Why an Investment in the Palm Oil Industry Makes Sense

An investor friend of mine had asked me a really interesting question recently: “Name one industry that South East Asia dominates in the global arena.”

I had to think hard, but eventually a few popped into my head: The rubber gloves industry and the palm oil industry. Just Indonesia and Malaysia have a combined share of over 80% of the global supply of palm oil.

There are many different palm oil companies in Asia and there are a few that are listed in Singapore and Malaysia. In Singapore, we have the likes of Wilmar International Limited (SGX: F34), Golden Agri-Resources Ltd (SGX: E5H), First Resources Ltd (SGX: EB5), Indofood Agri Resources Ltd (SGX: 5JS), and more.  The aforementioned companies have sizeable palm oil plantations of 240,956 hectares, 485,606 hectares, 207,575 hectares, and 187,400 hectares, respectively.

Meanwhile in Malaysia, there are palm oil companies such as Sime Darby Berhad (KLSE: 4197.KL), IOI Corporation Bhd (KLSE: 1961.KL), and Kuala Lumpur Kepong Berhad (KLSE: 2445.KL) among others.

When I answered my friend, I only mentioned the palm oil industry as I find it to have some desirable economic characteristics. I thought they’d be interesting to share, so here they are:

1. Rent-like recurring returns

It’s an oversimplification, but the basic business model for a palm oil producer works like this: Invest in a plantation, wait for three to four years, and then start harvesting every 10 days or so for the next 20 to 25 years.

The harvested fruits in an oil palm plantation can be seen as collected-rent from a property, provided that the price of palm oil does not collapse to very low levels.

Though fertilization and some maintenance work is needed during the harvesting period, there is no real need for extensive work to be done. Crop rotation, replantation, and other problems faced by other crops are largely avoided.

2. A necessary product with excellent crop economics

It’s logical to see that one of the best ways for a crop grower to increase his return on investment is to increase the productivity per unit area of land.

Given that vegetable-based oils are an essential ingredient in our daily lives that is used to make products ranging from cooking oil to soap and even fuel for vehicles, I find it hard to see how demand for vegetable-based oils will ever go obsolete. Nevertheless, palm oil needs to compete with other vegetable oils such as soybean oil.

One of the advantages that oil palm has over other oil-crops is that it is very efficient: It produces a far higher average oil yield as compared to other crops. Here’s a chart from Sime Darby that can illustrate my point:

Oil palm table

To put things into perspective, the chart shows that one hectare of land planted with oil palm can produce nearly four tonnes of oil per year – that’s eight times the output for soybean. For a crop grower, oil palm will look like an attractive crop. This efficiency of oil palm is what I think can give it an even bigger role in the global vegetable-oil supply chain in the future.

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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 Lawrence Nga doesn’t own shares in any companies mentioned.