Take a chunk,
Take a bite,
If you like it,
You got to have it.

It was a chilly midnight on the 24^th of August 2023. Lights at most offices were being flicked off to prepare for the morning. Not the Edge office in Kuala Lumpur. Just before the shorthand of the clock hit 1, both Syafiqah Salim and Jose Barrock hit publish on the news that will send the palm oil market into a frenzy in the morning.

Kuala Lumpur Kepong is proposing to buy 33% of Boustead Plantations (BP) and bring it private with its current majority shareholders of Boustead Holdings and LTAT.

If you are an investor for Boustead and KLK, here are 7 things that you need to know about the deal to bring BP private.

#1: KLK will spend RM1.15billion to buy BP’s shares at RM1.55 per share

RM1.15 billion for 33% of Boustead Plantation. Thereafter the privatization, KLK will hold 65% while LTAT (parent company of Boustead Holdings) will hold the remaining 35%.

This puts BP’s share price at RM1.55 compared to its closing price of RM1.37 on 23 August 2023. Since then, BP has requested Bursa Malaysia to halt trading of BP shares in the market.

In terms of valuation, this puts BP at a price-to-earnings ratio of 22.1 times which is much higher than its 2-year historical average of 5.2 times. This means that the takeover is expensive for KLK.

#2: BP made record profits in 2022, but suffered recently

What is interesting about the deal is that BP made record profits in 2022. It registered RM595 million in net profits in 2022, where it made losses in 2018 and 2019.

Just based on this, it makes no sense for LTAT to privatise BP at this juncture. But we need to keep in mind that 2022 was a good year for most palm oil companies when Crude Palm Oil Prices were sky-high (more on this in the next point). 

In 2023, its quarterly net profits declined to RM5.2 million in 1Q 2023 from a peak of RM435 million in 1Q 2022 in line with lower palm oil prices.

#3: Low palm oil prices for 2023 meant that profits for the sector declined

Here’s the most important figure for the palm oil sector as a whole. Average crude palm oil prices have declined by 27% from RM5,234 in 2022 to RM3,804 in 2023.

Based on this, the profits and margins for the sector have declined from their peak in 2022. BP’s profit margin declined to 2.6% in 1Q 2023 from a whopping 51% in 2022.

Moving forward, most analysts in the market think that profits for the palm oil sector will be weak in 2023 due to low CPO prices and the projected recession due to high-interest rates and weak demand.

#4: BP’s operational efficiency is lower than KLK

BP’s operational efficiency has been weaker when compared to the sector. Its return on asset (which measures how much income is being generated by its assets/palm oil) is currently at 3.8% and is much lower when compared to its peers’ average of 6.2%.

Hence, it makes sense that LTAT might be thinking a ‘back to the drawing board’ move might help improve the profitability of BP in this deal with KLK.

After all, KLK has proven to be much better at its operational efficiency and managing the palm oil business. KLK’s return on assets stands at 6.2% while its net profit margin is at 8.0%.

LTAT might be looking at this deal as just participating as a minority partner in generating profits and dividends and leaving most of the day-to-day to KLK.

#5: BP’s privatization is in line with its holding company going private also

Two months ago, the majority shareholder, Boustead Holding was privatized by LTAT in an attempt to restructure and align its businesses.

The interesting thing also is that Boustead Holdings recorded record-high revenue and profits in the latest financial years of 2022 and 2021.

However, this came in the context of it incurring losses from 2018 to 2020 even before the pandemic. This means one thing. LTAT is not confident in the sustainability of its businesses to generate income.

The willingness to let KLK take control of BP signals that LTAT might be adopting a more hands-off approach when it comes to their investments, preferring to let other more capable companies take the rein. 

#6: KLK has been on a buying spree

This move to take control of BP is consistent with KLK’s buying spree in recent years. On 6 September 2021, KLK completed its acquisition of IJM Plantations for a 56.2% stake for a sum of RM1.5 billion. IJM Plantations is also a major palm oil player in the market.

Recently, it has also completed the acquisition of Temix Oleo for an undisclosed amount and Temix reportedly generated a revenue of RM697 million in 2022.

The move to acquire the stake in BP seems consistent with its strategy these past few years in increasing its size and presence in the market.

Its cash position remains healthy as of 31 March 2023 at RM2.9 billion which theoretically gives it a further RM1.7 billion to engage in more acquisitions. Historically, it has generated operating cash flows of RM1.6 billion every year, which provides room for it to support its operations and expand its capacity.

#7: Acquisition estimated to improve KLK’s profits by up to 15%

As profits of palm oil companies are very dependent on crude palm oil prices, a back-of-the-envelope calculation estimates that profits for KLK and BP could decline by at least 27% in 2022.

This puts KLK and BP’s net profits at an estimated RM1.6 billion and RM434 million respectively in 2023. However, I think that this might be too bullish on BP’s part considering that its profits are highly volatile and it only generated RM5 million so far in 1Q 2023.

After all, palm oil companies are very reliant on scale to generate higher profits. What I mean by this is that it needs to incur fixed costs (such as machinery maintenance, land rent, and staff costs) regardless of how much it makes. Once revenue is past this fixed cost, its margins will improve sharply as it can ramp up its capacity.

BP does not have that big of a scale compared to KLK, hence it might suffer higher drops in profits and its margins. I am estimating it at around RM200 million for BP in 2023. This represents about 12.5% of KLK’s estimated profits.

Conclusion

KLK’s acquisition of BP represents a continuation of its purchases in recent years of IJM and Temix and is a major move in the palm oil industry in terms of consolidation.

These 7 points on top will help you to decide on whether KLK’s deal-making is profitable and sound, but at the end of the day, time can only tell whether this move is good for KLK.