Why does having just matured plantation could change overall performance drastically? That’s the big question. If you are quite resourceful, you would find that some analyst reports have been making this point as a key to their investment thesis since like..2 years ago! (sadly, I don’t have this resource anymore. No more Bloomberg terminal for me to access lots of analyst reports).
Basically, they would tell you that somewhere in 2017 and 2018 all of BWPT plantation has become mature, and that is a good thing. How so? This is where I think EVA approach could give much better explanation of why something is important than any other measures (have I told you that I have been promoting the use of EVA for stock investment analysis?).
Many analysts have rightly understood the importance of cash flows. Value is after all, a sum of present value of cash flows. Having just matured plantation means BWPT generate a lot more sales (more cash in), without requiring more land expansion (much less cash out). More cash is good.
The logic is sound as I’m sure you’ll agree. But that’s just about it. How do you show how important that is? Well, it is difficult (and I believe in many cases impossible) to do it with cash flows. Cash flows, amazing as it is, can’t be used as a performance measure. You will have a really hard time to tell what is important by just looking at cash flows. How many of you could still cling to analyst reports who believe BWPT key point is having a just matured plantation?
Let’s look at it another way. EVA way. Let’s see if you would come to agree with me that looking at things in EVA way is a better way.
Value is the sum of discounted cash flows, or it can be stated equally as the present value of EVA over its capital invested already in a business. Unlike cash flows, a change in EVA is a very good indication of a change in value. In fact, we could say that if EVA increases, then value has increased as well. That statement is only true with EVA, and EVA alone, not cash flows, and definitely not net income. It should be a good enough reason to pay attention to EVA.
There are two key drivers to EVA: EVA margin (profitability/productivity) and sales level (growth). It is really easy to see with EVA view what really drives the value of a company. In other writings, I have shown this by dividing the source of EVA momentum into productivity gain and profitable growth. The value of a highly profitable company like UNVR is driven mostly by growth (sales), while the value of a low and not profitable company like BWPT is driven by productivity (EVA margin).
Now that we know EVA margin is the reason d’etre for BWPT value, here is once again EVA margin of BWPT:
Not a pretty sight. Let’s go further to see the breakdown of this EVA margin. There are three key factors that make EVA margin: operating margin, fixed asset charge, and working capital charge. Their sums make up EVA margin. Unlike other ratios like ROE breakdown which is multiplicative, EVA margin breakdown is simply addition and subtraction. How do you interpret the multiple effect of one single factor to the whole like in ROE?
So, here is the breakdown of EVA margin of BWPT. EVA margin is simply these numbers added together.
Let’s take an example in Q3 2019. In Q3 2019, fixed asset charge (investors’ money is being used to invest in fixed assets. The assets do not come for free) is -73%. NOPAT margin is -24% because of bad CPO price. Add them together, (-24% minus 73%) equals -98%. That -98% is the EVA margin of BWPT in Q3 2019. Note that working capital for BWPT is insignificant.
Let’s take another example. During a boom in CPO price in 2014, NOPAT margin reached 34%. Fixed asset charge was -58%. Add them together (34% minus 58%) equals -26% for EVA margin. Easy.
Look again at the chart. You can immediately notice that EVA margin for BWPT is heavily influenced by fixed asset charge. Fixed asset charge for BWPT is so huge that it is very hard for this company to have a positive EVA margin. That fixed asset is the cost of its plantation, and the charge is relative to sales it could make. The higher sales it could make without adding more costs to its plantation (a.k.a higher fixed asset turnover), the lesser its fixed asset charge becomes.
Better operating margin may give a bit of boost to EVA margin, but its fixed asset utilization holds the key to transform BWPT into wealth creator. That EVA margin breakdown chart should make it clear to you why it is a game changer for BWPT if its plantation could produce much more sales without expanding its land. You are missing the key point of higher CPO price if you could only see better gross margin. Imagine if BWPT fixed asset charge could be like AALI. AALI fixed asset charge is somewhere between 12-15%. BWPT is 73%. If it could become like AALI, its EVA margin could improve more than 55%! I don’t think that is going to happen.
Look, BWPT screwed up big time in 2014 when it bought significant young plantation. I bet the land price was highly inflated back then. That is why the fixed asset charge for BWPT is so huge. I don’t know the details, but I know the numbers that matter.
I always do this EVA margin breakdown to know what is important for a company on the profitability side. Each company is different and the numbers could change every year, but it is crucial to understand what makes or breaks a company’s value.
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