$Wilmar Intl (F34.SG)$  $Yihai Kerry Arawana Holdings (300999.SZ)$  $FTSE Singapore Straits Time Index (.STI.SG)$ 
There has been recent talk about an inflationary spike and pressure on the overall economy. Commodities prices have been creeping up. This phenomenon is not surprising given the huge money press at work and it is still running on full steam- Biden’s recent 2 trillion infrastructure bill was passed.
The current US debt is at 28 trillion dollars. We touched on the Fiat Money symptom in our previous article supporting Silver as a hedge against hyperinflation.
 Source: Dow Jones Commodities Index- spglobal.com
Looking at the charts, the commodities prices have been on a steady ascent since mid-2020.
There have been new policies to increase wages of security guards to 3500 dollars by 2028. This is equivalent to or more than a fresh graduate pay in today’s term. We can still remember our starting pay when we graduated ages ago was just 1800–2000 dollars.
Speaking to an estate management friend, he highlighted the other laborious jobs such as the cleaners, landscape workers, etc would likely also see a hike in their salaries. Therefore, the monthly maintenance fees could see a substantial jump in the coming years.
For those who have done groceries shopping, you might not have felt the impact as prices are generally stable despite the recent surge in commodities prices. From the chart below, the ascent in Consumer Price Index could just be at the starting point and have started to gain traction.
Source: Singapore CPI- tradingecomics.com
The chart above is showing a gradual increase of Singapore’s consumer price index out of the range from 2014–2020. The latest inflation figure was 3.2% as compared to 2.5% year on year.
The last surge in CPI was from 2010–2014 where they increase from 85 to 100 level- 17.5% increase. So taking this as a reference, we could see an increase from 100 to 115–120 region if the spike in inflation comes into play.
Source: US inflation rate- TradingEconomics.com
To corroborate the spike in the inflation thesis, the latest inflation figure of 6.2% coming out from the US should make doubters relook into their argument. The inflation of the US economy has been around the 2% mark for much of the past 10 years.
Wilmar- Asia’s Leading Agribusiness Group
Source: Wilmar Annual Report 2020
With the likely further surge in commodities prices, we find Wilmar could be a potential proxy to ride this commodities boom. Wilmar’s business is split into 3 areas. They are namely:
Food Products- Processing, branding and distribution of a wide range of edible food products, which include vegetable oil produced from palm and oilseeds, sugar, flour, rice, noodles, speciality fats, snacks, bakery and dairy products. These food products are sold in either consumer and medium packaging or bulk depending on consumer requirements.
Feed and Industrial Products- Processing, merchandising and distribution of products, which include animal feeds, non-edible palm and lauric products, agricultural commodities, oleochemicals, gas oil and biodiesel.
Plantation and Sugar Milling- Oil palm plantation and sugar milling activities, which include the cultivation and milling of palm oil and sugarcane.
Therefore, Wilmar is an integrated commodities player where their business span through the different levels of the commodities chain. They are currently the number one vegetable cooking oil player- food products division- in China with a 45% market share with a well-established distribution network.
Source: 25 years price chart for Crude Palm Oil and Sugar- tradingeconomics.com
The business that would aid Wilmar greatly if there is a huge surge in commodities prices would be their Plantation and Sugar Milling division. However, this division just accounts for 10% of its total profits in 2020. Things are starting to look brighter for this division as it is now making up almost 15% of its profits in its recent 1H 2021 results.
The Food Products division has shown a decrease of 13% in profits for 1H2021 due to the increase in commodities prices. would be their Plantation and Sugar Milling division. However, this division just accounts for 10% of its total profits in 2020. Things are starting to look brighter for this division as it is now making up almost 15% of its profits in its recent 1H 2021 results.
The Food Products division has shown a decrease of 13% in profits for 1H2021 due to the increase in commodities prices.
While the Group had made upward adjustments to the selling prices of consumer pack products in 1H2021, there was still a time lag between the rapid increase in raw material cost and selling price adjustment, thereby negatively impacting margins.
Source: 1H 2020 Wilmar Earnings Announcement
Financial Metrics
Looking at the financial metrics, it looks like a reasonably priced stock. With a decent 3.32% yield and trading at close to their book value (5 years average is at 1.06- Source: YCharts) in an uptrend in the commodities sector, there could be a further upside as the valuation of their plantations could see revaluation gains.
The average PE for Wilmar over the past 5 years (Source: YCharts) is 14.5 and so at the current 12, there could be some upside.
The return on invested capital of 7% is decent too which shows management’s ability to allocate capital. This is in contrast to their commodity peer, Olam’s figure of 1.33%. Compared to a more efficient competitor, Archer-Daniels-Midland Co, which is also Wilmar’s biggest shareholder, the figure is comparable at 8%. However, ADM is trading at close to 1.88 times book.
Some metrics which we find is worth monitoring going forward. There has been an increase in the net debt to equity from 0.72 in 2020 to 0.97 in 1H2021. Their operating cashflows for 1H2021 is also negative at 1.4 billion as compared to a positive 2 billion in 1H2020.
This would be mainly due to an increase of 2 billion in inventories which we hope is due to preparation for better business and hence they are stocking up.
What are Crush Margins?
To understand Wilmar better, we need to understand what are crush margins. For soybeans to be useful, they have to be crushed and converted to their by-products. The by-products will be soybean oil (For cooking oil) and soybean meal (For animal feed).
The crush margin will be the market price of these two by-products minus the soybean price. A higher crush margin would therefore be beneficial for processors like Wilmar.
However, if there is swine flu affecting the hogs, it will drastically affect the price of the soybean meal as demand for it drops. This would hurt the crush margins.
You could have a better understanding of the crush spread through the CME website that have a great video that sums up the concepts.
Source: Soybean Crush Spread- barchart.com
The recent surge in crush margins is good news for Wilmar, as it is on a good upwards trajectory since May 2021. It is also near the higher end of the range since 2007.
Potential Headwinds
Volatile and Sudden Plunge in Commodities Prices
If there are volatile commodities prices swings, it will pose a lot of problems for Wilmar to hedge their commodities exposure.
Generally, Wilmar stock price will have a positive correlation with commodities prices which is good for their plantation division.
However, the ideal scenario will be a steady ascent, so they have the time to pass the higher cost to their end customers for their food products- cooking oil, flour and sugar.
Regulatory Risk
This is the risk that we are most wary of. Most of their food products business is in China. We guess with the regulatory effect on Alibaba and Tencent, there is no need to elaborate the regulatory risk if the CCP wants to clamp down on the food product prices.
The China government do have a precedent where they put a price cap for cooking oil from October 2010 to June 2011.
The price of Wilmar dropped from $6.30 to $5.30 during this period which is a drop of around 15%. The effect was felt but not devastating based on the previous episode.
The huge price plunge for Wilmar to $3 after 2011 was likely linked to the drastic drop in palm oil price during that period by almost 50%.
If prices spiral out of control, CCP coming in with price caps would be expected with the “Common Prosperity” theme. Moreover, most of the food products Wilmar is selling fall under staples.
Chartist Point of View
Looking at the charts, it is currently still on an uptrend. The support level of $4 dollar is crucial as a break below this level would likely derail the uptrend.
$4–$4.30 region could be a good area to accumulate the stock. Potential target levels will be $5.50 followed by $6.50-$7.
Summing Up
With the tailwinds of increasing commodities prices and improving crush margins, Wilmar could be a proxy to ride on this commodities boom.
Though the valuation is not deep value, it is trading at a slight discount to a reasonable valuation based on historical metrics. With the structural uptick in the commodities sector, Wilmar could surprise on the upside. It has grown its earnings 15% for 9M 2021 on a year to year basis.
Nonetheless, we have to take note of regulatory policies from China that could affect their business in food products.
With the recent divergence of commodities from Wilmar stock price, this could be an opportunity to invest in this well-managed commodities integrated player.