Watawala Plantations PLC (WATA) is primarily engaged in tea and palm oil cultivation. We initiate coverage on WATA at a time where the company has made a strategic move to dairy farming while adapting a “quality driven” strategy for tea having discontinued rubber.
On the back of rising prices and yields in the palm oil segment which is the major enzyme of its profitability, WATA is expected to grow its earnings at a CAGR of 31% during FY16-19E, despite the headwinds from wage hike. FC Research estimates a fair value of LKR 30.0 giving a total annualized return of 53% in FY18E. STRONG BUY
Oil palms shelter the bottom line: With the rising global palm oil prices and increasing yields at WATA’s palm oil nurseries, we expect palm oils to contribute significantly to the bottom-line. This we believe will completely offset the impact of recent wage hike which is estimated to be ~LKR 230Mn.
Palm oil prices are expected to increase in close correlations to the rising crude oil prices. WATA is the largest palm oil planter in the sector with 3,157 hectares of palm oil of which 76% is mature where the yields are peaking. As ~756 hectares foster young plants with expectations to add ~200 more, we expect the yields to increase going forward. Palm oils generated ~55% of gross margins in FY16 which could be seen improving to ~70% in 1HFY17.
Strategic focus nurtures future profitability: The Company adapted a “quality driven” strategy for tea, where they will produce less quantities for a superior standard. Moving away from quantities brings down the losses incurred in the tea segment, which is struggling with ever rising wage and utility costs that makes it difficult to sustain margins in a price-sensitive global market. Similarly WATA completely stopped its Rubber processing,
putting a full stop to losses from the segment while converting them to palm oil. Further, they made an important strategic move to Dairy Farming which is expected to have a sizeable under-tapped demand.
WATA to provide a return of 53% by FY18E: FC Research estimates WATA’s fair value at LKR 30.0 (DCF based LKR 30.0, PER based LKR 29.0) providing an annualized return of 53% in FY18E.
Investment risks: Extreme weather conditions, changing political and social landscape, pressure on costs from continuous wage demands and rising utility costs and difficulty of sourcing land for palm oil cultivations limiting further expansion are some of the risks WATA faces.