Profitability Woes Lasting For Palm Oil Downstream Sector


BMI View: Palm oil producers in Indonesia and Malaysia will continue to face a challenging operating environment in the next 16 months, as profitability will remain weak compared with historical standards. Upstream companies will fare better, as stronger palm oil prices in 2014 and 2015 will boost their margins. Meanwhile, overcapacity in the refining segment will continue to weaken profitability in the downstream sector.

The operating environment for palm oil companies in Indonesia and Malaysia will remain challenging over the rest of 2014 and in 2015, as the fundamentals for the industry remain unfavourable. Profits will be limited by slowing sales growth and rising costs. Although we expect global demand for palm oil to increase by 5.6% year-on-year (y-o-y) in 2014 and 5.2% in 2015, this represents a significant slowdown in consumption growth compared with recent years, which will limit sales volumes for companies. Meanwhile, operating costs will continue to grow steadily, driven by increasing labour, fertiliser and energy/transport costs. Indonesia increased minimum wages in most provinces in 2014 after passing a Minimum Wage Law in 2013 (see table below), while Malaysia extended its own Minimum Wage Law to SMEs in 2014.

Indonesia - Minimum Wage ('000 IDR) & Palm Oil Production By Province, 2012 - 2014
Province Min Wage 2012 Min Wage 2013 % Change 2013 Min Wage 2014 % Change 2014 Palm Oil Production, 2013 (% of total)
Riau 1,238 1,400 13.1 1,700 21.4 24.5
North Sumatra 1,200 1,370 14.2 1,506 9.9 12.4
Central Kalimantan 1,327 1,553 17.0 1,724 11.0 10.9
South Sumatra 1,350 1,630 20.7 1,826 12.0 9.3
West Kalimantan 900 1,060 17.8 1,380 30.2 8.8
Jambi 1,143 1,300 13.7 1,502 15.5 5.8
East Kalimantan 1,177 1,760 49.5 1,886 7.2 5.3
Source: Ministry of Manpower and Transmigration, BMI

Amidst this lacklustre outlook, upstream companies solely involved in palm oil plantation and milling activities will fare better than integrated players with both upstream and downstream businesses. These players will see an improvement in their profitability in the coming quarters, as crude palm oil prices will head higher in 2014 and 2015, following the weakness seen in prices in 2012 and 2013. We forecast palm oil prices to average higher for the first time in three years in 2014, at MYR2,650/tonne, compared with MYR2,405/tonne in 2013. Prices are likely to continue on that trajectory in 2015 and average MYR2,700/tonne as production expansion continues to slow in Indonesia and Malaysia (see ' Palm Oil To Average MYR2,650/tonne In 2014', May 30). Crude palm oil prices have a more direct impact on the upstream companies than on the integrated companies, as prices are the main driver of profit.

Profitability in the upstream sub-sector has already withstood better than integrated companies amidst an overall challenging environment in recent years. Profit margins for these companies (including Bumitama Agri, BW Plantation, Sampoerna Agro, IJM Plantations and TH Plantations) averaged 21% in FY12 and FY13, only slightly lower than the 23% recorded on average between FY04 and FY11. In contrast, integrated palm oil producers (including for example Golden Agri Resources, Astra Agro Lestari, First Resources, Felda Global Ventures, IOI Corporations and Sime Darby) have seen their profit margins decrease to 12% on average in FY12 and FY13 compared with 16% during FY04-FY11.

Plantation Business More Profitable
Select Companies - Palm Oil Upstream (LHC) & Integrated (RHC) Companies Operating Margins (%)

Companies with downstream palm oil activities - which include refining crude palm oil into palm olein and stearin and then processing these into specialty fats, oleochemicals or biodiesel - will see their profitability remain under pressure as their face severe overcapacity. Indonesia has lured a large wave of investment into its refining sector after revamping its trade tariffs in 2011 in order to favour higher-value refined exports. The country's palm oil refining capacity is expected to reach 45mn tonnes in 2014 according to Indonesia's Vegetable Oil Industry Association, up 45% y-o-y and higher than our CPO production forecast of 31mn tonnes in 2013/14. The consequences of these developments are more severe for smaller, independent palm refiners without plantations, which may be forced to close down as they see their margins squeezed further with the rise of CPO prices in 2014 and 2015.

Indonesian refiners will perform better than Malaysian downstream players, as they are more competitive due to lower production costs. Moreover, refineries in Indonesia continue to benefit from the differentiated export duty structure between Malaysia and Indonesia.

Indonesia & Malaysia Palm Oil Refining Capacity & Utilisation Rate
2011 2012 2013 2014e
Indonesia Refining capacity (mn t) 19.5 21.3 30.7 45.0
CPO Production (mn t) 23.6 26.2 28.3 30.9
Malaysia Refining capacity (mn t) 23.7 24.8 25.3 25.5
CPO Production (mn t) 18.2 18.2 19.3 19.4
Utilisation rate (%) 74.0 61.9 69.9 65.0*
* January-April. Source: MPOB, Indonesian Vegetable Oil Industry Association, Palm Oil Refiners Association of Malaysia

Different Strategies To Address Profitability Challenges

Interestingly, most of the pure upstream companies do not plan to diversify into the downstream sector in the coming years, probably as a result of the uninspiring profitability in the sector for the time being. The five companies mentioned above plan to expand existing uncultivated area and improve plantation efficiency (especially via increasing mechanisation in order to address soaring labour cost and shortages issues). Sampoerna Agro plans to prioritise attaining economies of scale before moving toward value-added downstream products, while TH Plantations is now looking at rubber plantations and may expand into palm oil refinery in the coming years.

Downstream players are looking into developing more value-added palm oil-based products (this is the case of Felda, Astra Agro Lestari, Wilmar International for example) and intend to diversify into new territories or businesses. Rubber and sugarcane have attracted most the interest so far, for example from Indofood Agri, First Resources, Wilmar, Astra Agro Lestari and Felda. Meanwhile, many palm oil companies are venturing into Frontier Asia and Africa to find new sources of land and markets for their products (see 'Asia's Foray Into African Farming: Early And Troubled Days', August 28, 2013).

INDONESIA - Palm Oil Production & Consumption
2013 2014f 2015f 2016f 2017f 2018f
Palm Oil Production, '000 tonnes 1 28,300.0 30,850.0 32,084.0 33,271.1 34,402.3 35,468.8
Palm Oil Consumption, '000 tonnes 2 7,800.0 8,993.4 9,802.8 10,342.0 10,786.7 11,250.5
Notes: f BMI forecasts. Sources: 1 USDA, Badan Pusat Statistik; 2 USDA.
MALAYSIA - Palm Oil Production & Consumption
2013 2014f 2015f 2016f 2017f 2018f
Palm Oil Production, '000 tonnes 1 19,320.0 19,400.0 19,943.2 20,342.1 20,708.2 21,122.4
Palm Oil Consumption, '000 tonnes 2 2,451.0 2,549.0 2,679.0 2,719.2 2,760.0 2,801.4
Notes: f BMI forecasts. Sources: 1 MPOB; 2 USDA.
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Related sectors of this article: Agribusiness, Oil Crops, Palm Oil - Agribusiness
Geography: Asia, Indonesia, Malaysia