Sarawak Oil Palms (SOP MK, FV RM7.09, Close: RM6.23)

4Q Hitch Unlikely to Resurfac

After SOP’s share price retreated by as much as 4.3% following its poorer than expected 4QFY11 performance, we took a closer look at its results and sought management’s clarification. In 4QFY11, the company was hit by a lumpy refining capacity backlog in Sarawak which led to delays in CPO shipments and revenue recognition. This should, however, work to SOP’s advantage once its refinery comes on stream in 2Q. In 4Q, it also paid out higher performance-based employee compensation after a record year. As these issues should clear in 1QFY12, SOP remains our Top Malaysian Plantation Buy call.

Delving into the numbers.  SOP’s 4QFY11 earnings were below expectations. Although 4Q revenue fell by a lower than expected 3.8% q-o-q and was 47.5% higher yo-y, the company’s costs of sales jumped 12.8% q-o-q and 82.4% y-o-y, dragging down its earnings to RM43.3m (-42.8% q-o-q, -10.8% y-o-y). As both the higher than expected revenue and costs were a surprise and admittedly puzzling (CPO production  -9.3% q-oq, realized CPO price -7.0%, but revenue was just 3.8% lower), we took a closer look at the numbers and sought clarification from management.

Higher revenue and cost as SOP seeks suppliers. In anticipation of SOP’s maiden refinery coming on stream in 2QFY12, the company has been buying CPO from vendors to  blend with its own CPO for shipment (which naturally  raises  revenue as well as costs). The company’s rationale was this would allow it to secure CPO suppliers for its refinery before it commences operation, on the understanding that a supplier who sells its CPO to another refinery is unlikely to return to SOP when the company’s refinery starts running. CPO trading could actually intensify in 1QFY12 as SOP builds up its CPO supplier base. We find comfort in learning that this move did not give rise to trading losses (SOP  in fact  made a negligible RM0.1m profit from it).  That said, the  1QFY12 earnings should not reflect much impact on an absolute basis although margins would naturally narrow as SOP progresses down the value chain. Some 30% of the company’s refining capacity will be utilized by third party CPOs.

Refining capacity backlog. SOP sold but was unable to ship 13,000 tonnes of CPO in December 2011 due a backlog in refining capacity in Sarawak. Assuming the same 4QFY11 realized CPO price of RM2,943 per tonne and a 20% net profit margin, successful shipment would have added RM7.7m to its earnings. Such issues should be resolved  once SOP’s  refinery in Bintulu begins operation. While Peninsular Malaysian refiners rely partly on Indonesian CPO, refineries in Sarawak have ample local production to cater to their capacity. Contrary to its peers on the other side of the South China Sea, capacity underutilization  at  SOP’s refinery is thus unlikely to be an issue even if Indonesia’s more favourable export tax structure is taken into consideration.

Source: OSK188