Gain More Understanding With Sensitivity Analysis: BWPT Case

As far as I’m concerned, building a financial model serves two major purposes:

1.       To reverse-engineer share price to get shareholders’ expectation

2.       Finding important factors that affect a company’s value

Unfortunately, without a framework that could clearly link performance measurement with value, building a financial model would lack insights in serving those two big purposes. It could easily fall into an exercise just for the sake of formality. A good model gives valuable insights.

Generally speaking, I have found that a model that serves the first point (reverse-engineer) is more useful for investing purposes. It may surprise you, but finding implied shareholders’ expectation is possible without making our own future projections. After all, shareholders’ already done that job for us. Read my other articles for this topic.

In some specific situations however, namely a concerning negative EVA situation, you may want a more complete model that could answer how plausible it is for a company to finally generate positive EVA. This is especially useful if you have the guidance from the company. This article concerns with this second issue. I will be taking Eagle High Plantation (BWPT), a palm oil producer, as my case and present to you that one of the more useful answer in point number two (finding important factors) could be answered by performing sensitivity analysis.

LAYING THE BACKGROUND

I do own BWPT shares, but I assure you that the analysis presented here is objective. I do not recommend anything here, other than persuading you to adopt EVA (Economic Value Added) into your investment analysis.

The main reason why I write this article and the analysis presented here is because there is increasingly negative comments that say BWPT is a fundamentally bankrupt company with no prospect, regardless of what happens to CPO price.

The major reasons they give are essentially: negative net income, a lot of debts, and bad owner (Rajawali Group). These are actually valid reasons if there is no change in BWPT conditions. I would also agree if that were the case, because BWPT has been a persistent wealth destroyer by producing a persistent negative EVA time series. But there is one major change: its field is finally entering mature phase. It is the big reason why I chose it. But speaking in numbers is different from speaking stories without numbers.

Sometimes a company publishes its operational data to public regularly. This is always a welcome. In case of BWPT, it gives a regular data update in excel. This data includes rainfall, production, operating cash expenses, and CPO prices. In recent updates, they include a financial model as well. The last one is particularly rare, but when they give one, I would pay particular attention. These data is helpful because it helps me to see the way the company sees of what matters. For instance, BWPT reports operating expenses per hectare. It tells me that the management is thinking costs in terms of hectare. In other words, operating cost is a variable cost in terms of hectare. If BWPT does not expand its plantation further, then this number would be a number that management would try to maintain or minimize. This gives us a great insight to what follows.

Quarterly model cash flow
Rpbn	Q4	Q1	Q2	Q3
Operating
Fruit	510	400	490	510
OER %	23%	23%	23%	23%
Oil	117	92	113	117
Price Rpm	5,6	7,0	7,0	7,0
Sales	652	644	789	821
Kernel	42	41	50	52
Add kernel	694	685	839	874
Cash cost per hectare Rpm	3,2	3,5	3,5	3,5
Hectares 000	143	145	145	145
Cash cost	(457)	(507)	(507)	(507)
EBITDA	237	178	332	366

(Company excel data)

The management also thinks of sales in terms of palm fruit production. As much as 23% of it could be converted to palm oil which then sold in market price. In February 2019, it was IDR 7,0/tons. BWPT also sells palm kernel, but instead of further details, the management likes to think of it as generating 5-6% of sales, a by-product. I will go along with that.

At the end of the table presented, there is EBITDA. I do my own work in calculating EVA, and there are some adjustments that I made in both income statement and balance sheet. I do not expect my calculations match with the company (we have to be confident as to why we do these adjustments, and not relying on company’s number), but it is a big clue that I could start with EBITDA margin to compute operational cost in operational term. From EBITDA margin, I could backtrack to find ‘cash cost per hectare’. That number is IDR 14 mil/Ha. The company estimate is IDR 3,2-3,5 mil/Ha in a quarter. In annual terms, that is about IDR 14 mil/Ha as well. It turns out we match.

Here is why I go into such length: I want to know in what scenario BWPT actually becomes a positive NPV company. You see, I expect because BWPT plantation has now just matured, it would benefit from having its relatively constant capital charge while its revenue just keeps growing. That translates into bigger EVA of course. But I have no idea whether operating expenses would also scale up with revenue. This is why I need to grasp how the costs actually work. In my finding, although not conclusive, I have found that BWPT operating costs is largely a fixed cost. This is why its EBITDA margin is rising when palm oil rises and down when palm oil plummets. The management also thinks operating costs in terms of hectare as mentioned above. Since there is no land expansion plan, which is true in the palm oil industry, EBITDA margin will be influenced heavily by CPO price alone. I have now what I need for the left side of EVA equation (NOPLAT) projection. On to the right side now – invested capital. This one will be faster.

On the balance sheet side, business like palm oil plantation is heavy in fixed assets. Its working capital is generally insignificant. Its fixed assets consist of three major items: lands with mature palms, lands with immature palms, and palm oil factories. Like I said, palm oil industry sees no land expansion anymore. That means we will see its fixed assets to be pretty much constant. And since palm oil industry also stopped its new plantation, we would see its immature land to be decreasing as some of it mature. This is what we are seeing, both in rupiah term (balance sheet) and in hectare.

As a matter of fact, fixed asset growth has been negative in 2017. I have now substantiated my intuition that EVA in the future will be growing because fixed asset remains unchanged, while just-now mature plantation will produce more for sales growth. To add, because it is likely that operating expenses are fixed to land area, it means more sales growth will add up more to shareholders’ wealth.

Unfortunately for me who has computed EVA of BWPT before, this analysis so far has not enhanced my understanding significantly as before. The data given from the company should enable us to dig deeper, especially regarding operating expenses. The only way that I could think of that could enhance my understanding substantially is through sensitivity analysis. There is no other way. I need numbers to work with, not stories.

GOING DEEPER WITH SENSITIVITY ANALYSIS

I will go straight to the point. BWPT has been an incredible wealth waster since its big land acquisition back in 2013-2014. Its EVA has been plummeting ever since then. This is something that you could guess by looking at its EVA. After all, it makes little sense to invest in the company that has no prospect of ever becoming a positive NPV company.

Since all the talks have been about CPO price and production growth, we now have the ingredients to start a proper ‘what-ifs’ scenarios involving both CPO price and production level. The ingredients are operational costs and fixed assets projections which I have described above. All of these factors could be summed up in just one number: EVA. Excel has a fantastic tool ‘Data Table’ to make sensitivity analysis quick and easy. I need to do this to answer two big questions:

1.       How fast value is being created when CPO price and/or CPO production change?

2.       Making EVA to be less negative is one thing (question 1), but how plausible is it that BWPT finally becomes a positive NPV company?  

Before going to the results, I want to explain about CPO production. I reason that in 5 years time, BWPT plantation is at its optimum output which is defined as CPO production per hectare. In 2018, BWPT plantation CPO output is 3,0 tons/Ha. It was its highest production so far, but I believe there is a lot more to come. This is why: An old plantation like AALI has an average 5,7 tons/Ha of CPO for the past 4 years, and there is no reason to believe that AALI palm seeds are far superior than BWPT. There are two critical measures that I want to know when CPO price and/or CPO production change: EVA momentum and ROIC to answer the above two questions. 

	5-year EVA momentum yearly average
		Max CPO yield (CPO tons/Ha)
	14,2%	4,0	4,5	5,0	5,5	6,0
CPO price (Rpm)	7,0	6,4%	8,7%	10,9%	13,2%	15,5%
	7,5	7,7%	10,1%	12,6%	15,0%	17,4%
	8,0	9,0%	11,6%	14,2%	16,8%	19,4%
	8,5	10,3%	13,0%	15,8%	18,5%	21,3%
	9,0	11,6%	14,5%	17,4%	20,3%	23,2%

	2023 ROIC
		Max CPO yield (CPO tons/Ha)
	14,3%	4,0	4,5	5,0	5,5	6,0
CPO price (Rpm)	7,0	7,1%	9,2%	11,4%	13,4%	15,5%
	7,5	8,3%	10,6%	12,8%	15,1%	17,3%
	8,0	9,5%	11,9%	14,3%	16,7%	19,0%
	8,5	10,7%	13,3%	15,8%	18,3%	20,7%
	9,0	11,9%	14,6%	17,3%	19,9%	22,5%

The first thing to note is that EVA momentum is incredible even if CPO price does not change from current level at IDR 7,0/tons. This is because operation cost is largely fixed, and most of all, there is no need for big investment in fixed assets to support production growth. The largest fixed asset investment in this kind of business is land, and the palm oil industry has no interest in expanding land anymore. Generally speaking, such projection where fixed assets do not scale up with sales is sinful and many analysts have done so unwittingly, but we now have a case where the situation is as such. Another reason for phenomenal EVA momentum is because BWPT started with an outstanding negative EVA close to IDR -1,5 T in Q3 2018 for the last twelve months. It destroys three times as much value per hectare compared to AALI. Making a great improvement in EVA is much easier when you have a lousy start than if you start from high ground.

Next, I would need to know how reasonable the projection is and when BWPT finally becomes a positive NPV company. Judging by EVA momentum alone, it is almost unreasonable because EVA momentum of just 4% is already great. Above 10%? We need a second opinion for that. That second opinion is ROIC. We could compare ROIC with its WACC (Cost of Capital) for comparison. Moreover, EVA is positive when ROIC exceeds WACC. WACC for BWPT is about 11,4%. Look at the second table. ROIC scatters from 7,1% to 22,5% with the majority in teens. It is actually a reasonable number. That tells me that the projection foretold that when the plantation is at its optimum level, BWPT business would give returns that exceeds its WACC, but not by much unless there is some significant rise in CPO price. Reasonable. Moreover, I highlight the situations in 5 years time when BWPT actually manages to have ROIC that is above its WACC, which is the same as saying making positive EVA and becomes a positive NPV company. From the table, we could see that the minimum production level needs to be on par with AALI in 5 years time if CPO price stays at current level. That production level is obviously getting less if CPO price goes up.

In short, this sensitivity analysis gives us valuable insights that the chance of BWPT becoming a positive NPV company in five years time is very good. We could also see EVA grows substantially even without a significant CPO price rise. Of course, I could easily make sensitivity analysis for the share price as well. But I do not intend to make this article to become a stock recommendation. It would require another article for stock analysis, but suffice it to say that BWPT has always been based on unearthly expectation, and since this expectation is heavy, it is a bit pointless to talk about fair value. This is not the usual case though, but it shows you how fragile it is for BWPT to make a consistent and long uptrend. This is not to say that there is no reasonable opportunity, and certainly it is not a case to say it is a bankrupt company. A business with positive EVA is a business with positive NPV. Positive NPV means the business is adding to the owners’ wealth, not adding to bankruptcy.