This article first appeared in The Edge Malaysia Weekly, on December 28, 2015 - January 3, 2016.

THE weak ringgit in 2015 has brought cheer to many export-based industries that sell their products in foreign currencies such as the US dollar. Unfortunately, the same cannot be said for oil palm plantation companies, although their chief produce, crude palm oil (CPO), is pegged to the greenback.

The languishing CPO price, which has remained soft since 2012, did not put plantation companies in a position to benefit from the strong US dollar. One reason is that edible oil prices have declined more than the appreciation of the US dollar.

While the low CPO price has been the reality for quite some time, fund managers and analysts are keeping a close eye on fertiliser costs, which show signs of creeping up, and foreign-currency denominated loans of some planters. These two could be the wildcards that become a drag on their earnings going forward, assuming edible oil prices do not pick up anytime soon.

“The issue of US dollar borrowings is not something people are worrying about yet, but some funds are watching it closely. The major concern is the growing liability and if that will eventually affect cash flows,” CIMB Research regional head of plantations Ivy Ng tells The Edge.

Ng adds that analysts and fund managers are not yet acting at this point, as it will depend on the ability of companies to refinance and pay off their debts.

Theoretically, raising debt in foreign currency should be a natural hedge for companies that earn foreign notes, simply because this would minimise their exposure to foreign exchange risks. Even if the ringgit weakens, like the current scenario, companies would not be affected much as their earnings are in US dollars.

For plantation firms with foreign currency loans, it is the case that they earn less due to low CPO prices and margin squeeze, hence, it may affect their ability to repay borrowings.

Among the plantation counters listed on Bursa Malaysia, IOI Corp Bhd and TSH Resources Bhd are the two that have relatively high foreign borrowings.

“Borrowing in US dollars serves as a natural hedge and we think it will balance itself out,” TSH group managing director Datuk Tan Aik Sim tells The Edge, adding that in any case, foreign exchange losses remain unrealised at the moment.

“Our borrowings are due in five to seven years’ time and who knows where the ringgit will be in that time,” says Tan.

He adds that fertiliser costs have risen some 5% to 10% over the year, largely due to the 23% depreciation of the ringgit against the greenback. This impact could have been worse if the cost of fertiliser in US dollars had not been on the decline this year.

Fertiliser costs, which are quoted in US dollars, are a key cost component to planters, accounting for more than a third of the total cost.

So far this year, the price of potash has reportedly fallen 12% in Southeast Asia to about US$293 per tonne. Urea has plunged 25% to about US$240 per tonne this month.

“On fertilisers, I feel that the weakness in demand will continue to put downward pressure on prices, as will cheaper feedstock for urea. Average November world prices [for the weighted average of urea, muriate of potash and triple superphosphate] were only 10% or so off their recent peak,” Dr James Fry, chairman of global agribusiness consultancy LMC International Ltd, tells The Edge.

“Malaysian plantation companies are in a position where many of their inputs, most notably fertilisers, are tied to the US dollar, which has pushed up their ringgit price, but wages are determined in ringgit, though there is upward pressure on wages from the imminent rise in minimum wages and as a result of competition with Indonesia for good plantation workers,” he says.

For IOI Corp (fundamental: 0.35; valuation: 0.30), more than 80% of its borrowings are in US dollars, while almost all of TSH’s (fundamental: 0.20; valuation: 0.30) borrowings are in US dollars.

According to the latest financial statements for the first quarter ended Sept 30, 2015 (1QFY2016), IOI Corp has RM6.4 billion borrowings denominated in US dollars out of its total borrowings of RM7.7 billion. Taking into account RM514.4 million in cash, IOI Corp’s net debt stood at RM7.15 billion.

Analysts point out that in IOI Corp’s case, the ballooning gearing levels could be a concern but are not at an alarming level. As at end-September, the group’s debt-to-equity multiple was 1.64 times compared with 1.29 a year ago.

In September, Moody’s Investors Service downgraded IOI Corp’s outlook to “negative” mainly because of the downside risk of the CPO price.

“The change in outlook reflects Moody’s expectation of continued pressure on palm oil prices over the coming year owing to the ample supply of both palm oil and other vegetable oils,” Moody’s says in a Sept 4 press release. Upward rating pressure is limited given the negative outlook and IOI Corp’s modest revenue base and current CPO prices, but the outlook could stabilise if IOI Corp is able to reverse its upward trend in leverage such that adjusted debt-to-(earnings before interest, taxes, depreciation and amortisation) returned to below 3 times to 3.5 times,” it says.

According to the latest data from Bloomberg, IOI Corp’s latest debt-to-Ebitda stands at 4.12 times as at end-July 2015.

That said, IOI Corp is unlikely to be cash-strapped. Moody’s believes that the company has “excellent liquidity”, having improved its debt maturity by refinancing its long-term debt.

As at end-September, IOI Corp had short-term debt of only RM802.8 million and long-term debt of RM6.89 billion. In contrast, short-term borrowings were RM2.6 billion exactly a year ago, while long-term debt came to RM5.1 billion.

One analyst points out that for now, IOI Corp is only seeing a paper loss, in the form of foreign exchange losses, caused by the exchange rate fluctuation.

“However,  TSH, which has 90% of its landbank in Indonesia,  needs to take up US dollar borrowings to fund new planting expansion, and this will have a negative impact. It sells CPO in rupiah, which is not better than ringgit,” says the analyst.

As at end-September, TSH’s US dollar borrowings stood at RM563.1 million against RM563.3 million in total borrowings, excluding loans.

According to its earnings announcement for 3QFY2015 ended September, total borrowings came to RM1.36 billion. Taking into account its RM50.2 million in cash, net debt stood at RM1.3 billion.

TSH’s net debt-to-equity multiple has risen to 0.98 times as at end-September from 0.9 times exactly a year ago.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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