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Is This a Cheap Share with Room for Growth?

When looking at valuations, palm oil producer First Resources Ltd (SGX: EB5) can be said to be a cheap share.

Currently, the SPDR STI ETF (SGX: ES3) is valued at around 13.5 times its trailing earnings; the SPDR STI ETF is an exchange-traded fund which mimics Singapore’s market barometer, the Straits Times Index (SGX: ES3). In contrast to the ETF, First Resources actually has a trailing price/earnings (PE) ratio of just 11.6 at its current price of S$1.905 – hence, cheap.

Looking at valuations

But, just comparing the company’s PE ratio against that of the market average can’t give us the full picture. Instead, we can look back at history to see how First Resources’ PE ratio has evolved since its listing in December 2007.

First Resources PE ratio

Source: S&P Capital IQ

From the chart, it’s obvious to see that First Resources’ current PE ratio of 11.6 is only slightly higher than its historical average of 10.6 going back to its listing date – that might mean the palm oil outfit could actually be cheap.

However, it’s good to point out that even looking at a company’s long-term valuation measures in this manner has its disadvantages too. As the investor Ric Dillon once said:

“On the behavioural-finance side, one of many inefficiencies comes from people anchoring on the past. People assume something is cheap, say, just because it hasn’t traded at such a low valuation for five or ten years. But that doesn’t matter, what matters is what will be [emphasis mine].”

What this means is that First Resources could still be an expensive mistake if its corporate future does not warrant any optimism despite its valuation being reasonable (from a historical perspective) or even cheap (when compared to the broader market).

Planting the seeds of future growth

Fortunately with First Resources, it’s worth noting that there are reasons to be optimistic about its business.

As a commodity producer (after all, First Resources produces palm oil and its refined products), it’s true that First Resources is essentially a price-taker. In other words, the company has scarcely any ability to control the prices of its products. However, what the company can do, is to drive the production of its primary products, crude palm oil (CPO) and palm kernel (PK).

And, that is exactly what First Resources has done over the years as seen in the table below.

Year Year-on-year plantation size growth Year-on-year growth in production of CPO and PK
2008 10.3% 16.7%
2009 14.4% 13.5%
2010 10.9% 2.1%
2011 9.5% 20.2%
2012 10.7% 16.7%
2013 16.5% 11.6%
First half of 2014 13.7% 10.7%

Source: First Resources’ filings

When compared to larger industry peers like Golden-Agri Resources Ltd (SGX: E5H), which has a much lower growth rate in terms of both plantation size and production volume, First Resources’ double-digit growth rates (on average) are noteworthy.

The growth in its business volume that First Resources has put in place has helped it to overcome volatile CPO prices and achieve remarkably consistent profit growth even as its industry peers – which include Golden-Agri and Indofood Agri Resources Ltd (SGX: 5JS) – suffer.

Year-on-year profit growth

Year First Resources Golden-Agri Indofood
2009 14% -56% 92%
2010 27% 134% -8%
2011 37% -11% 6%
2012 21% -68% -30%
2013 0% -24% -48%

Source: S&P Capital IQ

With First Resources possessing a “sizeable reserve of unplanted land bank” and a target of growing its CPO production capacity to one million tonnes per annum, there seems to be adequate head room for growth for the company (for some perspective, First Resources produced 588,792 tonnes of CPO in 2013 and has a total planted area of 183,921 hectares as of 30 June 2014).

Other levers for growth

There’re also other interesting statistics which might point toward an even larger opportunity for First Resources to tap into.

The first deals with the age profile of the company’s palm oil plantations. Oil palm trees are in their prime productive ages when they are between eight and 17 years old. With just 31% of its trees in the prime productive age-range and a further 56% between zero and seven years old, First Resources’ production yield (tonnes of CPO produced per hectare) has ample opportunity to improve steadily over the years.

The second deals with CPO consumption trends. According to Bumitama Agri Ltd’s (SGX: P8Z) listing prospectus, worldwide consumption of palm oil has grown at a compounded annual rate of 7.5% to 49.1 million metric tonnes (mt) for the decade ended 2011. Further, Bumitama’s prospectus also stated that world demand for palm oil is forecasted to “increase to about 78 million mt in 2020” according to ISTA Mielke.

Both trends described above bodes well for First Resources.

Foolish Bottom Line

Although there are reasons to be optimistic about First Resources’ future, there are still risks to consider with the company.

First Resources is still a commodity play at the end of the day. If palm oil prices are to crash and remain at depressed levels for prolonged periods of time, any growth in the company’s production volume might not be able to make up for the decrease in selling prices. This can ultimately lead to declining earnings, or even losses.

First Resources’ balance sheet is also not the strongest – it has been in a net-debt position (where total borrowings exceed total cash) since at least 2010. This increases the financial risks faced by the company, especially if depressed CPO prices causes strain on the business.

All told, investors would have to weigh the risks and rewards with this share in order to come up with an intelligent investing decision.

In any case, First Resources’ reasonable PE ratio could still make it a worthwhile target for further study.

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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 writer Chong Ser Jing doesn’t own shares in any companies mentioned.