The long case for Sipef

Socfinaf versus Sipef

Sipef Group is active in producing crude palm oil (CPO), palm kernel oil (PKO), natural
rubber, various other crops (i.e. tea, bananas, tropical flowers), and marine insurance.
Product
Turnover

Palm
84%

Rubber
7%

Tea
2%

Bananas

Insuranc

6%

e
1%

Its turnover country exposures are Indonesia (58%), Papoua-New-Guinea PNG (35%),
Ivory Coast (6%) and Europe (1%). We spend a separate chapter on palm oil activities, for
Sipef has a paramount exposure to this crop.

1. Palm oil activities

In 2014, Sipef produced 268 kTon of Crude Palm Oil. To put this in perspective, the total
need of the Ferrero group (owner of Nutella) is an annualized 150kTon.
Last years, Sipef group reinvested a lot of profit, with a lot of young palm trees planted as a
result. The below graph depicts Sipefs hectares planted per age (e.g. age 2 bucket
represent plants from 2013), this data can be found in the annual report.
Immature palm trees produce much less palm oil per hectare, as shown in the graph in red in
relative output percentages (right axis). Palm trees produce around maximum rated output in
the 8 18 years of age interval.

Figuur 1 Hectares planted (blue; source: Annual Report "Ouderdomstructuur") and oil yield per plant (%
of rated output, right axis; source: bursadummy.blogspot.be) both in function of plant age. Sipef has a lot
of immature plants.

With the age structure of the plantations on the one hand, and the yield per age on the other,
we can simulate the future production for Sipef, assuming no Capex is made in planting new
palm oil trees. We do this by correlating the two data series, and applying a +1 year offset on
the age of the plants for every year we want to look into the future.
We find that the effect of additional yield from the (numerous) immature plants maturing is
more important than the detrimental effect of the declining yields of older plants, and the
demolishing of +28 years plants for until 2019 (see below). Some findings:
-

Sipefs real turnover (in tons) will grow 23%, until 2019, without any planting Capex!
without any planting Capex, Sipef can sustain current level of production for until 2024!

With stable prices for all crops, this means Sipefs turnover will grow 19%1 organically, and
without any growth capex until 2019.

1 The simulated 23% growth only applies for Palm oil turnover owned by the
group. 84% of total turnover (palm, rubber, bananas...) derives from palm oil.
82% of the palm oil activities turnover is in turn coming from the groups
plantations (18% refining of third-partys crops), as derived from the figures in
the annual report on page 72. We conservatively assume all other crops have
homogeneous age structure and apply the 23% growth on the 82%*84% section
of total turnover.

Figuur 2 Without any new planting, future total production can be perfectly predicted. Ton per year for
Sipef group

Growth in real sales (ton) will only bode well for Sipef if its aggressive immature plantation
investments is not matched by the supply sides behaviour as a whole. Although I could not
find crop age statistics for the whole industry, I did find those of the two largest listed palm oil
companies: Wilmar and Sime Darby. These companies have respectively 10% and 9% of
their total portfolio in immature (1-3 year) plantations. That is about the allocation needed in
order to avoid a declining production, if one considers that this 3 year time interval
represents approx. 12% of commercial tree longevity (i.e. at 25 years). Wilmar also
published a 22% allocation to the total category of 1-6 year plants.
In contrast, Sipef has 19% of its hectares in immature 1-3 year plants, and 34% in 1-6 year
plants.
We see that there is clearly no immature planting bubble, at the top of industry. Considering
that global demand has been growing 4-12% annualised in the last 10 years, this promises
reasonable future prices for the guaranteed extra Sipef sales in 4-8 years, when the 1-6
year-old plants mature.

Palm oil market background

The large time lag between investment and production typically exacerbates boom-and-bust
tendencies (see below): high prices heavily encourage investment in new (immature) plants,
as no immediate effect of investment on supply are felt. This means a postponed price
pressure 4-8 years later as the trees mature. This is the major reason cited by many for the

current low prices: 4-8 years ago the boom in prices fostered extra planting (low petrol prices
is another reason). However, the relentless rise in demand (see figure below), driven by the
growing global middle class, is a dampener for busts.

Figuur 3 Nominal Crude Palm oil prices (30 year history 1985-2015) with price technicals (pitchfork).

Figuur 4 Global demand for vegetable oils grows 4-8% yearly in real terms.

The origins of demand for palm (kernel) oil are manifold. Its important to know the
breakdown, in order to understand the most important substitute products for palm oil.

Substitutes include other vegetable oils (Soybean oil the most important one2) competing in
the food and energy use category, and petroleum for the category energy uses
(vegetable oils are used for bio fuels in vehicles).
For soap and cosmetics, palm kernel oils only major competitor is coconut oil, as both
contain the indispensable lauric acids needed for forming foam. In 2014, the price for palm
kernel oil commanded a premium over palm oil (oil extracted from the pulp of the palm
flower) as typhoons impaired supply of Coconut oil from the Philippines.

2. Financials

Assets

Liabilities

Biological Assets*

Equity (deducted for minorities)

Other Long-Term Assets

Minorities Equity

Short Term Assets

Long-Term Liabilities
Short-Term Liabilities

14%
13%
44%

10%
5%

42%

73%

Consolidated Assets
329 MEUR Biological Assets*
319 MEUR Other Long-Term Assets
107 MEUR Short Term Assets
Consolidated Liabilities
548 MEUR Equity (deducted for minorities)
36 MEUR Minorities Equity
74 MEUR Long-Term Liabilities
97 MEUR Short-Term Liabilities

2 Soybean oil is considered as the better product, commanding a premium of 30300 USD/ton the last 10 years. In 2008-2009, the Soybean Palm Oil premium was
400 USD/ton (demand for inferior products tends to move toward superior
products when consumers get richer, e.g. domestic heating with coal is extinct
today as it was an inferior energy source). Today in the global slowdown and with
exceptional American harvests for Soybeans, the premium reverted back to
50USD/ton. The price slump for Palm this year has been due to these harvests
according to many.

44% of Sipefs total assets are plants. IFRS accounting rules for plantations require this book
value to be carried at real value, instead of marking it at past cost minus depreciation.
The real value of these biological assets is based on how much value can be reasonably
extracted from these plants in the future. Below, Sipefs valuation model inputs are given,
together with the valuation assumptions of a competitor, Socfinaf (100% exposure in African
countries).
Biological assets valuation

Sipef

Socfinaf

inputs
Discount Rate

Indonesia, PNG 15%

Sierra Leone, Ghana, Congo

African countries: 16%

13%
Liberia 11%
Ivory Coast 11%

Future Palm oil price

637 USD/ton

(USD/ton)

Nigeria 16%
Implicit price assumption: future
cash flow ~ average profit
margin 2010-2014 margin ->
876USD/ton3

We can see that Sipef applies much more prudent assumptions than its competitor Socfinaf.
We do not see a reason why a discount of less than 15% should be used in the above
African countries.
A constant cash flow in perpetuity calculated with a discount rate of 13% (Socfinaf) instead
of 15% (Sipef), is worth4 an additional 15/13th = 15%. If we apply the haircut factor of 13/15th
on Socfinafs biological assets to find a prudent asset value, its biological assets are reduced
from 740 MEUR to 641 MEUR. This 99 MEUR haircut reduces the equity book value
(exempt of minorities) from 532 MEUR to 459 MEUR.

3 Average price 2010-2014 876USD/ton from www.indexmundi.com

4 Present value for a perpetuity, PV = CF/DCR, see
http://en.wikipedia.org/wiki/Perpetuity

As for the future palm price, Socfinaf uses an optimistic measure as well. Currently, its palm
plantations are unprofitable (in 2014 it had gross margin of 68USD/t when prices were on
average 739USD/ton in 2014, todays price is at 605USD/ton)5.
In comparison, Sipefs 2014 profit margin was 36%. One reason for this discrepancy can be
found if we calculate the yield per hectare for the two companies (see below). Having double
as much output per hectare might be one cost saver for Sipef. Note that even for Indonesia,
Sipefs yield is unusually high.

Key metrics and valuation

Sipef

Socfinaf
6

Gross margin palm

267 USD/t (p97,p72 ) or

business (CPO+PKO)

36%7

(USD/Ton; %)
Hect yield (Ton / Hect)
ROC
Book value
Adjusted Prudent book

5.89 ton / hect

2014: 7.9% and 2013: 8.4%
547 MEUR
547 MEUR

value

68 USD/t (p658) or 8%

3 ton / hect
2014: 0% and 2013: 2%
532 MEUR
80-100MEUR for Rubber
plantation10 + extrinsic
optional value of palm assets

5 This does not mean these plantations are worthless. Production can be cut
when unprofitable, and started when profitable, as such Socfinafs palm business
can be valued as an out-of-the-money real call option on palm oil.
6 81 906KUSD/(268 CPO +38 PKO ton)
7 Gross margin divided by 739USD/ton, the average 2014 price
(http://www.indexmundi.com/)
8 P65 annual report Socfinaf. Margin transformed into USD.
9 Sipefs hectare yield is 1/3th above Indonesias average (Statistics: Tree Crop
Estate Statistics of Indonesia).
10 15 years of residual constant rubber production at 2014 margin with discount
rate of 15% (see page 65 annual report Socfinaf 14)

Mkt Cap
Price / book value11
Price / prudent book value
Price / sales 14
Price / earnings 14

443 MEUR
0.8x
0.8x
1.55x
9x

= 0-100MEUR
262 MEUR
0.5x
1.45x 3x
1x
N.A. as profits ~ 0

11 Share Prices (12th of May 2015): Sipef 49,5, Socfinaf 14.7

Conclusion
Sipef
Assuming current low margins stay stable12, Sipefs profits will rise in lockstep with the 19%13
rise in turnover by 2019, without any future capital expenditures for growth. As such, Sipefs
P/19E multiple is 7.5. Sipefs conservative price-to-book value is 80%.
Both current and future P/E valuations are low, given Sipefs
- nearly non-existent financial debt and
- quality business: Return on Capital is high compared to Socfinaf and other peers, yet still
camouflaged by Sipefs numerous immature plants, which count in the denominator of ROC,
but not yet in the numerator
From a return point of view, political risk is well accounted for in Sipefs book value, by
applying a discount rate of 15% on all future cash flows.
However, from a risk point of view, one should be aware that political risk is concentrated in
Indonesia (2/3th of turnover) and Papoua New-Guinea (1/3th of turnover).
Owing to concentrated risks, Id limit this position to 5-10% for my personal portfolio.
Socfinaf
-

its official book value is bloated with optimistic assumptions,

the margin for error is small with 40% debt to total assets,
its cost ($/ton) is much higher, one major reason might be the much lower yield per
hectare compared to Sipef (economies of density?). Socfinaf is currently unprofitable.

Socfinaf can be considered a call option on palm oil and rubber: if palm oil were to double or
triple in price in the near future, Socfinaf would be the cheaper stock, as its price / sales is 1x
compared to 1.55x for Sipef.

12 see analysis Palm oil Activities above.

13 see analysis Palm oil Activities above.