Chain Reaction Research: SE Asian Palm Oil Sector: Statistics Suggest Equity Overvalued
This report estimates the impact of undeveloped land on the market cap of publiclytraded SE Asian palm oil companies. Our analysis shows that investors and analysts have factored profits not only from acquired developed land, but also potential future cash flows which could be generated from acquired undeveloped land into their estimates. However, under demand-driven No Deforestation, No Peat, No Exploitation (NDPE) commitments – which may influence 60 percent of the global market – supply-side constraints such as the Indonesian moratorium, investors and analysts may need to reduce their current estimates as some land banks become stranded and unlikely to generate future cashflows. These policies put undeveloped forest and peatland at risk of stranding, as shown in the Chain Reaction Research report Indonesian Palm Oil’s Stranded Assets: 10 Million Football Fields of Undevelopable Land. The report stated that 29 percent of Indonesia’s available corporate land bank could be stranded, equaling 6.1 million hectares (ha).
This report distinguishes market capitalization changes from acquisition of already developed land versus acquisition of undeveloped land. This was shown by a regression analysis focused on 43 SE Asian palm oil companies’ profitability and market cap from 2010 to 2015. The results are statistically significant and financially material, as many companies have undeveloped land which may become stranded.
- From 2010 to 2015, a 10 percent landbank expansion was associated with a 7.2 percent market cap change. Market cap and net profit were closely linked, as a 10 percent increase in net profit was tied to an 8.8 percent increase in market cap. Net profit in turn was related to an increasing landbank. A 10 percent growth in the company’s landbank was associated with a 4 percent increase in profits. Thus, 3.7 percent is the “indirect” impact of developed land-profit-market cap. This implies that less than 50 percent was already developed land.
- 10 percent undeveloped land relates to 3.5 percent market cap. The model isolated the statistical relationship between landbank and market cap, and eliminated the net profit-market cap relation. As prior to the NDPE, the market considered all land developable, irrespective of whether it was forested, peat land, or contested, now under current market conditions it would have to adjust. This is because forest and peat land are no longer developable under NDPE. Hence, a 10 percent forest/peat land may result in 3.5 percent market cap loss. Companies with 20 percent contested land may exerience 7 percent market cap loss. Alternatively put, a 10 percent forested land acquisition, may not be expected to add 3.5 percent to market cap.
Conclusion: Due to stranded land risk, this analysis forecasts that the SE Asian palm oil business strategy where new land acquisition drives equity value will change. Instead, a new SE Asian palm oil business strategy may develop, characterized by more sustainable land-use and labor practices – but only if ‘leakage’ is controlled.
For more information, please contact Tim Steinweg.