In an earlier article, I shared four reasons why Bumitama Agri Ltd (SGX: P8Z) looks like a good investment opportunity at the moment after seeing its share price fall hard from its 2014 peak of S$1.23. For perspective, Bumitama Agri’s share price is currently S$0.65.
But, every investment contains risks, and Bumitama Agri is no exception. So, in this article, I want to share three important risks that investors should pay attention to.
As a quick introduction, Bumitama Agri is a palm oil producer. The company has over 180,000 hectares of plantation land located in three provinces in Indonesia, namely, Central Kalimantan, West Kalimantan, and Riau. Bumitama Agri’s primary business focus is on growing and harvesting palm oil fruits, processing them to obtain palm oil, and then selling the oil to customers – this is known as the upstream portion of the palm oil industry.
Risk 1: Fluctuations in palm oil prices
As such, Bumitama Agri’s business is widely exposed to fluctuations in the price of crude palm oil (CPO). Depending on how the price of CPO moves, Bumitama Agri may occasionally enjoy a windfall profit, or suffer losses.
Investors should consider this factor seriously before investing in Bumitama Agri, since even the company’s management has little means to control this risk with the exception of using some derivative contracts which do not offer anywhere close to full-protection from CPO price volatility.
Risk 2: Production risk
A palm oil producer’s production volume is generally affected by three factors, namely, the amount of land planted with palm trees, the fresh fruit bunches (FFB) yield per hectare, and the extraction rate which depends on the fruits’ oil content and the factory’s efficiency.
Of the three factors, the FFB yield per hectare is probably the most important driver of a palm oil producer’s production volume. But, the yield is highly dependent on many external factors that are beyond management’s control, such as weather conditions. For example, Bumitama Agri’s FFB yield grew from 14.6 tonnes per hectare in 2016 to 16.4 tonnes per hectare in 2017 due to favourable weather conditions.
In a similar manner to the first risk, Bumitama Agri’s management has little ability to control the production risk, and thus investors must be willing to accept this risk before investing in the company.
Risk 3: Currency risk
There are two angles that investors should pay heed to when it comes to Bumitama Agri’s currency risk. The first angle is due to the company deriving its income mainly in Indonesia. Here, investors need to pay attention to the effects of the Indonesian rupiah falling in value against the Singapore dollar; if such a scenario happens, Bumitama Agri’s financial performance in Singapore dollar terms will be weaker than in rupiah terms.
The second angle is from an asset valuation perspective. With Bumitama Agri, we are paying Singapore dollars to acquire Indonesian assets. As such, a significant devaluation of the rupiah will result in a devaluation in the value of the company’s assets in Singapore dollar terms. In other words, Bumitama Agri’s share price is likely to fall in the event of a devaluation of the rupiah.
The Foolish conclusion
Although Bumitama Agri could be an interesting investment idea right now, investors should be mindful of the aforementioned risks before investing in the company.
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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.