First Resources Ltd Has Been Hit Hard By Lower Palm Oil Prices: Should Investors Be Worried?

palm_oil_bottleFirst Resources Ltd (SGX: EB5) is one of the fastest growing oil palm plantation owners listed in Singapore. But, even it has run into difficulties. The company released its second quarter results this morning and saw a double digit decline in profit.

Performance highlights

For the first half of 2014, First Resources was able to grow its sales volume for Crude Palm Oil (CPO) by 10.5% year-on-year to 297.3 thousand tonnes. Its palm kernel oil (PKO) sales volume also increased at a rate of 7.8% to 61.5 thousand tonnes. That’s some nice growth there for an oil palm producer.

But unfortunately, the increase in sales volume couldn’t translate into an increase in sales dollars – First Resources’ revenue for the first half of 2014 had dropped by 1.4% year-on-year to US$290.1 million.

Meanwhile, the company’s profit showed a much larger 29.8% drop to US$71.1 million. According to First Resources’ Chief Executive Officer Mr. Ciliandra Fangiono, “the decline in profit from operations was mainly due to the lower average selling prices of crude palm oil… and its refined products.”

A deeper look at the numbers reveals that a huge 31.2% jump in cost of sales to US$154.4 million had played a big part in the profit decline. The huge increase was due to higher production costs and higher costs as the company raised its biodiesel, refinery, and kernel crushing plants volume. As the company expands its downstream business of refining CPO (the production of CPO itself is considered an upstream activity), we might be seeing lower gross margins in the future.

There are clues to such a situation. Although First Resources’ Refinery and Processing segment accounted for 41.6% of the company’s total sales in the first half of 2014, the segment only made up 14.5% of the company’s total EBITDA (earnings before interest, taxes, depreciation and amortisation).

Unlike the upstream portion of the palm oil industry, downstream activities (think refined palm oil and palm oil-related consumer products) typically run at very low margins. Mewah International Inc (SGX: MV4) is an example of a pure downstream palm oil outfit and it regularly records a net profit margin of less than 1%.

A strong balance sheet

With a decline in profit, First Resources is also seeing higher stress in its balance sheet. For instance, its net debt (total debt minus total cash) to equity ratio had increased from 21% at the end of 2013 to 27% as of 30 June 2014. The company’s EBITDA to Interest Expense ratio, a measure of a company’s ability to meet its interest payment obligations, had also dropped from 16.5 to only 13.8.

But while investors should take note of the decline in strength of First Resources’ balance sheet, it should also be pointed out that there really isn’t any risk of the company facing any liquidity issues in the near term.

Foolish Take

While there is nothing much to cheer about regarding First Resources’ results, investors should take comfort from the fact that the company’s figures are affected mainly by a drop in commodity prices and not poor operations. If a commodity-related company has strong operations and a solid balance sheet, shorter-term commodity price fluctuations would likely not matter over the longer-term.

In any case, First Resources’ second quarter results also highlight the risks faced by commodity companies: No one’s able to control the price of a commodity and every once in a while, those prices will act against you.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim owns First Resources Ltd