Analysis: Sustainability and Legal Issues Pose Serious Financial Risk for Palm Oil Producer SSMS

Sawit Sumbermas Sarana (SSMS), a large Indonesia palm oil producer, is exposed to significant financial risk due to sustainability and legal compliance issues that could prevent its plans for rapid growth, according to a new analysis released today by Chain Reaction Research (CRR).

“Our analysis indicates that SSMS has a record of illegal deforestation, development on carbon-rich peatlands and orangutan habitat, and lack of fair labor and human rights policies,” said Jan Willem van Gelder, of Profundo, one of the Chain Reaction Research partners. “In addition, the company could be exposed to legal penalties from the Indonesian government, which has recently stated its intent to crack down on companies continuing illegal forestland development. Taken together, SSMS could face a major hit to its customer base in a global palm oil market that has recently undergone dramatic transformation.”

“Major traders that buy and sell the vast majority of the world’s palm oil on the global market are driving positive change down through their supply chains,” said Joel Finkelstein, of Climate Advisers, one of the Chain Reaction Research partners. “That makes it increasingly difficult for producers that rely on upstream customers to maintain the old status quo of illegal deforestation. A company like SSMS that generates most of its revenue from traders with zero-deforestation policies will likely find that its lack of sustainability and legal compliance will hurt its ability to access global markets and grow going forward.”

SSMS is a publicly traded plantation company on the Indonesian Stock Exchange that currently has over 60,000 hectares of palm oil trees planted in Central Kalimantan, Indonesia. The company is looking to increase its plantation area by 5,000-6,000 hectares annually in the coming years. However, these expansion plans could be stopped by a loss of business and penalties for environmental and governance violations. Over the past two years, global traders controlling a vast majority of the commercial palm oil market have adopted No Deforestation, No Peat, No Exploitation (NDPE) policies that require suppliers to stop clearing all High Conservation Value, High Carbon Stock and peatland areas, regardless of depth. In addition, these policies require all suppliers to uphold human and labor rights, and to recognize the right of local communities to give or withhold Free, Prior and Informed Consent (FPIC) to any new developments on their lands.

Three companies with NDPE policies—Golden Agri-Resources, the Apical Group, and Wilmar International—have accounted for roughly 80% of SSMS’ total revenue. In recent months, these traders have all suspended new purchases from SSMS based on supply chain violations. The company is unable to go forward with plans for its currently undeveloped land bank without breaching the NDPE policies of its main customers and risking permanent suspension. If SSMS were to lose one or more of these major customers, it could have a significant negative impact on its revenue, net income and share price.

Based on an analysis of the company’s operations, the report reveals several core issues that could substantially limit SSMS’ future market access to its biggest customers that have committed to source deforestation and exploitation-free palm oil:

• SSMS cleared approximately 14,000 hectares of forests from 2003-2015, the vast majority of which took place illegally through the occupation and conversion of land without government authorization.
• Recent satellite imagery shows that SSMS’ plantations have been clearing carbon-rich peatland forests earlier this summer.
• The company is now looking to expand on a yet-undeveloped 10,000 ha area of lowland tropical rainforest that includes habitat for endangered orangutans.
• Another potential expansion area comprises 6,300 ha of peatland and 5,500 ha of orangutan habitat, for which the company does not currently have the location permits required to begin development.
• SSMS has no public policies barring the development of High Carbon Stock or peatland areas, nor does it have any policies requiring Free, Prior and Informed Consent (FPIC).

To evaluate the potential financial impacts of these sustainability risks, the researchers employed a model based on SSMS’ most recent financial statements and estimated future earnings. Compared to a baseline scenario in which sustainability issues have no impact on the company’s business, the report assesses two alternative scenarios and their impact on the company’s key financial indicators:

• The first scenario assumes that SSMS could lose global customers if it continues to violate those companies’ sustainability policies; this could result in a 22% loss in profit margin, a 11.2% drop in Return on Assets, and 24.2% drop in Return on Equity. It is likely that in this case the company will not be able to optimize its leverage and gearing would remain relatively high.
• The second scenario assumes that SSMS could be required to acquire and re-forest 11,700 ha of land to be given back to the government to compensate for its illegal developments – at a cost of USD 3,000 per hectare, the company could face costs of USD 35.1 million (around IDR 460 billion). This could result in an 8% lower profit margin than the baseline, a 3.5% drop in RoA, and 6.4% drop in RoE. In this case, although there are significant upfront costs, spending on legal compliance would likely be a positive long-term move as an investment in the company itself.

There is also a possibility that these different scenarios could occur simultaneously, creating cumulative and more serious impacts on the company’s bottom line. In addition, a significant risk embedded in all scenarios is that they could result in further serious damage to SSMS’ reputation among customers, investors and the public. This could trigger additional scenarios with negative consequences for the financial health of the company, such as other major customers cancelling purchasing contracts, or banks and investors denying financing and investments. CRR’s financial risk analysis therefore underscores that addressing current and past sustainability issues—deforestation and legality issues in particular—will be critically important for SSMS’ future financial stability.

In December 2013, Chain Reaction Research published an initial risk analysis on SSMS, just before the company was listed on the Indonesia Stock Exchange, warning that investors would be exposed to serious governance and sustainability risks. The report can be accessed here.

Analysis: Sustainability and Legal Issues Pose Serious Financial Risk for Palm Oil Producer SSMS
September 9, 2015
Sawit Sumbermas Sarana (SSMS), a large Indonesia palm oil producer, is exposed to significant financial risk due to sustainability and legal compliance issues that could prevent its plans for rapid growth in the coming months and years.

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