobody knows the future which is highly unpredictable. What about the competition from soya beans, and the fierce campaign by the western countries against the use of palm oil? El Nino will boast up the palm prices? Of course but then the yield can also be adversely affected.

It is really not a good practice to put so many eggs into one basket. In your case, you simply have too much money of a whopping 38.5% of your money in plantation companies. What if instead of price going up, it goes down? What if it goes down to RM2000, RM1500?

53% of FGVB’s palms are past their prime and earmarked for replanting, only 29% of the estate are producing. How much growth in palm oil production you can expect? Going forward, FGVB will have to fork out a lot of money for replanting. So what can we expect the growth of its earnings for the next few years?

But I won’t touch FGVB more of its corporate governance. Those at the helm appear to be all political appointments; especially the person at the very top has not shown any credibility in the past. These people were so used to handling the money and affair of the corporation as if it is their own. They talked about how they are going to build the company 8 folds to a 100 billion company. It is basically their quest of empire building all over the world. They want FGVB to be the biggest growth story in corporate Malaysia. It has shown that very rarely a company can be successful in enhancing shareholder value by acquisition trail. They will acquire businesses very different from their core business and beyond their competence level, often with high costs and associated leakages.

If you look at its balance sheet, it is messy. There are a lot of inter-party transactions. You owe me and I owe you, hundreds of millions.

This is my very frank opinion and with little knowledge in the plantation sector. I am talking about investing in a business, not forecasting about its share prices in the future. I have no ability to do that.

The closing price of FGVB is at RM4.14 on this date of writing.

KC Chong July 9 2014

Reference: FGVB 2013 Annual Report