Is Ta Ann a value trap?

Value Investing Case Study 58-1: A fundamental analysis of Ta Ann, a Bursa Malaysia timber cum plantation company, showed that it is not a value trap.

In 2019 I had invested in Eksons with plywood and property development operations. But Eskon plywood operations were facing log supply issues. I figured that Ta Ann (or the Group), with its plywood and logging operations, was better positioned to address the log supply challenge.

So, I decided to swap my shares in Eksons for those in Ta Ann in the third quarter of 2019. While Eksons depended on its property development arm to see over the log supply issues, Ta Ann depended on its plantation operations for this.

Ta Ann was then trading at RM 2.40 per share which seemed to be at a discount based on the FFB per acre (Fresh Fruit Branches) valuation. To make a long story short, I swapped my Ekson shares for Ta Ann at an average price of RM 2.42 per share.

By mid-December 2019, Ta Ann’s price had jumped by 33% and gone beyond its NTA of RM 3.03 per share. I thus decided to exit at an average selling price of RM 3.13 per share. OK, it was a good gain given that I had held it for only a few months.

Unfortunately, within 2 years of my sale, Ta Ann's market price reached RM 6.00 per share before declining to my average exit price. I sold too early but this is a story for another day.

Over the past few months, the market price of Ta Ann has begun to uptrend. I wanted to see whether there was another buying opportunity.

Join me as I take a fresh look at Ta Ann to see whether it is a value trap or an investment opportunity. My analysis shows that based on its historical performance, it is not a value trap.

Should you go and buy it? Well, read my Disclaimer.

Investment Thesis

Business background

Operating performance

Financial position

Valuation

Conclusion

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Investment Thesis

Ta Ann's performance over the past 12 years was driven by the plantation business. As such it is better to see it as a plantation Group with a timber arm. However, there is currently a limit to the growth of the plantation segment. In the immediate to short term, the Group has to rely on the recovery of the timber business. Despite these constraints and based on the historical performance, there is more than a 30 % margin of safety. Ta Ann is not a value trap but an investment opportunity.

Business background

Ta Ann can trace its roots to the mid-1980s when a group of entrepreneurs came together to establish a small trading company. The company has since evolved into a diversified entity engaged in logging, downstream timber processing, forest plantations, oil palm plantations, and crude palm oil processing.

Ta Ann was listed on the Main Market of Bursa Malaysia on 23 November 1999. It has today 2 main business segments – Timber and Plantations.

The Timber segment has 4 main operations – logging, plywood, saw-milling, and re-forestation. Plywood was the largest contributor accounting for slightly less than 2/3 of the Timber segment revenue in 2023. This was followed by logging which accounted for about 1/3 of the segment revenue in 2023. The balance came from sawmilling.

The Group has 3 active forest management units in the Rejang region of Sarawak covering a total area of 346,021 hectares.

The Group has 2 plywood operations. The one in Malaysia processed 61,642 m3 of logs in 2023. The other operation in Tasmania, Australia serves the local market processing 5,364 m3 of logs in 2023.

The sawmilling operation is a comparatively small operation processing 11,926 m3 of sawn timber and moulding products in 2023.

Ta Ann is one of the pioneers in forest plantation in Sarawak with 31,000 hectares of planted trees in 2023.

The Group ventured into the palm oil sector in 2000 and today has 13 oil palm estates spanning a total land area of 72,499 hectares. It operates 3 palm oil mills near its estates.

Over the past 12 years, the Plantation segment has overtaken the Timber segment in terms of revenue and EBIT contribution. Refer to Chart 1. Think of Ta Ann today as an oil palm plantation Group with a timber arm.

The challenge for the Plantation segment is the difficulty in securing more planted acreage in the immediate future. This is described by Ta Ann as follows:

“In the oil palm division, the absence of new land clearing and development initiatives implemented by the Malaysian government has been the key obstacle to CPO production growth…However, would the freeze on new land development for oil palm were to be lifted in the future, it could drive the growth of our oil palm division.”

Chart 1: Segment Performance

Operating performance

I looked at 2 groups of metrics to get a sense of where the business is heading. Refer to Chart 1.

The left part of Chart 1 tracks the trends of 3 metrics – revenue, PAT, and gross profitability (gross profits/total assets).

The right part of Chart 1 tracks the trends of 3 return metrics – ROIC, ROE, and ROA.

Over the past 12 years, there were uptrends in revenue, PAT, and gross profitability. Revenue grew at 7.1 % CAGR while PAT grew at 13.2 % CAGR.

But as shown in the left part of Chart 1, PAT was more volatile with a spike in 2021 due to about 50% growth in revenue and gross profit margin. If you refer to Chart 1, you can see that this was due to the Plantation segment. According to Ta Ann:

“Fresh fruit bunches… production in 2021 was almost at par with 2020, but our pre-tax profit for oil palm segment had more than doubled…average selling price of CPO and FFB surge by 63% and 71% respectively.”

Chart 2: Performance Index and Returns

Palm oil and plywood prices are cycle and with the price decline in 2023, PAT declined. This was explained by the company as follows:

“…The decrease was primarily attributed to lower average selling prices for all of our products, especially crude palm oil.”

Chart 3 illustrates the cyclical price pattern for palm oil and plywood since 2014.

Chart 3: Palm Oil and Plywood Prices

Source: Statista for Palm oil and Index Mundi for Plywood

Given the cyclical nature of profits, we see similar patterns for the returns. Refer to the right part of Chart 2. Over the past 12 years,

ROIC ranged from 3 % to 19 % with an average of 9%.

ROE ranged from 5% to 22 % with an average of 11%.

The current WACC and return on equity for Ta Ann were estimated to be about 6 % each. Comparing the average returns with the cost of funds, I would conclude that Ta Ann created shareholders’ value over the past 12 years.

To get a better understanding of the operations, I broke down the operating profit into its components as shown in the left part of Chart 4. I also carried out a DuPont Analysis of the ROIC as shown in the right part of Chart 4.

Despite the improving gross profitability (refer to the left part of Chart 2), there was no improvement in contribution margin.

The changes in operating margin accounted for the bulk of the changes in ROIC. However, there were also improvements in asset turnover and leverage.

Chart 4: Operating Profit and DuPont Analysis

Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.

Fixed cost = SGA, Depreciation & Amortization and Others.
Variable cost = Cost of Sales – Depreciation & Amortization.
Contribution = Revenue – Variable Cost.
Contribution margin = Contribution/Revenue

Peer comparison

Ta Ann has 2 main operations – timber and oil palm. As such I compared its performance with companies in the timber and oil palm sector.

There are about 40 Busa plantation companies many of which are much larger than Ta Ann in terms of revenue. As such I selected 3 plantation companies with about the same 2023 revenue as that for Ta Ann – BLD Plantation, Kim Loong, and United Plantation. For more details on the Bursa plantation sector, refer to “How the Malaysian plantation sector performed over the past 10 years”

As for the timber companies, I chose 3 that have both timber and oil palm operations – Jaya Tiasa, Subur Tiasa and WTK.

Table 1 summarises the 2023 revenue and revenue growth from 2012 to 2023.

Ta Ann delivered the best revenue growth when compared to the timber companies.

I would consider Ta Ann's revenue growth as ok when compared to the oil palm plantation companies.

Table 1: Peer Revenue

Chart 5 compares Ta Ann's performance on 2 metrics – return on capital and Debt-equity ratio. Based on the trends, I would rate Ta Ann among the top performers.

Chart 5: Peer Return on Capital and Debt Equity Ratio

Prospects

In my article “How the Malaysian plantation sector performed over the past 10 years”, I presented the prospects of the sector. Refer to the article for more details. This is not a sunset sector and there are still growth opportunities for Ta Ann.

But this timber segment is more challenging. The timber companies declining revenue over the past decade (refer to Table 1) is a result of a combination of issues. These ranged from stricter environmental regulations, a shift towards sustainable and alternative materials, changes in consumer preferences, and logistical challenges. These factors collectively impact both the supply and demand sides of the tropical timber market.

While challenging, the Malaysian government still has bullish views:

“The Plantation and Commodities Ministry is bullish about the timber sector's prospect…has targeted its exports to reach RM28 billion by 2030. The sector saw a decline over the past two years, with the export of timber and timber products coming in at… RM21.8 billion last year.” Business Times Apr 2024

But from a conservative perspective, I would consider the historical performance as a good representation of the future.

Financial position

Ta Ann is financially strong.

As of the end of Dec 2023, it had RM 503 million cash and cash equivalents. This is about 18 % of the total assets.

As of the end of Dec 2023, it had a Debt Equity ratio of 10 %. This had come down from its 2013 high of 50 %.

Over the past 12 years, it generated positive cash flow from operations every year. During this period, it generated a total of RM 3.1 billion in cash flow from operations compared to a total net profit of RM 1.9 billion. This is a good cash conversion ratio.

Over the past 12 years, its average Reinvestment rate (Reinvestment/NOPAT) was 17%. I defined Reinvestment = CAPEX & acquisition – Depreciation & amortization + increase in Net Working Capital. This low rate meant that a large part of the profits could be returned to shareholders.

It has a good capital allocation plan as shown in Table 3. Its cash flow from operations was sufficient to cover its CAPEX and the balance was used to reduce debt and pay dividends. I had earlier mentioned that the Group created shareholders value. This meant that investments in CAPEX and acquisitions were value-accretive.

Table 2: Sources and Uses of Funds 2012 to 2023

Valuation

The Asset Value of Ta Ann is RM 4.11 per share (as of Dec 2023) compared to its market price of RM 3.94 per share (as of 27 May 2024).

I estimated its Earnings Value to be RM 7.85 per share. You can see that there is more than a 30% margin of safety under the Earnings Value. Refer to Chart 6.

Chart 6: Valuation

Valuation model

The Earnings Power Value was determined based on the average of 2 valuation approaches:

Free Cash Flow to the Firm model as per Damodaran.

Residual Income model as per Penman.

I used the past 12 years’ time-weighted values to determine the relevant inputs. The cost of equity of 6.3 % and WACC of 6.0 % was based on Damodaran’s build-up approach.

Case Notes

When analyzing and valuing timber companies, you should go beyond the revenue streams.

Evaluating the company’s land holdings is crucial, as the quantity, quality, and geographic location of these assets directly impact future revenue potential.

When looking at operational efficiency, go beyond the financial statements. Consider metrics such as cost per acre managed and yield per acre harvested.

External factors and market conditions must be considered. Timber prices can be influenced by global demand for wood products, and environmental regulations.

Getting an overall view is important. This comes with experience. One way to accelerate your learning curve is to look at how others have carried out such analysis. One good source of this is sites like Seeking Alpha*. Click the link for some free stock valuation examples. If you subscribe to their services, you can tap into their business analysis and valuation.

Risks and limitation

The oil palm and timber businesses are cyclical. According to Damodaran, when valuing cyclical companies, extrapolating from the current performance can lead to misleading valuations. A better approach is to look at the “normalized” performance over the cycle.

To cater to the current size of the business, Damodaran suggests the following to determine the normalized earnings

Normalized earnings = Current revenue X normalized margins.

Where the normalized margins = average margins over the cycle.

The oil palm and timber sectors are driven by different economic factors. As such we should not expect both to have the same peak-to-peak cycle. The best approach is to determine the average margins for each segment based on their respective cyclical performance.

I did not do this. Instead, I used the average past 12 years' values to represent earnings over the cycle. To mitigate this, you should seek a higher margin of safety. I would like to think that I have done this.

Conclusion

I would consider Ta Ann a wonderful company in the Buffett sense.

There were topline and bottom-line growths.

It had diversified into the plantation sector delivered a big part of the growth.

The are signs of improving operating efficiencies as exemplified by the gross profitability, asset turnover, and leverage.

It is financially sound.

It has been able to create shareholders’ value.

At the same time, there is more than a 30% margin of safety under the Earnings Value. You can see why I do not consider Ta Ann a value trap. Rather it is an investment opportunity.

END

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I am not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them.

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such.

I may have equity interests in some of the companies featured.

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