Two brothers are the key people in a company that we have co-owned for a number of years. We are impressed by the efficiency of the plantations and the demonstrated business acumen. We like conservative balance sheets, but it can also end up being too much of a good thing and be costly in term of opportunity costs. We believe this imbalance should be addressed.
United International Enterprises (UIE) is listed in Denmark. UIE is a holding company in which the interesting asset is the palm oil plantations in the subsidiary United Plantations (UP). UP has industry-leading palm oil yields, and through our co-ownership of UIE, we are co-owners of UP at a significant discount that is relatively easy to measure.
UP owns 44,000 hectares of land in Malaysia and Indonesia. In this way, the company represents a little bit of Denmark in South-East Asia. The plantation was founded in 1906 by Aage Westenholz. From 1951, it was taken to new heights by Børge Bek-Nielsen. The sons of Børge Bek-Nielsen, Carl and Martin Bek-Nielsen are heading the company today. Additionally, the two brothers are the majority shareholders through their ownership of more than half the share capital in UIE.
The brothers have been involved in plantation operations their entire lives and have a strong commitment and focus on bringing down unnecessary costs. This has resulted in UP currently having the lowest production costs in the industry. UP’s production costs amount to a mere 900 Malaysian ringgit per tonne of palm oil. By comparison, the least efficient plantations in the industry are at around 2,000 ringgit. This should be seen in the context of the current price of palm oil being at around 2,300 ringgit per tonne. In other words, UP has an income profile that is very different from the majority of the industry.
Palm oil is used in a large number of consumer goods, including lipsticks, ice cream, soap, bread, shampoo, and washing powder. Hence, the demand for palm oil is expected to grow in the long term as the global population and consumption increase. The Bek-Nielsen brothers have taken the lead in making the operations sustainable. An example is that the company “hire” owls, snakes and other animals to control pests instead of using pesticides. There is an increasing demand for sustainability in consumer products. UP has long been industry-leading when it comes to traceability of its products – something that is currently in high demand as it allows customers to document sustainability to the end consumer.
Prospect of significantly higher yields on the plantations
Through 2018, UP harvested 220,000 tonnes of palm oil – an increase of 205,000 tonnes from the year before. This resulted in the yield growing by almost eight percent on the company’s plantations in Malaysia and Indonesia. The yield of 5.7 tonnes per hectare on these plantations is about 50 percent higher than the average for the palm oil industry in Malaysia. Four years ago, the more recently acquired plantations in Indonesia were seeing yields of around 4.2 tonnes per hectare. Thus, there has been a decent increase in this period – and there is still potential for increasing the yields further. The newer plant materials are expected to deliver yields of around 7.5 tonnes per hectare which would be an increase of more than 30 percent from current levels.
There is continual re-planting of areas because of issues with the palms growing too tall and becoming difficult to harvest efficiently. Over the last few years, UP has had an abnormal proportion of immature plantings (meaning palms under the age of three years) not yielding any palm oil. Today, approximately one tenth of UP’s hectares are immature palms. As these areas mature, the total yield is expected to grow significantly. The reason for this is that palms are at their most productive stage between the age of four to seven years.
The cost efficiency of the Malaysian plantations is positively impacted by a private railroad. The length of the railroad is around 500 kilometres, and the railroad makes it easier to transport the raw materials from harvest to extraction. To put this in a Danish context, the rail network would be the second largest in Denmark if it were located here. Only the publicly owned Banedanmark would have more kilometres of rail tracks.
UP’s areas in Malaysia are not just plantations, however – they are small local employee communities featuring schools and bakeries. We are pleased to see that UP creates these communities for the employees, and we believe this increases their motivation and loyalty.
Acquisition of plantations in Malaysia
To a great extent, the work on the plantations still involves a lot of manual labour. Even if the industry is constantly trying to automate, it has not yet been possible to find an effective way of using machines. Among other things, this is due to issues such as uneven and unstable terrain. Thus, UP’s investments in its employees should not be an underestimated factor in the process of operating the plantations efficiently.
Besides optimising the palm oil yields, UP can also increase the size of its potential harvest by acquiring new plantation areas. We are happy to note that in the fall of 2018 UP managed to acquire an additional 3,600 hectares in Malaysia, located close to its existing plantations. This new land was acquired at a decent price of just above 110,000 ringgit per hectare. Currently, these areas have low palm oil yields, but they are expected to be fully replanted with UP’s plant stock over the next three to four years. Hence, the yields are expected to increase significantly and, as a result, the value of the land is expected to increase as well.
We believe that the price of approximately 400 million ringgit for the new plantation has been a sensible allocation of capital. We appreciate when our companies allocate their cash flows to expand their core business – and when it comes to operating plantations, UP masters this like no other. Patience is rewarded, and it is good to see that no compromises have been made in terms of location, environmental risks, price or quality of soil.
A tangible conglomerate discount
As mentioned, UP is the core operating asset of the holding company UIE, through which we are co-owners. UIE has three primary assets of which the 48 percent ownership of UP’s shares is the largest with a market value of around 4,200 million Danish kroner. Secondly, the holding company holds shares in an unlisted Swedish investment company, MSAB, where the proportional ownership of a number of listed companies amounts to an additional 900 million Danish kroner. And finally, there are significant cash reserves of 730 million kroner. The total market value of UIE’s assets is thus 5.9 billion kroner, equivalent to 1,750 kroner per share.
Despite this calculation, which we find to be quite straightforward, a UIE share costs around 1,350 kroner. This corresponds to a discount of 400 kroner per share or almost 25 percent. Holding discounts are usually seen in large conglomerates where there might be significant uncertainty regarding how to price the underlying companies as well as management’s potential lack of focus. We do not believe this is the case with UIE. Over the last decade, they have been simplifying the ownership structure in order to clarify the value of the assets. We find that the management and executive board should continue working towards eliminating this discount and thus push the market value of UIE to better approximate the value of the company’s assets. Between 2011 and 2018, UIE repurchased around 1.7 million own shares, equivalent to a third of the capital, and this has resulted in significant value creation.
In 2018, UIE repurchased 61,000 shares at an average price of 1,380 kroner per share. The share buybacks create significant value for long-term shareholders when the shares are repurchased at prices below the company’s intrinsic value. The share buybacks in 2018 have thus created no less than 23 million kroner in value for the remaining shareholders. We find it regrettable that management discontinued the share buyback programme as there is still a significant discount on the outstanding shares and plenty of cash reserves in both UIE and UP.
The dividend policy at UIE has been made stricter over the last few years, and it is now stated that half of the dividends from UP and MSAB will be distributed to UIE’s shareholders. In 2018, UP decreased its dividends by 7 percent. In 2019, we thus received a dividend of 5 US dollars per share, equivalent to a yield of 3 percent, in addition to the abovementioned share buybacks.
The significant cash holdings enable UIE to potentially pay an extraordinary dividend, although we would prefer a share buyback programme due to the continued significant holding discount. This would also be in line with management consistently stating that UIE should not act as a bank.
The discount on UIE can, among other things, be attributed to its quiet existence on the Copenhagen Stock Exchange. It is not covered by the banks’ analysts, thus resulting in the company only getting very limited attention. On top of this, a number of loyal major shareholders are in this for the long term, which means that the volume of shares traded on a daily basis is limited. Finally, UP is listed on the Malaysian Stock Exchange, which means less interest in the share. The political situation and the religious tensions in Malaysia are considered to be improving with the election of a new president in 2018, and this should have a positive effect on the Malaysian economy.
Sometimes the cash holdings can be a bit too large – even for us
The management style of the Bek-Nielsen brothers can best be described as “old-fashioned business sense” where every coin spent is carefully examined in order to cut costs – perhaps even several times. Dato’ Carl Bek-Nielsen is the Chairman of UIE, while the younger brother, Martin Bek-Nielsen, is the Deputy Chairman. They are both part of the daily management of UP.
UIE’s CEO is Ulrik Østergaard, who has been in this role since 2010. In our view, he has contributed positively to how the company communicates and interacts with the capital markets and in simplifying the ownership structure of the holding company. There is a significant overlap of interests between the Bek-Nielsen brothers and the remaining shareholders due to the brothers’ significant ownership stakes. We would prefer if the remaining board members and management team also had meaningful ownership stakes in UIE.
Today’s market value of UIE is not much higher than the value of the company’s UP shares. This means that you only pay a little amount for the significant cash holdings and the MSAB shares. Additionally, UP has significant cash holdings of its own, amounting to around 450 million ringgit, even after paying 400 million ringgit for the plantation areas (equivalent to almost 750 million Danish kroner or almost 10 percent of the company’s market value). If the proportional ownership of these cash holdings is taken into account, almost 45 percent of UIE’s market value is in cash equivalents, not even counting the UP shares. We find that remarkable.
We appreciate a conservative balance sheet and the flexibility this provides. However, sometimes the cash reserves can be too excessive. This will lead to an opportunity cost which is defined as the cost you pay for missing potential returns due to superfluous and unproductive liquid assets. These “lost” earnings do not appear in the financial statements.
If the cash had been invested in operational or financial assets, these assets would have generated earnings. These earnings are “lost” when the money is just sitting tight in a bank. A relatively simple example of this is that UIE’s cash has exceeded 100 million US dollars over the past five years. If this cash had been allocated to the company’s owners and invested in global equities, it would have generated an average of 10 percent in annual returns, equivalent to missed annual earnings of more than 10 million US dollars.
It goes without saying that it would have been even better if the cash holdings had been distributed to shareholders and subsequently placed in BLS’ Global equity strategy with annual returns of 14 percent. In this case, it is equivalent to missed earnings of almost 15 million US dollars per year. These above calculations of lost returns only deal with the cash holdings of the holding company, UIE. On top of this, UP has also been sitting on a cash position of almost 200 million US dollars over the last five years. This should not be interpreted as a recommendation to invest in global stocks. It is merely an illustration of the hidden costs involved with having a too conservative balance sheet, even if conservative balance sheets are to prefer.
We would find it positive if management of UP finds opportunities for acquiring more high-quality land or merely resume returning cash to the holding company UIE and, in continuance, UIE reactivate the value-creating share buyback programme.
Palm oil can be extracted within a narrow range of latitudes around the equator, which limits the amount of potential land that can be utilised for it. If management cannot find good opportunities for value-creating acquisitions in their core competency of plantation operations, we continue to expect that the cash flows will be distributed to shareholders, primarily as share buybacks, if willing sellers can be found.