An analysis of FGV’s massive downstream losses

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THE first quarterly loss reported by Felda Global Ventures Holdings Bhd (FGV) since its high-profile listing two years ago caught many observers by surprise. The agri-commodities giant fell into the red with a net loss of RM9.3 million for the three months ended Sept 30, 2014 (3QFY2014), on the back of its largest ever quarterly revenue of RM4.3 billion.

Its much maligned downstream segment, which has a presence in Malaysia and Canada, was largely responsible for the earnings downturn. Some RM105.54 million in losses in the segment were attributed to its derivatives exposure linked to forward and futures contracts as well as negative refining margins for palm oil in Malaysia.

A major concern is the nature of the losses, which mainly comprised commodity contracts that were acquired earlier this year. The total contractual amount in FGV’s derivatives book nearly doubled from RM1.18 billion as at Dec 31 last year to RM2.34 billion as at Sept 30 this year.

Total liabilities from forward and futures contracts stood at RM128.68 million as at Sept 30, compared with RM20.66 million in the previous quarter. In comparison, contracts classified as assets were valued at RM58.67 million in 3Q and RM43.12 million in 2Q.

In its financial statements, FGV disclosed that its downstream operations registered an unrealised loss on commodity contracts amounting to RM52 million during 3Q, most of which were attributed to its Canadian operations.

The group was lambasted in a Dec 3 statement by Opposition Member of Parliament (Petaling Jaya Utara) Tony Pua, who questioned its risk management practices.

“The shareholders of FGV, including FELDA, Lembaga Tabung Haji and the Employees Provident Fund, must be concerned about the substantial increase in the risk exposure, which is big enough to cripple the entire FGV group,” he says.

A closer look at FGV’s derivatives exposure tells a different story. Due to its purchases of forward commodities contracts earlier this year, the subsequent fall in edible oil prices had resulted in large paper losses.

In a response to questions from The Edge, FGV says the losses were related to the purchase of soybean and canola contracts by its wholly-owned Canadian subsidiary Twin Rivers Technologies-ETGO du Québec (TRT ETGO).

“Like other commodities companies, TRT ETGO is exposed to volatile price movements for soybean and canola that are beyond its control,” FGV says in a statement.

Back in May, FGV chairman Tan Sri Isa Samad said TRT ETGO was planning to buy almost a million metric tons (mt) of locally grown soybean and canola from Quebec and Western Canada for its plants. As one of the largest grain processing plants in the country, TRT ETGO has a crushing capacity of 3,000mt and a refining capacity of 1,200mt per day.

This explains the drastic increase in FGV’s derivatives book throughout this year. Between March 31 and June 30, some RM1.06 billion worth of futures commodities contracts were acquired for this endeavour, which includes soy (RM218.87 million), soy meal (RM352.41 million), soy oil (RM251.64 million) and canola (RM233.36 million).

In its reply to The Edge, FGV reiterates that TRT ETGO intends to take full delivery of the commodities in question and that they are not used for short-term trading in the highly volatile futures markets.

“Futures contracts entered into by TRT ETGO are meant solely to secure raw materials for the company’s commercial crush plan, and not for speculative activities.”

The liabilities of RM128.68 million imply that TRT ETGO had purchased the futures contract at a price much higher than what the underlying commodities are worth now. Since March 21, the active futures contract for soybean quoted on the Chicago Board of Trade had fallen 16.5% to US$9.96 per bushel as at Dec 1.

Likewise, the active contract for Canadian canola futures fell 14% to C$410.60 per mt over the same period due to the bumper harvest for rapeseed this year, similar to the record high soybean output in the US.

The oversupply of edible oils in the global market had caused the decline in the prices of commodities such as palm oil and soybean, which had recently hit multi-year lows before mildly recovering.

It is worth noting that all of the commodity derivatives in FGV’s book have a maturity period of less than a year. This means that upon expiration, TRT ETGO will receive the soybean and canola for use in its crushing and refining operations by June next year.

With the paper losses classified as liabilities in the group’s derivatives book, actual losses will only be recognised after the contracts are settled. This leaves the group vulnerable to further fluctuations in the futures markets, which could mean larger losses should commodity prices continue to decline.

On the other hand, it could also mean that the paper losses would start to shrink if edible oil commodities begin to trend upwards next year, as forecast by many analysts.

“Negative mark-to-market values will always be an issue but the reversal of those positions should be considered when the actual physical trades are completed and positions are squared off,” says FGV.

Be that as it may, the group could have better articulated the nature of the losses and its growing derivatives liabilities to shareholders. While TRT ETGO did find itself in the unfortunate position of purchasing edible oil futures just before their decline, the existing contracts also leave FGV vulnerable to the potential of higher losses when these contracts start expiring in June next year.

This article first appeared in The Edge Malaysia Weekly, on December 8 - 14, 2014.