Golden Agri-Resources: An Undervalued Stock With Significant Growth Potential

| About: Golden Agri-Resources (GARPY)
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Golden Agri-Resources Ltd (OTCPK:GARPY), which is the world's second largest palm oil plantation company, is an underfollowed and undervalued stock with tremendous growth potential. This investment note discusses the valuations and business prospects for a potential value creator.

Golden Agri-Resources has approximately 463,400 hectares of oil palm plantations in Indonesia as of FY12. The company also has 40 mills to extract crude palm oil and palm kernel from fresh fruit bunches. The refineries have a total capacity of 1.98 million tonnes per annum. Golden Agri-Resources also has a presence in China where it operates an integrated business including a deep-sea port, oilseeds crushing plants, production capabilities for refined edible oil products as well as other food products such as noodles.

Before discussing the positives related to the business and financials, I would like to discuss the current valuations and the upside potential for the stock.

Biological Asset Value Implies 22% Upside From Current Levels

For an entity in the business of plantation, the biological value of assets is a key valuation metric. Very similar to the discounted cash flow method to calculate the equity value, the DCF method can be used to calculate the present value of biological assets. Golden Agri-Resources calculates the fair value of biological assets using the average lives of plantations, yields per hectare, extraction rates, discount rates, expected changes in crude palm oil and palm kernel prices and direct costs during the period.

The balance sheet value of biological assets for the first quarter of 2013 was $7.9 billion. The calculation shown in the table indicates a 22% upside from the current stock price of $44.2, if the stock were to trade at the fair value of biological assets.

Besides the current biological value, it is important to mention that the company is expanding the current palm oil plantation by 35,000-40,000 hectares in 2013. This will further add to the biological value of assets. Further, 16,000 hectares relate to mature palm oil plantation acquisition, which has a higher yield per hectare.

Another factor, which would support an increase in fair value of biological assets going forward, is the favorable age profile of the planted area as indicated in the chart below.

As of 1Q13, 23% of the planted area comes under young and immature plantations. Over the next few years, these plantations will enter into prime age (where yields are the highest), boosting the fair value of assets. Therefore, if investors discount the future yield profile in the stock price, the upside can be higher than 22%.

Demand For Crude Palm Oil To Remain Robust Supporting Margins And Biological Value

Despite an increase in revenue to $6051.7 million in FY12 from $5952.9 million in FY11, the company witnessed a decline in EBITDA and EBITDA margin (by 300 bps to 13% in FY12 compared to 16% in FY11). The average crude palm oil price for FY12 was $959 per tonne, which declined from $1083 per tonne in FY11. It is therefore important to discuss the long-term expected trend for crude palm oil in order to analyze the future margins and biological value expectations.

Currently, palm oil is the most consumed vegetable oil in the world. The top six crude palm oil consumers in the world are India, China, Indonesia, Malaysia, the EU and Pakistan. India and China are home to 2.5 billion people with a gradually increasing standard of living and a good demographic profile. Younger people (primarily in urban areas) tend to consume more packaged foods, which use significant quantities of palm oil. As India and China witness rapid urbanization, the demand for crude palm oil will remain robust. The OECD-FAO Agricultural Outlook, 2013-2022 expects palm oil to maintain its share of 34% of the total vegetable oil production in the outlook period (2013-2022). A gradual increase in palm oil consumption is evident from the table below and it underscores the point that crude palm oil prices will remain robust over the long-term.

High Yield Per Hectare Compared To Industry Average

Golden Agri-Resources has a high yield per hectare for fresh fruit bunches and crude palm oil as compared to its peers. Overall, a higher yield than industry average gives the company a competitive advantage and ensures higher operating margins than peers.

Strong Credit Metrics

As of 1Q13, Golden Agri-Resources had excellent credit metrics, which gives the company scope to leverage in the future for land acquisition and expansion in China. As of 1Q13, the company's net debt to EBITDA metric was at 1.4 and the EBITDA to interest was 9.0. Therefore, the company is generating sufficient operating level income to easily service debt. The company's projected capital expenditure of $550 million for 2013 should therefore be easily funded. Further, the company has generated a positive operating cash flow of $408 million for FY12 and $650 million for FY11. Internal accruals will also support the growth plans and the working capital requirements.

Conclusion

Golden Agri-Resources is the second largest crude palm oil producer in the world and is going aggressive on its expansion plans through land acquisition and entry in the high growth market of China. Revenue for the company has grown at a CAGR (2009-12) of 27% and the EBITDA has grown at a CAGR of 18% during the same period. Considering the past performance, a high yield per hectare, the benefit of economies of scale and the fundamentals of the industry, the company will continue to exhibit robust growth in the future.

The company is undervalued considering the fair present value of biological assets and the potential growth going forward through acquisition of new assets. A PE ratio of 13.4 based on FY12 earnings is also attractive for a company that has significant financial flexibility to utilize for its growth and expansion. The underfollowed stock can witness significant upside and act as a portfolio catalyst. Investors can therefore consider exposure at current levels with a medium to long-term investment horizon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.