RHB FIC Credit Brief - Golden Agri-Resources 19/2/16

19 February 2016

Credit Brief

Golden Agri-Resources Ltd       

Another Downgrade for GAR

Update:

¨      GAR’s rating was cut by RAM to A1 from AA3 on 17 February, while its outlook remains negative. The low CPO price and elevated leverage position has led to a weaker FFO/Debt coverage (of 0.1x in Sep-15) which fell below RAM’s threshold (of 0.15x) for the AA3 rating, that resulted in that action. We reiterate our underweight view on the credit despite YTD gains of c.6% in CPO price to c.MYR2,550/MT from the El-Nino effect and lower production which, in our view, is temporary in nature. CPO prices are likely to stay flat, at best given the constant weakness in edible oil and Brent oil prices, which provides little catalyst for meaningful recovery. GAR will release its full year results on 29 Feb, and we will closely monitor its performance over the next few quarters.

Key Credit Highlights

¨      Second largest planter in the world with integrated business model. Total planted area of 484,221ha is the largest in Indonesia and GAR produced 2.4m tonnes of CPO or 4% of total global palm output. The Group plays a leading role in the industry further supported by its downstream refining capability of 3.78m tonnes that produces refined palm products such as cooking oil, margarine, shortening and fats.

¨      Favorable tree age profile and operating track record. GAR’s upstream operations remains solidly backed by its healthy tree age profile as 44% of these trees are considered as ‘prime’ with 15% of trees as young and immature, although the average tree age is older at 15 years. This has allowed GAR to maintain a stable operating track record as seen with its fresh fruit bunch (“FFB”) yields and oil extraction rate (“OER”) that averages around 22MT (metric tonne)/ha and 22% over the past few years (Malaysia industry average: FFB yield: 18.6MT; OER: 20%). GAR also has relatively low cash cost of production that will likely be around USD320-340/MT (MYR1,200-1,300/MT) in FY15. GAR's upstream operational track record is similar to that of large Malaysian planters such as Sime Darby and KL Kepong.

¨      Earnings has been impacted by soft CPO prices, thinner margins. Like other planters, GAR posted weak YTD 3Q15 results due to lower CPO prices (2015 average: MYR2,191/MT), thin refining margins in Indonesia and lower production output as seen with its lower revenues and EBITDA of USD4.9bn (-14% YoY) and USD357m (+0.3% YoY) respectively. Although there was a slight improvement in its Chinese oilseed business, GAR’s overall EBITDA margins has been on a declining trend since FY11 from the highs of 18% to 7.2% in 3Q15. To address this, senior management is banking on its improved efficiency from its two new biodiesel plants that will come online (1H16 and the other in 2H16), and is further focusing on optimizing margins from its trading business, logistics and refined branded products.

¨      Debt levels remain elevated; deleveraging efforts hinges heavily on CPO price recovery. A mix of aggressive debt-funded capex and low commodity prices has significantly impacted its credit metrics with debt levels soaring to USD3.3bn (80% increase since FY12). As a result, its gearing rose to 0.38x in 3Q15 from 0.21x in FY12 with net gearing similarly rising to 0.28x (FY12: 0.15x). In addition, its debt-to-EBITDA soared to approximately 7.0x during the same period (FY12: 2.5x). Separately, senior management guided higher capex spending in FY15 is to be in the region of USD400-450m for the construction of two additional biodiesel facilities (USD150m), this was above its original guidance of USD300m (FY14: USD478.2m). Going forward, the group expects capex to moderate to USD150-200m in FY16 and USD100-200m in FY17 to provide some respite to its credit position.

¨      Debt servicing metrics remain fragile. The group’s thinning margins has impacted its funds from operation (FFO) to debt ratio which has stayed below 0.10x (FY12: 0.27x), while its interest coverage ratio is relatively low at 3.4x. Furthermore, net debt-to-EBITDA exceeds 5 years, in excess of its average debt maturity profile. Overall, topline numbers, gearing and liquidity metrics indicate deterioration in its credit profile over the last 3 years (please see following financial highlights table) as its plantation business accounts for more than 90% of its revenue and EBITDA. Hence, a meaningful recovery in CPO prices is key for GAR to improve its overall credit metrics.

¨      Liquidity remains relatively weak. GAR sits on a tight liquidity position with cash ratio of 0.3x (FY12: 0.53x). As at 3Q15, it has short term debt of USD1.7bn with upcoming maturities of USD60m and USD855m in 2016 and 2017. This is partly mitigated by its cash plus short term investments position of USD832m and USD746m inventories position that can be converted into cash. The expected EBITDA generation of USD450-500m in FY15 also provides some relief to its liquidity profile.

¨      CPO prices likely to be subdued, temporary relief from El Nino. Similar with all planters, GAR is highly vulnerable to CPO price volatility, whereby demand of CPO is expected to grow at 5.8% against supply growth of 6% (according to the US Department of Agriculture) as supply demand imbalances remain in the short to medium term further plagued by high inventory level across Malaysia (Jan: 2.31m) and Indonesia (Dec: 2.9m - survey), low crude oil prices (YTD average: USD32.55/bbl) and slowdown in global growth – especially that of China. This may be mitigated by weather factors such as El Nino and the recent haze that has temporarily provided some support for CPO prices. We nonetheless opine that weather anomalies are unlikely to provide sustained support to a CPO price recovery due to more important global growth concerns that plague the industry in the short-to-medium term. Furthermore, initiatives like the biodiesel mandates in Malaysia and Indonesia that targets rising inventory levels will provide some respite, but this is less substantial since the slump in global crude oil prices may keep biodiesel projects on hold.