1H 2017: Bouncing Back

While the results reported for 1H 2017 are marked by the difficult operating conditions created by the post El-Nino weather conditions, and by the impact of the management upheaval created by the sudden departure of the company’s most senior operating officer in the region in Q1, the 2H of 2017 is expected to see the business not just ‘bouncing back’ from adversity, but moving decisively towards the completion of the project over the next few years. REA’s 1H 2017 report states “the problems of the difficult past two years…are now largely behind us”.

• Strategy: REA Kaltim, the principal division of REA, is developing a land bank of some 108,000 ha. At the current, accelerated rate of development, the proprietary plantations should be completed by 2021 at circa 60,000 ha.
• Changing fortunes: REA’s financial performance should undergo significant change from end 2019: it is the point at which the business becomes self-sustaining (we are assuming 37,000 ha of mature plantations) and by end 2021, REA could be generating annual free cash in excess of $100m.
• Valuation: Using an Indonesian risk biased WACC of 12.2%, a valuation range of £4.44 – £4.76 per share is suggested (on the basis of our long run projections for cash flows), depending on the terminal growth rate applied. The WACC makes no adjustment for REA being listed on the London Stock Exchange.
• Risks: Agricultural risk, commodity price risk, and country risk are constants of palm oil production. 1H 2017 net debt of $235.5m (79.4% of total equity), will grow further as the project moves towards completion. However, REA has options, which if exercised could markedly strengthen the balance sheet.
• Investment summary: REA now has some 25,000 ha of plantable land still to develop. With gearing estimated at 89.4% for year-end 2017, choices may have to be made. It was interesting to note the hint ‘tucked away’ at the end of the Financing section of the Chairman’s statement: “the group is…exploring the possible divestment of certain outlying plantation assets which, if effected, would materially reduce the group’s overall borrowings”.