All Change From 2019

As weather patterns revert to more normal conditions, REA is hoping to see production levels rise across its oil palm plantations in Kalimantan during 2017. However, full recovery in oil palm production can take up to 18 months, so improvement in production will spread into 2018. Nevertheless, revenues should see growth of more than 20% y-o-y, helped too by contributions from the electricity generating operations and possibly, also by the coal mining activities, as demand for coal grows domestically and abroad, providing support for prices.

• 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.
• 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. We would argue for a terminal growth rate range of 1% (bearish outlook), to 3%, more reflective of emerging market growth rates, which are the big consumers of palm oil. The WACC makes no adjustment for REA being listed on the London Stock Exchange and therefore subject to the LSE’s good governance requirements.
• Risks:  Agricultural risk, commodity price risk, and country risk are constants of palm oil production. End 2016 net debt of $205.1m (66.3% of shareholders’ funds), is expected to rise again in subsequent years (subject to new equity raises) as the company drives for the completion of its plantations.
• Investment summary:  REA has scope, with its existing landbank of 108,215 ha, to develop a planted estate of 60,000 ha, possibly 65,000 ha. On the basis of our projections, the group’s financial performance undergoes significant change from 2019 forwards. We are assuming some 37,000 ha of mature plantations for end 2019, coupled with stronger agricultural production across the estates, and a firmer CPO price. If these factors align as anticipated, then this will mark the point at which the business becomes self-sustaining: generating sufficient cash to fully meet its obligations on interest payments, preference dividends, estate development and taxation. According to our projections, the plantations will be fully planted by end 2021 (60,000 ha), with a mature area of between 45,000 ha and 46,000 ha, implying that from 2025, the group could be generating free cash in excess of $100m annually.