Rotten multi-year earnings predicted for Wilmar oilseeds and grains

The traditionally high-profit segment is likely to plunge into a prolonged decline due to poor market conditions, says Maybank Kim Eng.

Overcapacity in China, and the increased cloudiness in predicting when to purchase beans and when to forward-sell are all pulling down margin projections for Wilmar's core profit business.

Also troubling is how demand for soybeans, partially driven by the Chinese using it as as a form of alternate financing for real estate/ stock market investments, might crash property prices in the mainland continue to cool.

Here's more from Maybank Kim Eng:

Earnings risk from Oilseeds & Grains. This segment has been an important pillar of group profitability historically, making up 21% of overall PBT in FY2011. However, we now see a potential multi-year decline, which we believe the market may not have factored in. Flour and rice milling also contributes to this segment although oilseeds (mainly soybeans) crushing in China is the majority component.

15-20% market share in China. Under this segment, Wilmar has 50 oilseeds crushing plants in China. In this “buying-processing-selling” business model, the timing of beans purchase, as well as forward-selling of the end-products will have an impact on margins. However, these shorter-term fluctuations should not obscure the underlying situation of over-capacity in China. In short, it is difficult to get “timing of beans purchase” right when the operating environment is difficult.

Negative margins in 1Q12 may be a prelude. Industry sources estimate current China soybean crushing utilization at about 50%, and yet state-owned companies continue to expand. In a business with little product differentiation, over-capacity will hurt even efficient producers. With capex already sunk-in, operators will continue operating above variable cost, with state-owned companies even crushing at negative margins to generate revenue and cash-flow.

The case of the “financial beans”. Anecdotal evidence from industry players suggests that the misuse of soybeans as a form of alternate financing for real estate/ stock market investments has become prevalent in China over the past 2 years. The effect is difficult to quantify but has probably inflated real fundamental demand for soybean crushing. With property prices in China cooling, there may now be an adverse effect on soybean crushing demand.

Don’t hold your breath for a quick turnaround in this segment. We believe the market is still too optimistic on Wilmar’s profitability, on the premise that 1Q12 losses in this segment are a one-off. These hopes may be dashed following the next set of results and consensus estimates should continue adjusting downwards.