R.E.A. Holdings Plc (LON:RE) 2015 has been a tough year with harsh climatic conditions and depressed commodity prices. We are forecasting a small and reduced profit for the year as a consequence and cash flow has been impacted negatively. The company has responded by introducing a net new $19.3m of funding being a mixture of equity and debt capital. But behind the fog of difficult business conditions, operating efficiencies can be seen to be rising and the electricity supply operations have begun to generate first year revenues. This is a significant development and we do not think that it has been adequately reflected in the valuation.
► Strategy: REA is developing and operating high quality palm oil production assets in East Kalimantan. By end 2016 the company should have planted some 40,800 ha of oil palm with 20,000 to 25,000 ha of further plantable area to complete, out of a total land bank of circa 111,000 ha. A mid-size plantation by Indonesian standards, REA represents an attractive consolidation target.
► Share Price: the ordinary shares and the 9% Cumulative Preference shares have been weak, reflecting depressed palm oil prices. The Prefs have been impacted by the re-pricing of corporate and EM debt, a change in UK tax treatment of dividends and concerns about cash flow, yet the 2015 Pref dividend has been paid and one director has acquired Pref shares recently.
► Valuation: Currently REA is trading at a discount of circa 21% to its peers. This looks anomalous on the basis of asset quality and operational efficiencies and taking into account a possible value of circa $30m for the electricity operations which began to generate revenues during 2015.
► Risks: Agricultural risk, commodity price risk and country risk are constants of palm oil production. A bias to the use of debt finance means that the net debt to equity ratio is currently 68.6%. REA has stated its intention to rebalance debt with permanent capital. Investors will be watching for progress on this front.
► Investment summary: REA Holdings Plc is developing and operating high quality plantation assets to produce sustainable palm oil. With more than 40,000 ha expected to be planted by end 2016, the estate will boast 60,000-65,000 ha planted when completed. Against a background of tightening land availability in Indonesia, REA reports that it is in discussion with various parties about a possible sale of a strategic stake in the business.
