CLSA A pending moratorium on forest conversion will push up prices

There is trouble afoot in Indonesia’s golden industry. Palm oil is a US$18bn industry that generates 2.5% of GDP and employs 4.5% of the workforce. Indonesia accounts for almost half of total global palm oil production, and increasing, with palm oil also lifting its share of the global edible oil market. In sum, it is an Indonesian success story. Now, however, a pending government moratorium on forest conversion is challenging assumptions on the industry’s future growth. Supply constraints mean higher prices; we are OWT plantation firms which have a large landbank such as Golden Agri and Indofood Agri.

Environmental issues to the fore. Indonesia’s success story is on the back foot. Environmental groups have successfully raised issues surrounding sustainability, pressuring large European consumer companies to temporarily halt purchasing palm oil. President Yudhoyono has gone one further and imposed a two-year moratorium on forest conversion starting year-end. While there are good reasons to question the enforceability of this approach, the industry is struggling to find an appropriate response.

Needing a better regulatory regime. We spoke with five of Indonesia’s largest palm plantation companies on Indonesia’s regulatory frame work and the challenges the industry is facing. In aggregate, these companies accounted for 90% of Indonesia’s listed palm plantation universe. There was a universal agreement that NGO’s are leading a shift in perception towards industry practices. But less than half of the companies we spoke with believed the moratorium will impact their business because they sufficient land bank not yet planted. The industry’s biggest problem lies in
pedantic legalology defining a forest.

Supply constraints mean higher prices. Indonesia’s palm oil output has compounded by 10% per annum for the past five years, faster than the industry’s total growth of 7.0%. Thus, Indonesia’s share of the palm oil market has risen to 47% from 33% a decade back. New regulations mean securing land for planting has now become extremely
difficult. As future planting slows so will Indonesia’s supply growth. This will bid up the price of existing landbank; over half of the industry players we spoke with expect land prices will rise by more than 30%.

Who are the beneficiaries? It remains to be seen how government promises meet the reality of the marketplace. Palm oil is an important wealth generator for the country; it is an US$18bn industry that generates 2.5% of GDP and employs 4.5% of the workforce. Greater environmental demands favours corporate plantations over individual smallholders while firms with a large unplanted land bank also stand to gain. On this basis, beneficiaries include Golden Agri (GGR SP - S$0.60 - BUY), London Sumatra (LSIP IJ - Rp9,600 - BUY), Indofood Agri (IFAR SP - S$2.40 - BUY) and Gozco Plantations (GZCO IJ - Rp385 - BUY). Some other companies that are indirectly exposed to palm oil plantation development include heavy machinery providers such as United Tractors (UNTR IJ - Rp19,750 - O-PF) and Hexindo Adiperkasa (HEXA IJ - Rp5,200 - BUY).