Source: New Straits Times, Saturday, 17 May 2003

Khong & Jaafar Sdn Bhd presents a case study on how to calculate the value and worth of a plantation

There are two intrinsic issues investors of oil palm estates must take cognisance of. One is the market value of an estate; the other is its market worth. They might should alike, but the difference between the two is the trigger-point that sways decision making.

Essentially, market value is an estimate of the price agreed to between vendor and purchase under open-market conditions. Market worth, on the other hand, is a measure of what an investor ought to pay bearing in mind the investor's target rate of return.

Thus, an investor should always measure worth, and make the move to acquire based on the variance between both.

The most appropriate valuation approach to compute either market value or market worth is the Discounted Cash Flow technique. This allows the inflows, outflows and the discount rate to be assessed based on size, type of soil, stage of development, management and yields.

Once this value is derived, it is then counter-checked using the Comparison approach to ensure that the final value falls within the range indicated by actual transactions in the market over the past decade.

In a case-study model involving a 12,381-acre estate managed as two divisions, the discounted cash flow method is based on inflows computed for 30 years. Thereafter, the cash flow of the 30th year is capitalised in perpetuity and discounted to the present.

The inflows are obtained on a field-by-field basis recognising a typical yield profile as the oil palm tree ages. When they are young, at three years of age, their initial yield is taken at two tonnes per acre, and this rises to 11 tonnes when the palms reach nine years. Thereafter, the yield would tapper off to a low to six to seven tonnes per acre before the trees are felled and replanted.

However, it is important to note that the yield from each field may vary for reasons of soil, palm stand and so on. The yield of fresh fruit bunches (FFB) is also adjusted to an oil yield based on an extraction ratio of 20 per cent for crude palm oil (CPO) and five per cent for palm kernel oil (PKO).

In the model, the price of CPO varies from RM1,000 per tonne in the first year to RM1,200 per tonne in the second year and RM1,500 per tonne thereafter, while the extraction ratio used varies from 14 per cent to 20 per cent of FFB. For the price of PKO, the model is based on RM600 per tonne in the first year, RM700 in the second year and RM900 per tonne thereafter while the extraction ratio used varies from 3.5 per cent to five per cent of FFB.

Costs in the outflows include production and replanting expenses. The former, amounting between RM80 and RM100 per tonne of FFB, covers weeding, pest control, maintenance of roads and drains, pruning, manuring, harvesting and transportation cost.

For the latter, which works out to over RM1,000 per acre, it is made up of the cost of planting material (nursery), felling/clearing, holing, planting, terracing, cover crop, roads/drains, fertiliser, pests and disease control and overheads.

Maintenance for the first three years of planting is based on RM600 per acre for the first two years, and RM570 for the third year.

Having determined the inflow and outflow features of the estate, the nett cash flow is then discounted at 14 per cent. This is the adjusted rate based on an analysis of the sale of oil palm plantations over a 10 year period.

The resultant value of the plantation is RM10,177 per acre.

It can also be said that the pre-tax Internal Rate of Return (IRR) based on the purchase price of RM10,177 per acre and the nett cash flows as mentioned would also be 14 per cent.

Of course, should the price of CPO and PKO increase, the value of the plantation could also improve and even generate a healthier IRR. For instance, a 10 per cent increase in CPO and PKO prices would support a 20 per cent increase in the value of the plantation to RM12,204 per acre, which would give rise to an IRR of 16.45 per cent.

On the flipside, though, a 10 per cent increases in production and processing costs would result in the value of the plantation decreasing by only six per cent to RM9,595 from the base of RM10,177 per acre and generate a lower IRR of 13.22 per cent.

As a general rule, good plantations in the range of 5,000 to 10,000 acres are sustainable at a purchase price of about RM10,000 per acre. With increasing yields and oil extraction ratios in the future, the sustainable value ought to move to about RM15,000 per acre.