This article was written by Peter Shearlock published in The IRS Report in December 2010

New Britain set to exploit palm oil boom

Next time you fill up a supermarket trolley, check how many items contain palm oil. If your shopping includes soap, detergents, biscuits, bread, pizzas and other processed foods, you will probably see palm oil listed among them.

The growth of demand for palm oil over the past decade has been dramatic. In part, that is down to its new-found use as a feedstock for biodiesel. But it is the food industry worldwide that accounts for the lion's share of the near-50m tonnes of the stuff currently being produced.

According to the publication Oil World, global demand for eight key vegetable oils will exceed demand this year for the first time in eight years. A La Nina climate event has resulted in excessive rain in Indonesia and Malaysia, which produce 90% of the world palm oil crop. Estimates for production of soya bean oil - a competitor to palm oil - have also been cut.

Given this backdrop, it is not surprising that the price of crude palm oil recently pushed back over the $1,100 per tonne mark. That compares with a pre-crisis high of close on $1,400 per tonne in 2007 and a low of $435 in 2008. While the shares of the world's leading palm oil producers have all performed strongly this year, one still stands out as offering real value: New Britain Palm Oil.

NBPO emerged from the old Harrisons & Crosfield conglomerate in the early 1990s. After a big acquisition earlier this year that expanded its plantations by about a half, it now has more than 75,000 hectares of plantations, largely in West New Britain, which is part of Papua New Guinea (PNG). Its shares are listed in London and on the Port Moresby Stock Exchange in PNG.

NBPO is a high quality producer in every sense. First, it is among the most efficient. According to one of the firm's joint brokers, Macquarie, NBPO produces greater tonnages of raw fruit per hectare than any other leading producer. The yield on plantations that have been within the company's ownership for any length of time is an industry-leading 28.4 tonnes. That compares with returns of less than 20 tonnes per hectare for the two most recent acquisitions.

The broker also expects NBPO to become one of the most efficient upstream producers in the industry, with production of oil to rise to 5.6 tonnes per hectare by 2012. That compares with an average for the industry of 4.77 tonnes per hectare. While NBPO's yields in PNG have been affected by the high rainfall this year, the impact appears to have been marginal.

All told, NBPO is set to generate the highest earnings growth of any of the leading palm oil producers over the next few years. One reason is the company's position as the largest producer of certified sustainable, segregated and traceable palm oil in the world. One of the drivers of the Roundtable on Sustainable Palm Oil, NBPO is reaping dividends from its investment in sustainable production.

In the first nine months of this year, NBPO lifted production by 22% and revenue and profits before tax by 49% and 42% respectively. The company has been making forward sales of palm oil at prices ranging between $820 and $863 a tonne but is likely to achieve significantly more for the bulk of its 2011 output. It also produces a small amount of sugar, whose price has been generally strong in the past year.

Despite this good news, NBPO has been trading at a discount to most of the big Malaysian producers. Macquarie recently lifted its price target to 933p, which compares with a current share price of 757.5p. Liberum Capital, NBPO's other broker, forecasts a rise in earnings from around 37p this year to 46p next and 52.5p in 2012. That puts the shares on a 2011 P/E of 16.5. However, the figures assume an average palm oil price of just $820 a tonne next year. But, NBPO shares are better value than these numbers would suggest.

There is a solid asset base. The last accounts show net worth of around £330m, but, again, this understates the true figure. Taking the price per hectare paid for the last acquisition puts a value of well over £400m on the company's plantation land alone.

I normally make it a rule not to look at any value stock that does not offer a decent yield. With NBPO I would be prepared to break that rule. At the time of its latest acquisition, which was financed with around £130m of borrowings, the company said it was to suspend dividends for a year. They will recommence in the second half of next year. In total, NBPO has around £170m of debt, which is easily manageable in the context of its asset base.

Clearly, much depends on the future price of palm oil and in particular demand for sustainable oil. Demand from China and India, two of the biggest markets for palm oil, shows no sign of slackening. Western world food producers are using more and more vegetable oils, palm oil included, and are being pressed to show that those oils are responsibly sourced. The recent price action looks soundly based, while NBPO's credentials as a 'green' producer leave it ideally positioned at the fastest-growing end of the market.

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Peter Shearlock writes in The IRS Report regularly

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