KEY INVESTMENT HIGHLIGHTS

• Cabinet approves the termination of land lease agreement (LLA) between Felda and FGV on 28 October 2020

• Nonetheless, FGV has yet to receive any official notice from Felda on the said termination

• According to the agreement, we understand that Felda needs to give 18-month notice to FGV, thus there might be no immediate impact on the group’s businesses

• FGV is expected to receive compensation range between RM3.5b to RM4.3b upon termination

• Potential cost savings and leaner balance sheet for FGV

• Maintain NEUTRAL with an unchanged TP of RM1.18

News on cabinet decision. On 28 October 2020, the Cabinet has approved the recommendation for the termination of the Federal Land Development Authority (Felda)’s land lease agreement (LLA) with FGV Holdings Bhd (FGV). While the LLA issue has been a discussion point for the past years, we believe that the decision and backing by the Government could potentially increase the likelihood of the said termination in the intermediate term. This would lead to Felda to reclaim its estate of about 350.7k ha that were leased to FGV. However, we understand that the group has yet to receive any official written notice from Felda to activate the termination process.

Salient points of LLA. As shown in Appendix 1, there are a few important clauses as reported that we gather thus far as below:

• A tenure of 99 years starting year 2012 for the 350.7k ha land leased to FGV (LLA lands), with the first point of negotiation on the terms of agreement to only be about 20 years into the deal

• Amount payable to Felda by FGV is RM248m per annum plus 15% of operating profits from the leased lands (appendix 3)

• In the event LLA is terminated: (a) A 18-month notice to be given to FGV to complete the whole termination and determining the compensation process (b) FGV’s compensation to be calculated based on the average profit per mature hectare for the entire leased land multiplied by the loss of FGV’s future profits (c) If the termination is less than 8 years or 5 years from the leased lands’ last replanting, FGV will be compensated for 10 years and 8 years in future profits respectively (d) Felda is obligated to take over the employment of relevant plantation staffs with the same employment terms or better than what was offered previously Based on the agreement and FGV’s internal assessment as announced, the expected compensation amount due to FGV could be in the tune of between RM3.5b to RM4.3b.

Potential impacts on FFB supply could be moderate. Should the LLA be terminated, we expect FGV’s total landbank to shrink by about 80% to about 89.0k ha based on the removal of 350.7k ha leased land from FGV’s current total landbank of 439.7k ha, most of which are oil palm planted area. While there might be concern on the supply of fresh fruit bunches (FFB) and hence CPO production to the group, we understand that the FGV-owned mills are largely located at proximity to the LLA lands, leading to a higher chance that the FFB supplies from the LLA lands to be still sold to FGV albeit possibly with a higher pricing. Note that the group currently procures about 30% of its FFB supplies from the LLA lands, 46% from Felda-managed smallholders and 24% from third parties (refer to appendix 4). Nonetheless, we do not discount the possibility of any supply disruption arising upon the said termination which could be a bane to the group’s business operations and financial performance.

More asset-light balance sheet and potential cost savings for FGV? According to FGV’s management, the group incurs annual operating costs of about RM1.5b for the maintenance and upkeep costs such as replanting, fertilising, staffs’ quarters and plantation workers’ wages mostly on LLA lands. As such, we anticipate that the group could potentially have a leaner cost structure should LLA is terminated as Felda would probably need to assume those expenses, in addition to the removal of the fixed lease payment of RM248.0m per annum to Felda. Adding onto that, we are of the view that FGV’s earnings could possibly experience less fluctuation or less impacted by the fair value changes in LLA liability as well. These should be a boon to the group’s financial performance. The expected compensation could also boost the group’s coffers in pursuing more earnings-accretive and strategic investments. Thus, we posit these assumptions would be a boon to the group. With the said, we do not rule out any potential unfavourable terms for FGV or long drawn-out legal proceedings during the negotiation process should the two parties kickstart the termination procedures.

Earnings forecast. We are making no changes to our earnings forecast at this juncture. We expect there will be no immediate impact on earnings at least in the immediate terms should the LLA is terminated in accordance to the 18-month notice period.

Target Price. We are maintaining an unchanged target price of RM1.18. This is based on pegging FY21 BVPS of RM1.18 to a higher PBV of 1.0x which is the group’s 5-year historical average.

Maintain NEUTRAL. While we are encouraged by the group’s continuous efforts in executing its turnaround plan, there are several issues that are placing it in an unfavourable light. Firstly, the ban on the group’s palm oil by the United States (accounts for <5% of total revenue) on alleged unfair labour practices might potentially have negative spill-over effects in the longer term in which the group is currently actively resolving. Secondly, the Malaysian government’s decision in supporting the termination of LLA is casting a shadow on FGV’s position as one of the biggest plantation companies. We also postulate that it is still early to assess the possible impacts on the termination of LLA, depending on the outcome of the negotiation phase. Meanwhile, the group has also received an expression of interest from Perspective Lane to inject its plantation assets into the group and potentially becoming its single largest shareholder at the same time which, in our view, could face major hurdles from multiple fronts. On the business fundamentals, we expect the group’s aggressive fertiliser application during early of the year could help to improve the FFB yield going forward and thus resulting in better CPO production. Coupled with an elevated palm oil price and expectancy of lower losses from MSM in 2HFY20, we foresee the group to record a better financial performance, in line with its transformation plan. All factors considered, we are maintaining our NEUTRAL recommendation on FGV. Nonetheless, we do not discount the possibility of an execution risk which is dependent on the development surrounding the Covid-19 pandemic. Although the expected total return of the Group is more than 10% which require us to upgrade our call, we are maintaining it at current juncture. This is due to our cautious stance on the much uncertainties currently shrouding the group’s business positioning and operating model moving forward. However, we do not rule out the possibility of an adjustment to our TP should more clearer details on the LLA and the potential M&A activities be in FGV’s favour.

Source: MIDF Research - 30 Oct 2020