The Chain: Stranded Assets, Revenue-At-Risk, Land Tenure, And U.S. SEC Regulation S-K

by: Gabriel Thoumi, CFA

Summary

579 Corporate Supply Chain Commitments Puts Palm Oil Growers Revenue-at-Risk.

2015 Bunge Pulled out of Concession in Brazil to Mitigate Risks.

SEC Regulation S-K and Investing in Land.

Stranded Assets

As reported by Chain Reaction Research, Malaysia and Indonesia produce about 85% to 90% of global palm oil. Palm oil is used in about 50% of all packaged food products in supermarkets.

In Malaysia and Indonesia, palm oil stranded assets include land concessions, refining and transport assets that suffer from unanticipated or premature write-downs, devaluations, or conversion to liabilities as a result of various market pressures influenced by both physical and regulatory / economic risks.

Global pressures include the fact that 579 corporations have committed to ending tropical deforestation in their supply chains, primarily focusing on the big four agriculture commodities that cause deforestation - wood products, soy, cattle, and palm oil. This is because 71% of tropical deforestation, from 2000 to 2012, was driven by agriculture expansion primarily related to these four products.

These 579 corporations have made various types of time-bound zero-deforestation commitments for purchases they make in their supply chains. These agriculture products originate from Latin America, Africa, and Asia.

In fact, McKinsey recently stated "public concern over climate change is a particularly acute risk factor and source of value at risk."

Revenue-at-Risk

As global corporations increase their commitment to reduce deforestation so as to prevent climate change, market pressures are beginning to impact the development of stranded assets in the palm oil industry related to land tenure.

For example, as analyzed by Chain Reaction Research, quarterly 2016 revenue at risk models suggest that by not meeting buyers' "No Deforestation, No Peat, No Exploitation (NDPE)" policies, palm oil growers are putting potential future revenue at risk.

In this scenario, 3 companies which comprise 37% of the Jakarta Agricultural Index Composite Index involved in the business of agriculture, have significant revenue at risk. These companies, according to Bloomberg, valued collectively at roughly $3.5 billion on negative $145 million free cash flow in 2015, are:

  • Austindo Nusantara Jaya (ANJT:IJ) would have 35% quarterly 2016 revenue-at-risk.
  • Sawit Sumbermas Sarana (SSMS:IJ) would have 42% quarterly 2016 revenue-at-risk.
  • Provident Agro (PALM:IJ) would have 15% quarterly 2017 revenue-at-risk.

Yet tropical deforestation, besides clear negative climate change and biodiversity impacts, is often linked to social conflict from disputed land tenure that can cause stranded assets beyond Indonesia and Malaysia.

The land tenure landscape settings for extractive industries in developing countries often include large areas with many different public and private actors including government officials, local communities, migrant populations, and businesses.

Land Tenure Risks

As a result, social conflict matters to U.S. institutional investors who need to become more aware of these risks. According to Land Matrix, which has documented over 1,000 land deals, the U.S. ranks first for institutional investments in large-scale land acquisitions.

For example, according to the Columbia Center on Sustainable Investment at Columbia University, in 2011, a federal prosecutor in Brazil requested that U.S. agriculture giant Bunge Ltd. (BG:US) cease its operations in the state of Mato Grosso do Sul due to continuing human rights impacts flowing from a land tenure dispute with the local Indigenous Peoples community.

By 2015, BG ceased its operations on this concession to avoid this land tenure conflict.

Globally, GRI and United Nations recently published guidelines on reporting on land tenure.

SEC Regulation S-K and Investing in Land

In the United States, this is why institutions are proposing to the U.S. Securities Exchange Commission (SEC) that corporations disclose indirect use of land through their supply chains. This would require a simply change to SEC Regulation S-K, currently under review by the SEC, to include mandatory line-item reporting on:

Land acquisitions in countries with weak land governance (according to the World Bank's Land Governance Assessment Framework), and Due diligence regarding land tenure risk tied to supply chains.

SEC regulation S-K is the prescribed regulation under the US Securities Act of 1933 that governs mandatory reporting requirements for SEC filings used by public companies. It is currently being updated to potentially include land-tenure risks as a subset of stranded assets.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: We published this market update at Chain Reaction Research today. We are now expanding focus to capital markets across the tropics from just SE Asia previously.