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.
In December 2013, Chain Reaction Research (CRR) published a report on Sawit Sumbermas Sarana (SSMS), just before the palm oil company was listed on the Indonesia Stock Exchange (IDX). CRR warned that investors buying shares of SSMS would be exposed to serious governance and sustainability risks.
SSMS is a medium large Indonesian palm oil company. It presently has 60,000 hectares of oil palm trees planted in Central Kalimantan, and it wants to increase this figure with 5,000-6,000 hectares per year.
SSMS is controlled by Abdul Rasyid, a former Indonesian parliamentarian. In the past his companies have been accused of massive illegal logging. SSMS maintains close relations with its parent company PT Citra Borneo Indah, which also has its own oil palm businesses.
New sustainability standards filling the market place
Since late 2013, new sustainability standards affecting SSMS’ business have filled the market place. Global traders controlling at least 60% of the commercial palm oil market have adopted No Deforestation, No Peat, No Exploitation (NDPE) policies. These companies require suppliers to stop clearing all High Conservation Value (HCV) areas, High Carbon Stock (HCS) areas and carbon-rich peatlands, regardless of depth. In addition, they 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) account for 80% of SSMS’ total revenue. In Wilmar’s and Apical’s case SSMS must be compliant with the NDPE policy by the end of 2015 and 2016 respectively.
In June 2015 SSMS experienced that its three main customers all suspended their trade with SSMS. The NGOs Environmental Investigation Agency (EIA) and JPIK Kalteng filed a RSPO complaint, after SSMS announced to clear more than 10,000 ha of good forest and potential/actual orangutan habitat. The complainants argued that documents with regard to HCV and FPIC were seriously flawed. At the same time the Indonesian NGO Greenomics reported about recent clearings of peatland forests by a subsidiary of SSMS. Following the NGO reports Golden Agri-Resources and the Apical Group suspended trading with SSMS for “new purchases” and “further purchases” respectively. After announcing its NDPE policy in December 2013, Wilmar had already largely stopped buying from SSMS.
For this report an assessment was conducted with regard to SSMS’ sustainability policy and its practices on the ground. The research focused on deforestation, peatlands, biodiversity and FPIC.
SSMS lists several commitments focused on sustainability, including no burning, no planting on High Conservation Value (HCV) areas, zero waste, and a commitment to conduct HCV assessments. However, SSMS has no publicly announced policies on peatlands, High Carbon Stock (HCS) areas and FPIC. Therefore, the sustainability policy of SSMS is not in line with NDPE requirements.
SSMS is a member to the RSPO, but so far only one of its five running palm oil mills has received RSPO certification.
Plantation companies of SSMS have cleared 14,000 ha of forests in the period 2003-2015. The vast majority of the deforestation took place through occupying forestland, without central government authorization for conversion to oil palm plantations. Therefore the deforestation was illegal.
Satellite imagery shows that the company has been clearing peatland forests and forests in May/June 2015, through its plantation companies PT Kalimantan Sawit Abadi and PT Sawit Multi Utama respectively.
The development plan of SSMS’ plantation company PT Sawit Mandiri Lestari contains than 10,000 ha of good lowland tropical rainforest and potential/actual orangutan habitat. SSMS’ other undeveloped landbank refers to the plantation company PT Ahmad Saleh Perkasa (PT ASP). For PT ASP the company currently does not have a location permit, essentially meaning that it has no right at all to begin development. PT ASP’s area comprises 6,300 ha of peatland and 5,500 ha of actual or potential orangutan habitat. Together the peatland and orangutan areas almost entirely cover PT ASP’s surface.
Potential loss of main customers
SSMS is at high risk of being permanently suspended by its main customers. Its sustainability policies and practices are not in line with NDPE requirements. SSMS’s main customers Golden Agri-Resources (GAR), the Apical group, and Wilmar have each adopted sustainability policies that should require them to cut ties with SSMS if serious reform is not made soon. SSMS has the ambition to plant 5,000 – 6,000 ha of oil palm each year, yet the company’s present undeveloped landbank doesn’t allow the company to do so without breaching the NDPE ambitions of its main customers. If SSMS were to lose one or more of these major commodity traders as its major customers, it could have a significant negative impact on its revenue, net income, and share price.
Under the Indonesian Government Regulation No. 60/2012 from 6 July 2012, SSMS should have to acquire and reforest 11,700 ha of land in the “Other Land Use” (APL) category and return this land to the state. The costs of acquiring and reforesting compensation land to be handed over to the government are estimated to be USD 3,000 per hectare. For this amount of land, the compensation costs would then be USD 35.1 million (around IDR 460 billion). SSMS has no clear financial plan to address this significant financial liability, suggesting the potential for further law-avoidance.
Financial risk analysis
In our financial risk analysis, we compared three potential scenarios. The first, the baseline scenario, assumes that sustainability issues have no impact on SSMS’s business. The second scenario assesses the impacts of SSMS losing its major customers, which results in more than double digit declines in Asset Turnover, ROA and ROE. It is likely that in this case the company will not be able to optimize its leverage and gearing would remain relatively high. A third scenario assumes that the company will be forced to pay the government to have its occupation of forestland estates legalized in order to stay in operation and avoid further costs. In this case, the company spending on forestland legalization is a positive move in the long-term, although the immediate effect on the company performance might appear negative. Indeed the profitability is expected to change downwards, due to the increased expenses. This in turn would result in a moderation of ROA and ROE. A full recovery is though expected, since the legalization of forestland estates can be viewed 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’s reputation among customers, investors, and the public. This could trigger further scenarios with negative consequences on the financial health of the company, such as major customers cancelling purchasing contracts, or banks and investors denying financing and investments. CRR’s financial risk analysis therefore underlines that addressing current and past sustainability issues – deforestation and legality issues in particular – will be directly relevant for SSMS’s future financial health.