A growing global population needs feeding, and the stock market is home to a slew of firms plugged into this trend. Among them are the quoted plantation companies, sitting within the Food Producers sector, whose agricultural assets can have great strategic value for bigger plantations players. Profits can grow sharply, though patience is required while estates are developed and crops cultivated, and weather and commodity volatility are inherent risks.

Tellingly, earlier this year (25 Mar), Papua New Guinea-headquartered New Britain Palm Oil was delisted from the London Stock Exchange, having been taken over by Malaysian conglomerate Sime Darby (SIME:MK). Already one of the world’s biggest palm oil producers, Sime Darby was prepared to pay out 715p a share, a whopping 85% premium to New Britain’s share price before the offer was announced (9 Oct ‘14) and valuing the target at £1.073 billion, to gain control. In addition, late last year Malaysian palm oil play Asian Plantations was acquired by agri-business and strategic buyer Felda. Listed on Aim in 2009 at 75p a share, Asian Plantation’s take-out price was 220p a share, generating a return of around three times for sage investors who backed the initial IPO.

With the forces of consolidation having swept up New Britain and given long-term demand for food and commodities from China and India, M&A activity should continue in the plantations space, where the palm oil industry looks to be a particular sweet spot. New Britain Palm Oil’s premium takeover underscored how much acquirers are prepared to pay for the limited amount of land able to sustainably produce palm oil, the highly-competitive vegetable oil used as a food and a feedstock for the biofuel industry. Land scarcity is an issue because oil palms require the combined climactic conditions of a humid climate, regular rainfall and sunshine found near the equator.

Palm oil explained

For the uninitiated, palm oil, together with its related product, palm kernel oil, is derived from the fruit of the oil palm. Oil palms begin to produce fruit three years after planting and have a commercial life of about 25 years. Their fruit grows in tight bunches known as fresh fruit bunches (FFB) which are harvested manually throughout the year. Palm oil is widely used in domestic cooking in Asia and generally as an ingredient of processed food products, while non-food uses span soaps, detergents and bio-diesel. One of the four major vegetable oils, palm oil is second only to soya oil by volume of world production, but it is the most traded oil internationally.

However, the palm oil price continues to be weak, due to a large soybean crop last year as well as a fall in the crude oil price, resulting in reduced use for biodiesel as the lower mineral oil price causes it to become increasingly uneconomic. The CPO price closed at $655/mt in mid-May 2015, down 7% since the start of the year, though the Australian Bureau of Meteorology recently predicted a moderate-to-strong El Nino with increased intensity from this September.

This is likely to create drier conditions in palm oil growing sweet-spot Indonesia and parts of South East Asia. Historically, El Nino results in lower rainfall in palm oil producing regions, so this should result in lower CPO inventory and drive higher CPO prices, although any effect is likely to be felt post 2015. Near-term, given seasonally higher production and high stockpiles, CPO price upside seems limited. Yet the long-term fundamentals underpinning palm oil pricing are undeniably compelling. Demand for the world’s most widely used edible oil is forecast to double by 2020, in large part driven by voracious demand from China and India.

Ways to play

Ways to play the long-term demand story include R.E.A. Holdings (RE.), engaged in the operation and development of palm oil plantations in Indonesian province East Kalimantan. According to Hardman & Co agribusiness analyst Doug Hawkins, R.E.A. Holdings ‘owns some of the best plantations in Asia and it possesses a significant land bank that provides it with the opportunity to double the size of operation, but over the last five years the pace of development has been painfully slow. There are indications now that 2015 will mark a turn in the pace of development.’

Palm oil production attracts opposition, as it competes with the rainforest within the tropical belt. So one interesting aspect of R.E.A., offering investors ordinary share and higher-yielding cumulative preference share lines, is its focus on sustainability. ‘Within the sector R.E.A. sets best in class standards for sustainability, including the setting aside of more than 20,000 hectares for conservation, and the establishment of a separate operating unit (KON) to manage its conservation programme,’ says Hawkins. His view is ‘the company has raised the bar on the sustainability of palm oil production with the generation of electricity from palm oil mill effluent to meet its internal requirements and for sale to local communities who were previously without supply.’

Floated on the London Stock Exchange in 1985, Anglo-Eastern Plantations (AEP) owns and develops plantations in Indonesia and Malaysia which produce mainly palm oil. FinnCap plantations expert Raymond Greaves points out the company trades at an unusually wide discount to peers - enterprise value (EV) divided by the number of planted hectares is the most sensible metric for valuing plantations companies - despite boasting ‘good assets capable of producing good yields, over $100 million of cash on the balance sheet and lots of scope for expanding its plantations’.

The reason for the anomaly seems to be the presence of Genton International as the controlling shareholder with over 50%. This means minority shareholders are disadvantaged, as Genton, controlled by Anglo-Eastern’s non-executive chairman Madam Lim Siew Kim, can decide what returns are delivered to shareholders. The stake also makes Anglo-Eastern bid-proof, unless its astute majority shareholder decides otherwise.

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Nourishing picks

For a more diversified entree into palm oil, investors might investigate M.P. Evans (MPE:AIM). Assets spanning majority and minority-held palm oil plantations in Indonesia, beef cattle interests in Australia and residual Malaysian property assets in the midst of disposal, means the £235 million cap’s fortunes aren’t entirely linked to the palm oil price. That said, the strategy to expand its Indonesian palm oil areas is compelling. M.P. Evans is one of the industry’s most immature palm oil businesses - the age profile of its palms is circa eight years - with a major part of production growth coming from new areas that are approaching prime production and set to generate rising crops for years to come.

Full-year results (14 Apr ‘15) showed a 62% rise in pre-tax profits to US$37.1 million, as its cattle operations benefited from improved prices and plantation profits were buoyed by an upwards trend in fresh fruit bunch (FFB) crops on new projects. Peel Hunt’s Charles Hall, with a ‘buy’ rating and 650p price target, expects a sharp increase in volumes from M.P. Evans, albeit weather impacted in the short-term, implying more than 50% potential upside.

Risk-tolerant investors might also look to micro cap DekelOil (DKL:AIM). The 51%-owner and operator of a palm oil project at Ayenouan in Ivory Coast could in time draw a bid, given the strategic attractions of palm oil production in West Africa, where the palm oil majors are seeking to expand production to address a lack of land in South East Asia. DekelOil’s low-cost crude palm oil (CPO) processing facility is being transformed into a profitable, cash generative asset which will help to fund the roll out of Guitry, DekelOil’s second palm oil project in Cote d’Ivoire.

The shares surged on news (5 May) that total CPO production in the first four months of 2015 exceeded the total produced during the nine months of operations in 2014, with record monthly production of 4,818 tonnes achieved for April 2015. Then, the £18.32 million cap pleased followers with news (15 May) its kernel crushing plant had been shipped. Once operational in Q4, this plant will add another revenue stream to, and maximise the profitability of, Ayenouan.

This is due to the premium pricing commanded by palm kernel oil (PKO) compared to simply selling palm kernels. For calendar 2015, N+1 Singer conservatively forecasts sales more than doubling to €20.6 million, which should shift DekelOil from a €2.5 million loss to an adjusted pre-tax profit of €2.7 million.

Another plantations tiddler worth watching is United Cacao (CHOC:AIM), the first publicly-listed pure-play cacao stock and a canny way to profit from a booming global confectionery market and an associated looming global cocoa shortage. Debuting on AIM late last year (2 Dec) at 128p, the company seeks to be the largest grower of sustainable, fully-traceable cacao, the tropical tree crop that yields cocoa beans - in Latin America by 2016 and the global low-cost corporate grower.

Cacao is potentially more exciting than palm, due to its significantly greater profitability per hectare at maturity, and the £39 million cap’s agricultural land is located in Iquitos (Northern Peru), the world’s premier cacao growing one and a tax free-location with low cost logistics at that. Led by CEO Dennis Melka, the proven plantation developer who built up and sold Asian Plantations, United Cacao’s asset could eventually pique the interest of larger tropical crop players.