May 06, 2019 / 03:15PM / ARM Research / Header Image Credit: Guardian
Bumpy Year Ahead
The Okomu Oil Palm Plc Q1 19 numbers released earlier this week, came with few surprises to us, with the major one being the more than expected decline in revenue over the period. Beyond doubt, the numbers can only be tagged a “Worrisome start to the year” as the company reported its weakest first quarter performance since 2014. Going by our communication with management, the poor performance stemmed largely from material erosion in global crude palm prices when compared to same period in the prior year and the increasing influx of lower priced CPO into the country. Beyond the obvious, we believe the high base in the prior year (due to bumper harvest and a much more favorable pricing) further magnified the material revenue crunch.
With the Q1 numbers signaling a bumpy year ahead, we have updated our models accordingly. Particularly, with year to date appreciation in global CPO prices still far from the level in the prior year and growing intensity of smuggled CPO, we expect local CPO prices to remain depressed over 2019. Worthy of note, while large corporates typically have controlled quality on the use of CPO and palm olein products, our market check suggests that much smaller corporates and individual households (which in our view accounts for the largest share of consumption) are not as concerned about the quality of CPO and its end products. With this in mind and our understanding of the need of management to empty its excess tank over Q2, guides our expectation of 13% YoY decline in domestic CPO price to N337,620.
On volumes, with our discussion with management suggesting that only ~54% of volumes produced over Q1 19 were sold, we see further pressure on volumes over the rest of the year. Specifically, while we expect some pick up over Q2 19, we believe volume will remain depressed for most part of the year and thus estimate a 12% YoY decline. Beyond 2019, we believe better volumes and relatively flat price will be central to revenue growth. We remain broadly optimistic on volumes growth over the medium-term stemming from management’s decision to nurture the first set of acreage area staged to mature in 2019 in anticipation of reaping better yields in 2020. This takes into cognizance commissioning of a new 30 ton/hour oil mill in extension 2 in 2021 and 2023 which should bring its total oil mill capacity to 135 ton/hour in 2023. Hence, we have raised our FY 20-23F sales forecast by 16% (Previous: 12%) on average.
Medium term gross margin expansion on the cards. In line with our expectation for lower CPO volumes over FY 19E, we forecast 2019 production cost to decline 19% YoY to N4.1 billion (Cost to sales ratio: 25%) which translates to a gross margin compression of 20bps YoY to 75%. However, given our expectation for cost savings from the acquisition of a 5MW turbine and room for a better economy of scale emanating from the production of higher volumes over our forecast horizon, we lower FY 20-23E Cost to sales forecast to 22% on average. Consequently, we model 400bps expansion in EBIT margin over our forecast horizon.
According to management, Okomu is averse to expensive credit facility and hinted at limiting its source of financing to CBN, BOI or other concessionary sources. This in addition to the lower interest rate environment informs our expectation of slower increase in interest expense by 5% YoY to N308 million in 2019. Cumulative impact of our adjustments translates to double-digit decline in EPS to N6.75 (-24% YoY) over FY 19E.
Factoring the gloomy expectation for 2019 into our model, we cut our FVE by 22% to N75.60 and downgrade to a NEUTRAL rating. Okomu trades at a forward P/E of 10.6x relative to 9.2x for Presco and Bloomberg Middle-East and Africa (MENA) peers of 12.94x.
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