, Singapore

See why Golden Agri-Resources' new downstream strategy is "sensible"

Although positive impact could be tiny.

Golden Agri-Resources has adopted a strategy to expand more into downstream operations, a move that Barclays Research believes is "sensible" in that it will help the company reduce its dependence on crude palm oil (CPO) prices.

But the research warned that the incremental contribution from the strategy is "too small relative to the current size of the business to move the needle."

Here's the full analysis from Barclays Research:

We believe Golden Agri's (GAR) asset suite ranks first amongst the Big Four palm oil producers globally, with the best FFB yield and OERs. Its growth rate has also been strongest. We think the strategy to expand more into downstream operations is sensible and Indonesian tax changes support the investment case at the margin. However, with a 76% correlation to the CPO price (highest among ten big listed palm oil producers), it remains a call on pricing in the medium term. Valuation at 11.9x 2014E P/E is not particularly attractive relative to peers at 13.0x. We rate GAR as Equal Weight with a DCF-based price target of S$0.62.

Best pure play on CPO amongst the Big Four producers: Amongst the large and liquid palm oil plantation companies, GAR has the best key operating statistics – Fresh Fruit Bunch (FFB) yields of 23.3t/ha (compared to peers at 18-19) and oil extraction rates (OERs) of 23% (vs peers at 20.5-21.5%). It also has a relatively young plantation profile and the best growth options in prime CPO country.

Inflection point in margins potentially on the horizon; absolute earnings still growing irrespective: The reduction in export duties out of Indonesia and cost benefits due to the weaker IDR could support margins even if CPO prices don't stage a recovery in the medium term. However, we think the salient point of the GAR investment case is that growth in absolute EBITDA has doubled due to 150% volume growth over the last three years, offsetting margin contraction.

Good operator but valuations not supportive: While we see many positives in GAR's investment case, we do not consider valuations to be attractive in absolute terms or relative to the sector. GAR above all else is a play on the CPO price and is hence unlikely to outperform the sector until we see a definite inflection point in the commodity price, which is not imminent in our view. While the downstream strategy is sensible and helps GAR reduce its dependence on CPO prices, the incremental contribution is too small relative to the current size of the business to move the needle. Our DCF-based price target of S$0.62 (which incorporates a modest recovery in CPO price) leaves only 18% potential upside to the current share price.

Key risks: 1) Volatility in CPO prices; 2) increase in export tax; and 3) delays in downstream expansion in Indonesia.

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