Biological assets with an emerging market twist

I was profiled this weekend in an article by Norm Rothery in the Globe and Mail, the article has two French stocks I think are attractive. (Norm also writes at the Stingy Investor, I'd recommend bookmarking his site.)  After reading the article I thought it would be nice to do a follow up post on another French name, so I went searching.  I came across some interesting French names, but stumbled on a British listed stock that I found far more fascinating, Narborough Plantations (NBP.London).

Readers ask me all the time how I find "oddball stocks", I really don't know, it's more like they find me.    Narborough Plantations is clearly a stock that found me, I could trace the twisted path I took before I encountered it, but it wouldn't really be useful to anyone.  The quick summary is I constantly turn over lots of rocks, when I want to look for something new I'll create a broad search and pick companies off one by one.  I probably looked briefly at 10-12 companies before I started to read Narboough's annual report.  As an aside, I noticed there appear to be a number of attractively priced Polish companies, I need to explore this further at some point.

Narborough Plantations is a fascinating stock, if the company hadn't been founded 103 years ago, it might arouse suspicion of fraud.  The company is listed in London, and proudly exclaims that they were incorporated in England and Wales in 1910.  Outside of the company's listing they appear to have no ties to England, their operations are all located in Malaysia.  Back when they were founded Malaysia was firmly in the hands of British control, and was a colonial territory.  If British Malaysia doesn't ring a bell then the name Singapore might, it was a city founded in the same general area (globally speaking) as Narborough's Plantations.

The company's business doesn't appear to have changed since its founding, they grow oil palm trees in order to produce palm oil.  Long before traders in New York and London were trading oil, the Egyptians and Arab traders were trading in palm oil.  If you ate any processed food today it likely contained palm oil as an additive.  The irony to this is the company uses organic farming methods as a way to keep costs down, yet the organic product when used as an additive is potentially harmful.

The company caught my eye for a number of reasons:

• Debt free
• Selling for 60% of book value
• A P/E of 6
• A dividend yield of 3.33%
• The company has a bit of intrigue surrounding them, who can resist that?
• Their annual report is very colorful with a lot of pictures of their fields and processing.  I've noticed this is common with other emerging market companies as well.

From the company's annual report here are some relevant statistics:

From the stats table this appears to be an absolute dream stock, cheap assets, cheap earnings, cheap growth, incredible margins, why isn't everyone in the palm oil business?

I didn't have to look very far in the annual report to realize why this company was cheap.  The company's earnings are about as sturdy as a palm branch in a hurricane, the assets aren't too far behind.

Narborough owns two things, their own plantations, and an interest in another palm oil company.  The associate company is never named, but in the notes it states that the company has significant influence over them. 

The company's earnings appear reasonable at first glance:

The company has a fantastic operating margin, especially for an agricultural company.  But operational earnings are less than half of reported earnings for 2012.  The conclusion is that the associate must be just as profitable, right?  Maybe not:

The associated made just £86,266 before adjustments were made to their earnings.  The adjustments are revaluations of both biological assets (the trees) and their property (the land the trees are on).  The company, and apparently their associate undertake a full valuation once every five years.  The property and trees are held on the books at fair value.

Asset adjustments are not sustainable earnings, unless management wants to continually adjust asset values.  It's also strange the company passes asset revaluations through the income statement.  They note that if property values were to decline they would report a loss.  Management states that it's very unlikely this would happen, and their land will continue to appreciate into the future.

A statement like this is something I would expect from a Vancouver California resident during boom years.  I don't think management is riding a wave of increasing palm oil land prices, I think they know the appraisers, and "know" that prices will continue to go up.  Maybe I'm reading between the lines, but it seems strange to me that the company's trees and land would suddenly double in value.

The good news is the company's cash flow backs their operational earnings.  Free cash flow is £542,099, of which £536,469 was paid out as dividends.

The problem is the company is only attractive on an earnings basis when their associate's earnings are included.  The opaque nature of the associate and their earnings leave me unsatisfied.

If the earnings aren't what they initially appeared to be, then maybe it's still a good stock at 60% of book value?  The issue I have with this is closely related to my issue with earnings, the company's assets increased from £10m to £20m over the last year due to their asset revaluation.  This is an enormous jump, and warrants caution if nothing else.  The company's assets might not provide a level of protection that investors desire.

What initially appeared to be a great investment turned into an average agricultural company after a deeper look.  For an investor who understands the industry, product, and Malaysia there might be a lot of value here.  Unfortunately I'm not that investor, so I'll be taking a pass.

Talk to Nate

Disclosure: No position