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Special Report: ESG selling of plantation stocks overdone, says KLK CEO Lee Oi Hian

IT is a fact that plantation stocks have not benefited from the rally in crude palm oil (CPO) over the last 18 months as investors shunned or reduced their exposure in these counters due to environmental, social and corporate governance (ESG) concerns. In Kuala Lumpur Kepong Bhd’s (KLK) CEO Tan Sri Lee Oi Hian’s view, the selling is overdone.

“There has been a spate of selling in plantation companies by foreign investors. It has affected the share price. It may have been a little bit overdone because most of the major companies are conscious of ESG and have concrete plans to continuously improve the standing of ESG through many ways,” he tells The Edge in an interview.

Over the last year alone, KLK’s share price rose 7.7% to RM24.14 last Friday, valuing it at RM26.0 billion in contrast to the 70% increase in CPO prices over the same period due to labour shortage and high soy bean oil prices. Meanwhile, the Bursa Malaysia Plantation Index was mostly unchanged.

“Because of ESG, people are cautious about plantation stocks. ESG is not a trend ... it is happening. With climate change, people are more concerned about ESG and the environment. It is a company’s responsibility to manage the assets well,” Lee adds.

Be that as it may, foreign investors who are known to be the early adopters of ESG investing have reduced slightly their interest in KLK over the last five years from 13.48% to 12.22% as at January this year.

KLK has been a member of the Roundtable on Sustainable Palm Oil (RSPO) since October 2004. While over the years it has had its share of run-ins with environmentalists and regulators over allegations of labour abuses, among others, KLK has managed to hold its own.

But despite the challenges in the form of intense scrutiny on the ESG front, KLK has gone ahead to acquire non-RSPO member IJM Plantations Bhd last year at RM3.10 per share, valuing the latter at RM2.7 billion.

“IJM Plantations was on the market for some time but it was inconclusive. A broker came to us, the time was right for some discussions that can lead to a definitive conclusion. IJM (Corp Bhd) wanted a much higher price, we wanted a lower price. Given that the spirit was right for both sides — we were willing to adjust.

“The timing was right, we haven’t expanded in the last five years and CPO prices at that particular time had gone up from low levels. Prices were below RM2,000 last time. So we decided to meet up to IJM’s terms, which was higher than what we originally wanted to pay. RM3.10 was a big premium over the average traded price,” Lee explains how the acquisition that was announced last June and completed in September came about.

The offer price is a 31% premium over the ex-interim dividend share price of IJM Plantations on June 8, a day before the offer was announced — demonstrating the group’s resolve to take over the last few remaining large tracts of prime oil palm estates in Sabah.

IJM Plantations has some 25,000ha of planted area in Sabah and 36,263ha across the border in East Kalimantan, for a total planted area of 61,277ha.

With the acquisition, KLK’s planted area in Sabah was bumped up to 63,000ha while its total oil palm planted area increased by 28.7%, from 213,411ha to 274,688ha, as at September 2020. According to the latest information, KLK’s total oil palm planted areas measure 289,135ha, making it the third largest plantation counter on Bursa Malaysia, based on this metric.

On the rationale for the acquisition, Lee says, “[For] KLK for a long time, over the last five years, our plantation hectarages were pretty much stagnant, at 220,000 planted ha. We know that for us who are RSPO members, the only way to expand is to acquire brownfield sites because we are committed to No Deforestation, No Peat, No Exploitation (NDPE).

“In a way, IJM Plantations was a good opportunity, although they are not an RSPO member, it developed the plantations some time ago. Our intention is to make them join back RSPO and to obtain the RSPO certification within the three-year period that we have set,” he says, noting that this will increase the RSPO hectarage and pool of products.

Lee notes that there is compensation to be paid in order to comply with the Principles and Criteria of RSPO but he says the amount is not substantial.

“IJM Plantations has some good practices, reasonable. They are not part of RSPO but obviously, they need to have some improvement before they can comply. Together with the IJM Plantations team, [we] make a commitment to comply with RSPO,” he adds.
Reaping of synergies takes time

Following the completion of the deal, the integration of IJM Plantations’ operations near Sandakan and East Kalimantan into KLK is ongoing but reaping synergies from the merger will take time, Lee says, given the vast estates acquired.

“Reaping synergy takes time because a plantation is not like a factory, we are talking about a huge area,” he says, pointing out that IJM Plantations’ estates are in Sandakan while KLK’s are near Lahad Datu and Tawau.

“We don’t overlap a lot,” says the 70-year-old, who is the eldest son of the late Tan Sri Lee Loy Seng, the founder chairman of KLK.

While acknowledging that IJM Plantations has a good management team in Sandakan, Lee says there remain issues that have to be addressed, notwithstanding the shortage of workers, flooding and replanting to be undertaken. Meanwhile, the Indonesian estates’ oil yield of 18 metric tonnes per ha (mt/ha) trails behind KLK’s yield of 23.5 mt/ha in the archipelago, indicating the need for improvement.

Aside from IJM Plantations, KLK’s other recent acquisition was for 60% of PT Pinang Witmas Sejati — which has cultivation rights of over 14,980ha in Sumatera, Indonesia — in 2021.

A notable acquisition by KLK was that of a 63.2% stake in London-listed Equatorial Palm Oil Ltd (EPO), which owned and operated oil palm estates in Liberia, in 2013. In 2020, KLK’s interest in EPO was reduced to a minority stake following a series of fundraising and corporate exercises by EPO that KLK did not participate in. Nevertheless, it acquired 50% of the Liberian assets from EPO in May 2020 and now fully owns them.

KLK has invested US$140 million (RM586 million) in Liberia and has written off about half of it due to difficulties encountered in one region.

“Liberia is a very challenging environment with very poor people. We have to do a lot of CSR there. Now what is left is just over 6,000ha with a palm oil mill. At this particular price, we are still profitable, so we don’t foresee another major write-off for Liberia unless CPO prices collapse. At the same time, our yields are going up. The yields are still very low, about 11 to 12 tonnes per ha. We hope to at least go up to 14 to 15 tonnes next year,” Lee explains.

When asked whether the risk of operating in the West African nation has come off, Lee says the risk is ever present. “Liberia has been quite peaceful so far. Although people there are really underemployed, there is potential ... Many [plantation companies] have pulled out from Liberia for different reasons,” he says.

Lee acknowledges that KLK may still have some appetite for M&A given its net gearing of 40% but says the group already has a lot on its plate. “There is still a little bit of room for [M&A], but we have a lot of work to do, as well as integration, expansion programmes and organic growth. Like anybody, our job is to keep looking for acquisitions. If it is the right deal with the right size, right cost and earnings accretive to the company.”
No adverse impact from DMO

On the downstream, it is expanding in Indonesia with the construction of a refinery, jetty, kernel crushing plant and oleochemical plant in East Kalimantan. The integrated complex was initially a joint venture with IJM Plantations, but with the merger, KLK has control over the entire project.

In fact, Lee says the complex costing RM700 million was one of the reasons KLK acquired IJM Plantations.

“With IJM Plantations, it makes the JV so much seamless because it is no longer a JV between two parties ... The whole idea of the complex is that we have a lot of production in this region and this will enable us to process our materials from our own plantation, so we can have traceability. Traceability is a very key element for our customers and big MNCs.

“They want to seek traceability and know that raw materials that you use for their products do not come from illegal deforestation and areas that are not properly managed. The whole complex will give us much more raw materials [with 100% certainty] that these come from RSPO areas that are well managed and comply with regulations,” he says.

The refinery facility is expected to start operating by the fourth quarter this year followed by the oleochemicals plant a year later. This is KLK’s second facility in Indonesia, aside from an oleochemical plant in Dumai.

KLK was listed as one of the Malaysian players with exposure to Indonesia that would be impacted by the implementation of the Domestic Market Obligation (DMO), which requires 20% of palm oil exports to be sold domestically to ensure sufficient cooking oil supply.

“Indonesia’s Domestic Market Obligation is mandatory and KLK, like all producers in Indonesia, will comply with the requirements. The current rules under the DMO is applicable for olein, CPO and UCO (used cooking oil). Other than the fact that the initial announcement and implementation of the ruling were somewhat hurried, and had caused some frenzy, we do not expect the requirements to have adverse impact on our operations there as executions become clearer,” says Lee.

The DMO is expected to cool local prices with the 20% mandatory volume imposed on the local market but the move would also raise international prices and off-set the negative margins borne from the local portion sold.

“Additionally, the Indonesian government again in the last couple of days indicated that the DMO requirement might be extended to a longer list of palm products. As there is currently very little clarity available and with many execution details still to be addressed, it remains to be seen how this latest extension of the DMO requirement will further shape the palm oil industry there,” he adds.

KLK has a vast footprint in the downstream, with 13 oleochemical facilities in seven countries for a total production capacity of 3.3 million metric tonnes per year. It plans to venture further downstream and increase its specialty products offering.

On whether high CPO prices will lead to margin compression for the segment, Lee says that margins downstream are mainly a function of surplus in capacity and demand, and not related to raw material prices.
Addressing worker shortage

Like other planters, KLK has been affected by the shortage of workers in its Malaysian estates due to the closure of borders amid the Covid-19 pandemic. The sector is dependent on migrant labour, especially in the upstream portion.

According to Lee, pre-Covid-19, KLK’s estates had a worker to land ratio of 1 to 8ha but this has worsened to 1 to 14ha.

While the problem will be alleviated with the government allowing migrant workers into the country again, Lee hopes plantation companies will be allowed to recruit directly from the source countries.

“The key problem — we are not allowed to recruit directly. We comply with all regulations. There are unscrupulous agents that demand payments from the workers, especially in Bangladesh. The government has to correct it to ensure workers are not exploited, make sure our labour recruitment system is right,” he says, adding that the government is working to resolve this issue.

Mechanisation and the deployment of technology in the estates have helped KLK in mitigating the labour problem. “Mechanisation is the key, together with new technologies of satellites, drones, IT and IoT (Internet of Things). They are all ongoing at the same time to improve workers’ productivity,” says Lee.

Attracting locals to work in the estates remains a challenge despite the best efforts by planters to recruit and keep them. With locals preferring to work in factories, the annual retention rate is only about 20%.

“When it comes to the hard work of harvesting oil palm, most of them shy away from hard work. That’s why we need foreign workers. They get close to RM3,000 for big crops, they (locals) still prefer the easier work,” he adds.

The worker shortage has obviously affected output and yields. KLK registered fresh fruit bunch yield of 21.43 mt/ha for its financial year ended Sept 30, 2021 (FY2021), lower than 22.01 mt/ha in FY2020. Lee concedes there is much room for improvement towards the gold standard of 25 mt/ha through the use of higher-yielding planting materials, better planting techniques and adoption of best agricultural practices.

“We have to improve productivity because labour cost is expensive, fertiliser cost has almost doubled. In terms of ESG, the higher your productivity, the better ESG you are. We are disappointed we haven’t reached there yet, but we must not lessen our efforts,” says Lee, who foresees CPO prices averaging at above RM4,000 per metric tonne this year.

Lee and his family indirectly own 55.43% of Batu Kawan Bhd (BKB), which has a 47.74% stake in KLK. The third generation of Lees plays a role at the management level in KLK, with the appointment of Lee’s son Jia Zhang, 38, to the board in 2018 and subsequent appointment as chief operating officer last October.

Meanwhile, Lee’s nephew, Yuan Zhang, was appointed to BKB’s board last March. He is the son of BKB managing director Datuk Lee Hau Hian. At KLK, he holds the position of regional plantations director.
Sustainability part of business

Since the mid-2000s, sustainability has been a key focus of plantation companies with the establishment of the Roundtable on Sustainable Palm Oil (RSPO) in 2004.

With the rapid expansion of oil palm cultivation, mounting pressure came from non-governmental organisations (NGOs), who opposed it as it led to deforestation and encroached on the rights of indigenous groups.

In response, planters adopted a No Deforestation, No Peat, No Exploitation (NDPE) policy in their efforts to transform the palm oil supply chain.

Then the pressure came from investors, who adopted environmental, social and governance (ESG) policies as a cornerstone of their investment strategy.

When asked if the push for sustainability has been disruptive to business, Tan Sri Lee Oi Hian, CEO of Kuala Lumpur Kepong Bhd (KLK), says sustainability has become part of the group’s business.

“Sustainability is part of our business; it’s also part of the responsibility of an organisation to take care of the planet. To make sure all those High Conservation Value areas are being preserved, steep land where you cannot plant, you don’t. And take care of the animals in the plantations — what we call set aside, for high conservation-value [areas], for the animals and indigenous people to preserve their way of life and culture,” he tells The Edge.

KLK has been a member of RSPO since 2004. With plantations located in Indonesia, Malaysia and Liberia, KLK has been in the crosshairs of NGOs that accuse the group of deforestation, forced labour, open burning and even land grabbing.

For example in 2014, KLK’s plan to expand in Papua New Guinea hit a roadblock when the indigenous people went to court to contest its claim over land it had acquired in the Collingwood Bay region.

In its 2014 annual report, it stated that “... it remains KLK’s policy to invest in areas where it is welcome and only after (a) the conduct of the requisite Free, Prior and Informed Consent process with independent observers’ participation; and (b) the confirmation that areas earmarked for development are not those with High Carbon Stock.”

KLK was ranked 15th out of 100 in the 2021 assessment by the Sustainable Palm Oil Transparency Toolkit (SPOTT) which was developed and managed independently by the Zoological Society of London. SPOTT assesses producers, processors and traders of tropical forestry, palm oil and natural rubber on their public disclosure regarding their organisation, policies and practices related to ESG issues.

http://www.theedgemarkets.com/article/special-report-esg-selling-plantation-stocks-overdone-says-klk-ceo-lee-oi-hian

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