We use commodities such as rubber, coffee, and cocoa frequently in our daily lives. Global companies that deal with the supply chain for commodities are giants in their own right, and without them, we would not be able to enjoy our current standard of living. However, do such commodity companies make good investments?
The very nature of a commodity implies that anyone can grow, harvest, or mine it, and that there are indiscernible differences in the quality of the output between different companies within the industry. This implies that commodity prices are essentially not controlled by the companies, and that companies within the industry end up being price-takers. I will use two names in the crude palm oil (CPO) industry as examples to illustrate my point.
Golden Agri-Resources Ltd
Golden Agri-Resources Ltd (SGX: E5H), or GAR, is a palm-oil plantation company with a total planted area of 500,000 hectares as at 31 March 2019, all located in Indonesia. The group has integrated operations focused on the production of palm-based edible oil and fat. GAR also harvests oil palm trees and processes fresh fruit bunch into CPO.
In its first quarter of 2019 (1Q 2019) earnings, GAR reported an 11% year-on-year fall in revenue but an even larger decline of 53% year on year in underlying profit. Part of the reason as stated in the company’s presentation slides was a 21% year-on-year fall in CPO prices to US$512 per metric tonne, and this is despite a 3% year-on-year rise in palm product output.
Bumitama Agri Ltd
Bumitama Agri Ltd (SGX: P8Z) is an Indonesia-based company whose principal activities are those of operating palm oil plantations and mills, as well as the production of and trading of CPO and related products.
Its 1Q 2019 earnings were also lackluster — revenue dipped by 12.1% year on year while attributable profit to owners plunged by 52.3% year on year. A glance at the company’s presentation slides reveals the problem: Though sales volume of CPO increased by 9.1% year on year, the average selling price had declined by 16.3% to IDR 6,555 per metric tonne from IDR 7,830 a year ago.
Companies are at the mercy of commodity prices
These two examples illustrate something about companies within the commodities industry: Their fortunes wax and wane according to the price of the underlying commodity, which is totally out of their control. Having pricing power is what makes a company investment-worthy, as that allows it to raise the prices of its products and services in line with inflation and rising costs.
With commodity companies not having much visibility into their pricing and revenue, this makes them poor investment candidates.
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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 Royston Yang does not own shares in any of the companies mentioned.