When people talk about the oil price, it’s almost certain that they mean the cost of crude.
But there’s another type of oil that’s very important. It doesn’t get anywhere near as many headlines as crude. Yet it has a wide – and growing – variety of uses, both food and industrial.
It’s called palm oil. And it could be about to surge in price.
Here’s how to profit.
Palm oil is in demand
Palm oil is a vegetable oil that’s extracted from the fruit of palm trees. It possesses unique properties that other oils don’t have. This makes it an ideal ingredient in producing other edible oils, as well as being a very efficient and high-yielding source of food and fuel.
Around 80% of the world’s palm oil output is used by the food industry. It’s ideal for making cake mix, sauces and fat substitutes that are used in condensed milk and powdered milk. It’s also one of the best frying oils. And it’s an excellent source of tocotrienols, which are powerful anti-carcinogens and help protect against thrombosis.
But it’s not just about food. Palm oil consumption is steadily increasing in other areas too. Household and industrial products that are now made using palm oil include soaps, detergents, surfactants, cosmetics, pharmaceuticals and nutraceuticals. Indeed, the world’s largest user of palm oil is the international consumer products group Unilever.
Biofuel manufacture has been another big factor behind the global growth in palm oil use. And with global governments increasingly trying to move away from fossil fuel-based products, growth in demand for this alternative is set to continue.
From an investment perspective, the overall supply story is promising too. Indonesia and Malaysia account for over 85% of worldwide palm oil production. Both countries have been progressively increasing their plantation acreage in recent years to try to meet rising demand.
But they haven’t yet succeeded in producing enough product. In fact, palm oil production in Malaysia is set to slow in the first half of this year, says Dorab Mistry at Indian consumer products group Godrej International, who correctly forecast that palm oil prices would bottom last autumn.
Maybe even more importantly, he says, the current drought in South America will damage the harvest in soybean crops. These are also used in making cooking oils. If fewer soybeans are available, that will mean extra demand for palm oil to plug the gap.
How high could the palm oil price go?
Add it all up, and global edible oil reserves are set to drop to their lowest levels since 1977, according to the US Department of Agriculture. In turn, that’s likely to lead to a jump in the cost of palm oil.
“The palm oil price could hit a high in the second quarter”, Ivy Ng of CIMB Group tells Bloomberg. That’s good news for the share prices of palm oil plantation companies. “As there’s quite a good correlation, stocks will follow the rising palm oil price”.
How big could this price bounce be? Dorab Mistry is forecasting a 16% surge in palm oil prices by mid-year. If that were reflected in plantation stock prices, we’re looking at a tidy short-term profit here.
Better yet, buying into this business now wouldn’t be just a near-term trade. Demand for palm oil looks like it will stay strong for several years, and it’ll take quite some time for supply to catch up. So it would also be the chance to invest in a commodity that’s in a longer-term bull market.
So how do you play palm oil as an investor? One way is to dabble in the futures market. But unless you’re prepared to live with the volatility and the risks involved, that’s not something I’d recommend.
A simpler and safer route is buying plantation shares. Singapore-based Golden Agri-Resources (SP: GGR) is the world’s second biggest palm oil planter by revenue. To be more precise, it cultivates, harvests, processes, refines, distributes and sells crude palm oil and palm kernel. So it’s as good a pure play on palm oil as you’ll find.
With a prospective current year p/e ratio of just over 11, which Bloomberg-surveyed analysts see dropping to 10.5 next year, Golden Agri-Resources is selling on a reasonable valuation multiple. And this is a company with a $7bn market cap.
Even better, there’s almost no net debt, and the shares are standing on an 8% discount to their tangible net assets. So you’re getting some really good value here. As well as in Singapore, the stock is also listed in both Germany (under stock code 4G3A) and in the US over-the-counter market (code GARPY).
Category: Investing in Technology