Strong palm oil prices to boost Malaysia’s IOI

By Umesh Desai

HONG KONG, Nov 22 (Reuters) - Malaysian oil palm planter IOI Corp’s move to cut capital and plan to issue bonds has raised alarm bells at rating agencies but analysts say solid cash flows and strong oils prices will bolster its credit profile.

Standard & Poor’s Ratings Services and Moody’s Investors Services have both warned they may cut the ratings on Malaysia’s second-most valuable firm after it revealed a plan to sell $600 million of exchangeable bonds to fund expansion.

The decision to raise funds came after an exercise earlier this year in which the firm used about 1.3 billion ringgit ($387 million) of its cash reserves to cancel one in 20 shares.

“The large capital distribution and the proposed exchangeable bonds issuance will weaken IOI’s financial profile by reducing its buffer against down-cycles,” said Moody’s analyst Peter Choy.

Standard & Poor’s said the company’s financial profile could weaken because rising inflation in key markets may soften demand conditions and put pressure on palm oil prices.

But market analysts say the uptick in crude palm oil prices, up more than 49 percent this year, should continue and the bond offering is unlikely to dent its balance sheet because of strong cash flows.

“We think the price upcycle will extend for another year because supply from Indonesia will not be as large as expected as the severe drought of last year will have a prolonged effect,” said Alvin Tai, analyst with OSK Investment Bank.

Benchmark crude palm oil futures are currently just 1 percent off a record high of 3,013 ringgit a tonne reached two weeks ago.

NEW BOND OFFER

Last week, the company said it plans to issue up to $600 million in 5-year bonds exchangeable into new IOI shares to fund capital expenditure and acquisition opportunities.

The news sparked the warning from rating agencies, which hit the firm’s debt and shares.

Its 2015 bonds widened by 40 basis points (bps) to 190/150 bps over 10-year U.S. Treasuries and its 5-year CDS moved out by 20 bps to 60/65 bps. It’s shares are down 7 percent.

But analysts say the concerns that are reflected in the asset price declines are misplaced.

“IOI is a cash cow because of the rising CPO prices,” said James Ratnam, senior research analyst with TA Securities.

He expects IOI to generate 2.7 billion ringgit in cash flow this year, enough to fund its operations and expansion programme.

He said that cash was increasingly becoming important in this sector which is seeing a wave of acquisitions.

The nature of the firm’s acquisition plans means that cash flows would not be impacted after the capital expenditure, OSK’s Tai said.

“They are looking to acquire ready planted assets — in other words those which are giving immediate cash flows,” he said.

CPO is increasingly taking direction from the red-hot energy markets due to its use as a feedstock for biofuel and IOI’s Lee Yeow Chor, group executive director, has predicted prices will hover between 2,800 and 3,100 ringgit per tonne in 2008, straddling current levels.

And although Moody’s expects prices to peak soon, analysts say the company’s diversification provided a cushion.

Dilip Parameswaran, credit analyst with Calyon Corporate & Investment Bank, said IOI’s downstream units would help offset weakness in CPO prices.

“If palm oil prices fall it is negative for the plantation business, but good for the downstream business — there is a natural hedge,” he said.

He expects the bonds to outperform and the cost of debt insurance to fall because of IOI’s solid fundamentals.

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