Felda legacy – boon or bane?

By A. Stephanie

In the second of a four part series on  Felda Global Ventures Holdings Bhd (FGV) KiniBiz looks at how the older lands and ageing palm areas inherited from Felda and the land lease agreement (LLA) accounting for these have played havoc with its financials. However, this non-cash-flow item nevertheless results in fluctuating profits.

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Take a cursory look at Felda Global Ventures Holdings Bhd (FGV)’s website and the word that stands out is large.

Not only is it the world’s third largest oil palm plantation operator, FGV is also the world’s largest producer of crude palm oil (CPO).

Size, we’ve heard, doesn’t matter.

But in the world of oil palm plantations, economies of scale and land size – and hundreds of thousands of hectares of it –  should ideally translate to higher oil palm output,  increased productivity and better financial performance.

So why isn’t this the case with FGV?

Old lands, ageing palm

As of Dec 31, 2013, FGV’s land bank stood at 446, 656 hectares, of which 347,517.5 hectares or 77.8% were planted with oil palm.

Based on hectarage alone, FGV can indeed claim to be the third largest oil palm plantation operator. But of this total of 446,656 hectares, almost 80% or 355,864 hectares are Felda lands, most already planted with oil palm and rubber.

“Owing to legacy issues, about 53% (184,184.3 hectares) of the Group’s oil palms have passed their prime, being more than 20 years (old),” CEO Mohd Emir Mavani Abdullah noted in the company’s 2013 annual report.

In less delicate terms, the lands the relatively new FGV – incorporated in 2007, previously operating as the commercial arm of Felda – got from Felda are less fertile, with aging palm and lower yields.

According to the Malaysian Palm Oil Council (MPOC), palm starts bearing fresh fruit bunches (FFB) within 30 months after field planting and continues for the next 20 to 30 years.

Nevertheless, the prime FFB-producing age is between seven to 12 years old, and the much older palms FGV inherited from the land development authority is a result of less replanting on older, less fertile lands.

This means more than half of palm managed by the world’s ‘third largest oil palm plantation operator’ is past its prime, with less CPO yield for ‘the world’s largest CPO producer.’

Seesawing land lease valuations

Though FGV is part of Felda Group, the lands nevertheless remain under the land authority’s possession and is used by FGV on a 99-year lease.

Thus, FGV pays a yearly rental of RM248.4 million to Felda, in addition to 15% of annual operating profit attributable to the 355,864 hectares of lands.

The 15% profit as part of these payments outlined under the land lease agreements (LLA) with Felda fluctuates based on several factors that have themselves proved erratic in recent years: implied discount rate, CPO prices, FFB prices, FFB yield, estate replanting costs and the lease term.

In 2014, this profit sharing payment amounted to RM88 million, compared to RM77.5 million the previous year. Even on a quarterly basis, total LLA payments in 2014 fluctuated but the big fluctuation comes from changes in the fair value of the LLA liabilities in the accounts.

Calculating LLA liability under fair value accounting is hard  for the plantations giant, as FGV’s chief financial officer Ahmad Tifli told The Star in late February.

“It gets complicated when we need to assess the future 15% share of the operating profit to be paid based on the future value of the CPO price, costs of production and CPO volume,” he told the publication.

FGV’s 2013 annual report has helpfully outlined the key assumptions backing its LLA computations and how sensitive the individual factors are:

As can be seen from the table, the LLA fair value liability is very sensitive to even minor changes in price, yield and the discount rate used. Since these liabilities are valued at over RM4 billion, minor changes can affect the value by as much as several hundred million ringgit, giving rise to wildly fluctuating profits.

However, they are not cash flow items but simply mean that the change in value of the liability is taken into the profit and loss account every year under accounting rules.

Much like the rest of the plantations sector, FGV has been hit hard by the fluctuating CPO prices, as lower demand and additional supply sent prices down. MPOC’s average for 2014 was RM2,371/MT, down marginally from RM2,382/MT in 2013.

Within FGV however, the group recorded higher average CPO prices of RM2,410/MT last year compared to RM2,333/MT in 2013 – still below their assumed rate.

Regardless, profit before taxes (PBT) decreased 39% year on year due to fair value losses on LLA liability of RM172.84 million versus a gain of RM494.5 million in 2013.

“We are in discussions with our counterparts in Felda to have a more stable mechanism for our LLA payments,” FGV CEO Emir Mavani confirmed last week.

When queried about the effect these payments have on FGV’s core net profits, Mohd Emir said, “It’s more of an accounting (matter), it’s not real. If you look at our real profits, we have actually improved.

“Our profit before taxes (PBT) without LLA last year was actually 10% higher. If you put the LLA aside, you look at our core profits, you can see they are rising and improving. So our core focus now is to stabilise our LLA payments together with the current company,” he said.

Operating profit in 2014 was RM1.03 billion, up 10% from RM940 million in 2013, excluding LLA payments.

High payments, low yields

The LLA payments also reflect the productivity of FGV plantations, which points back to how its size does not necessarily translate to commensurate returns.

And with industry experts putting CPO prices for 2015 anywhere between RM1,600 to RM2,500 per metric tonne (MT), it is plantation yields that FGV must further improve to lessen the twin blow of low CPO prices and LLA payments will bring.

Even putting aside CPO prices and LLA payments, FGV clearly lags behind its competitors:

With this in mind, Emir is looking to improve productivity across the group’s plantations in the coming year.

He said, “Within FGV plantations, we are looking at improving productivity via mechanisation, and we have quite varied labour policies coming in, especially from Indonesia.”

Though he said yields had improved year-on-year, FGV refused to divulge its current productivity figures and noted that currently, labour policies were as status quo.

The lands Felda leases to FGV are unfortunately planted with matured trees past their prime, which FGV did note in its listing prospectus and annual report.

FGV’s two remedies for these are an aggressive replanting plan of 15,000 hectares annually on its current land bank and acquiring new brownfield and greenfield plantations  – so as not to incur additional LLA payments – within Malaysia as well as in Indonesia, Vietnam, Myanmar and Papua New Guinea.

“Right now, we have just completed two acquisitions, the recent one being Asian Plantations Ltd (APL). The trees are aged at three to four years old, which will come to production in three to four years time.

“We have a very strict replanting programme of 15,000 hectares annually, and we are diligently at it and are on track. We are going to have an optimised tree age profile (Felda’s 2013 annual reports puts this at 12 years) by 2019,” Emir said.

Simply put, investors are not going to see much change in yields until these newly-acquired plantations mature  and only if FGV sticks to its replanting plan by then.

Tomorrow, KiniBiz looks at FGV’s ambitious replanting plan and multiple acquisitions and joint ventures to mitigate the effects of its Felda legacy and an uncertain plantations sector outlook.

Yesterday: The politics behind FGV

Tomorrow: Whither FGV’s buying spree?