The Nigerian Oil Palm Sector Report… Full Steam Ahead

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Afrinvest Research

Executive Summary

Oil Palm is currently the most consumed edible oil in the world with Malaysia and Indonesia being the top major producers. Globally, production of oil palm has continually evolved, rising from 1.2 million MT in 1964 to 73.3 million MT in 2018 based on United States Department of Agriculture (USDA) data. Indonesia (41.5 million MT) and Malaysia (39.5 million MT) accounted for an average of c.80.1% of global production between 2016 and 2018. This is unsurprising given that plantations in both countries account for c.65.0% of land area under cultivation globally. Other leading producers of oil palm as at 2018 included Thailand (2.9 million MT), Colombia (1.5 million MT) and Nigeria (1.0 million MT).

Similarly, the consumption of oil palm has also expanded significantly primarily due to higher global income, oil palm affordability and use versatility compared to other oil crops. This is evident by oil palm consumption data which showed a jump to 69.6 million MT in 2018 against 1.2 million MT consumed in 1964. This indicates that the oil palm industry is currently over-supplied with supply glut averaging 4.2 million MT between 2016 and 2018; hence leading to a moderation in global prices of oil palm.

In Nigeria, oil palm production and export historically contributed substantially to Nigeria’s external reserves and agricultural GDP as palm oil and palm kernels exports composed 15.0% to 20.0% of the country’s total exports. The sector in Nigeria has since witnessed a downturn with contribution to global market share tapering to a meagre 1.4% as at 2018 according to data from the United States Department of Agriculture (USDA).

This production downturn and consequently, Nigeria’s market share, may be attributed to the sustained use of traditional and crude production methods bysmall holder farmers that account for c70.0% of industry supply, the country’s focus on exploration and export of crude oil (for generation of revenue and foreign reserves), persistent low yields per hectare as well as the impact of the civil war on oil palm producing communities. This culminated in the country becoming a net importer of the commodity in the 1980’s as rising domestic consumption could not match the sluggish growth in production. Nigeria has sustained this net importer status with sector deficit averaging 393,000 MT over the last ten years based on USDA’s estimates. We opine that this deficit may be higher if we consider palm oil smuggling via neighbouring countries – such as Benin, Togo and Cameroon.

Furthermore, oil palm prices in Nigeria are relatively higher than international prices primarily due to import restrictions on the commodity following the introduction of the Central Bank of Nigeria’s (CBN) list of 42 FX excluded items. This policy, when introduced in 2015 led to a surge in oil palm prices as local demand for CPO soared while importation and total industry supply tapered. Consequently, average local CPO prices jumped c.54.4% and c.58.9% in 2016 and 2017 respectively as local demand expanded without a commensurate increase in supply. Based on this, listed companies Okomu Oil Palm Plc (OKOMUOIL) and Presco Plc (PRESCO) witnessed notable and faster pace of improvements in revenues and profitability even as growth in production expansion has been slower.

Also, we highlight that listed companies have focused on expanding production, especially over the last three years by investing in increasing total land area under cultivation, expanding milling and refining facilities to meet up with expected additional output. We hence expect both companies to record continuous revenue and profitability growth over our forecast period.

However, we also noted the several internal and external constraints to growth within the industry that include the multiplicity of small holder farmers (SHFs), the huge working capital requirements restricting new investments, the sparse distribution of skilled and knowledgeable agricultural personnel across the country and Nigeria’s large infrastructural deficit. Also, we highlighted some external risk factors that include Nigeria’s participation in AfCTA and the ongoing threat posed by backward integration programmes by local off-takers in the industry. We opined that improving the industry’s knowledge gap via focused recruitment, training of extension workers, aggregating SHFs’ production as well as privatising NIFOR may, however, catalyse industry growth and productivity.

Overall, we believe there’s Full Steam Ahead for the sector as we expect the positive earnings and profitability of listed companies to improve at a faster pace over our forecast period. We also expect these companies to record significant price growth and capital appreciation over this period while providing annual dividend income for investors.

Investment Thesis

Based on our understanding of the sector, it is our view that the oil palm industry is keenly positioned to soar further over the coming years as investments in expanding milling and refining capacity of listed sector players – OKOMUOIL and PRESCO – crystallize. Also, the sector, which has ridden on positive government support since 2015, based on oil palm import restrictions introduced by the Central Bank (CBN) has provided premium pricing opportunity for players. Similarly, the federal government posture towards supporting agriculture has enabled low cost capital expenditure financing by industry participants compared with other sectors in Nigeria.

We believe that OKOMUOIL, where we expect oil palm and rubber trees on about 8,809 hectares and 1,989 hectares to mature within our forecast period presents an outlook on additional output. Management has also guided to expanding its milling capacity first from 60.0 FFB MT/hour as at FY:2017 to 75.0 FFB MT/hour in FY:2019 and to 90.0 FFB MT/hour in FY:2021. Also, it also revealed that ongoing investment in Extension II plantation will see a further increase in milling capacity to 120.0 FFB MT/hour in FY:2020 and to150.0 FFB MT/hour in FY:2022.

This suggests strong growth in company revenues and overall profitability as we expect the cost containment strategy to continually deliver slow pace of expansion in costs of sale and operating expenses. Specifically, we note that the business connectivity to Benin Electricity Distribution Company (BEDC) has led to significant moderation in operating expenses for the company while we also note that the company’s intention to power its plantations (plants and factories) via a steam turbine fed by empty fruit brunches (EFB) would support cost moderation.

PRESCO, which has chosen to specialize in the production of speciality fats and oil – RBD and PFAD -, enjoys premium pricing on its products. We opine that the company’s profitability has been constrained by the weak capacity of its refinery and fractionalisation plant which has a capacity of only 100.0 CPO MT/day. Our discussion with management revealed that expansion in the capacity of this plant to 500.0 MT/day would be completed in Q4:2019 and hence presents an upsurge in output and company’s profitability above sector comparable – OKOMUOIL.

Also, we expect oil palm trees on about 7,100 hectares to mature within our forecast period and to support the expanded refining capacity. Management also noted that sales of CPO will moderate to focus more extensively on sales of RBD and PFAD.

For the industry, we opine that there are attractive opportunities presented by current supply deficit within the sector and growing demand suggested by Nigeria’s rising population. We suggest that investors positioning in currently listed companies will offer an opportunity to earn impressive capital appreciation as well as consistent dividend payments. Also, we believe that the industry is accommodative for additional listings by other smaller companies – Real Oil Mills Limited (owned by Flourmills Plc), Grand Cereal & Oil Mills Limited, Poko Oil Mills Limited, PZ Wilmar Limited and BUO Oil Mills (owned by BUA Group) – as well as stable and supportive for long term investments by new companies seeking superior return on investment.

Finally, our analysis suggests that the sector is poorly priced relative to global peers. For example, OKOMUOIL and PRESCO have a P/E ratio 7.95x and 2.51x respectively (sector average of 5.23x) compared with similar companies in South East Asia (17.64x) and Africa (12.61x). This indicates significant capital appreciation prospect for companies OKOMUOIL and PRESCO for which we have a rated a BUY and ACCUMULATE respectively.

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