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This Share has Almost Doubled in the Past Four Years: Can it Continue?

First Resources Ltd (SGX:EB5) has been a big winner over the last four plus years. The share price has recorded returns of about 95% from 1 Jan 2010 to the closing price last Friday. By comparison, the capital gain returns of the SPDR STI ETF (SGX:ES3), a proxy for the Straits Times Index (SGX:^STI), was 11.7% for the same duration. Over the past four financial years, the palm oil producer paid out a total of 14.9 Singapore cents in dividends. My fellow Fool Ser Jing has more information about the company here.

While the returns from First Resources has been growing like its palm trees — as Foolish investors, we should look behind the curtains to understand what the business drivers for this move in the share price.

A closer look

First resources graph 1

Source: Company Presentations

The business of First Resources is segmented into two major buckets. The first one, Plantations and Palm Oil Mills, can be further divided to two sub-segments, namely the Crude Palm Oil sub-segment, and the Palm Kernel sub-segment. The second business segment would be the refinery and processing segment.

The Plantations and Palm Oil Mills segment mainly covers the cultivation, harvesting and milling of crude palm oil and palm kernel. The refinery and processing segment involves processing crude palm oil into higher value products such as biodiesel and other products.

Overall, the company’s sales benefited from growth from the crude palm oil sub-segment, and a move into the refinery and processing segment. Both made up the bulk of the sales for the financial year ended 2013 (the calendar year aligns with the financial year). The refinery segment was started in late 2010, and has grown by a whopping 1,175% over the past four years.

We would ideally like to see the revenue dollars drip down to the bottom line. For that, we look into the profitability of the business segments.

First resources graph 2

Source: Company Presentations

The earnings before interest, tax, depreciation and amortization or EBITDA is the preferred method of profit measurement for the company. From this, the source of the company’s profits over the past four years becomes clear. The plantations and palm oil mills made about 92% of the company’s profits for 2013. It has also grown by 52.5% over the past four years.

Finally, Foolish investors would look for the accumulated profits have to check out the balance sheet. To do this, we look at the cash and debt development.

First resources graph 3

Source: Company Earnings Report

The company has generally been in a net debt position for the past four years. According to the company’s presentation, the prime age for palm trees is during the eighth to the 17th year of production. As such, First Resources may have to plan its plantations years in advance in order enjoy the fruits of its labor a decade or so later. In another note, the company completed its US$69.4 million acquisition of Lynhurst Investment in February 2013.

A quick look ahead

As of the end of 2013, the management team commented that the company was hit by a double whammy of lower palm oil prices, and low production volume for the year. However, the company expects the demand for palm oil in 2014 to remain strong, and plans to add two more palm oil mills by 2015. In line with this, First Resources has also expanded its annual refinery capacity to 850,000 tonnes.

The optimism by the palm oil producer was partly based on Indonesia’s biodiesel mandate for 2014. This mandate raises the minimum requirement for bio content in diesel to 10 percent, and raises the minimum bio content to 20% for the power industry. Despite the mandate, a report from Wall Street Journal highlighted the possibility of Indonesia missing its biodiesel target for 2014, and various challenges in implementing the mandate.

Foolish take away

As lifelong students of Foolish long term investing, it pays to look under the hood to understand whether a rise in the company’s share price is supported by the quality of growth that we are looking for.

As my Foolish colleague Stanley highlighted, investing in commodity companies exposes the individual investor to the volatility of crude palm oil prices. Palm oil prices may be influenced by the cost of alternatives such as soybean oil as well. Perhaps, the best time to look into a commodity company might be when palm oil prices are deemed low. It is the comparative cost advantage which First Resources has against its competitors which may give it the edge in the end.

As of last Friday’s close of $1.99, First Resources traded at a price-to-earnings ratio of about 12 and has a dividend yield of around 2.3%. You can learn more about First Resources and other similar stocks by signing up now for a FREE subscription to The Motley Fool’s weekly investing newsletter. Take Stock Singaporeteaches you how you can grow your wealth in the years ahead!

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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 Chin Hui Leong doesn’t own shares in any companies mentioned.