June 12, 2017
The palm oil industry’s transformation towards sustainability gained traction in 2013 when major purchaser Unilever engaged SE Asian refiners and traders to embrace ‘No Deforestation’ policies. As a result, in 2013, Wilmar was the first SE Asian refiner or trader to adopt a No Deforestation, No Peat, No Exploitation (NDPE) policy. Many other trading companies in SE Asia, Europe, U.S., and Latin America followed suit.
However, a segment of the market continues to produce or purchase palm oil from recently deforested plantations and cleared peatlands, creating a ‘leakage market’ for unsustainable palm oil. Leakage is defined as any activity in the palm oil industry, production, trade and/or consumption, that is not compliant with NDPE policy requirements. Leakage creates an unlevel playing field and slows and dilutes industry transformation, thereby incurring various financial and reputational risks. The history of Sawit Sumbermas Sarana (SSMS) is instructive.
- Due to non-compliance with its buyers’ NDPE policies, Sawit Sumbermas Sarana (SSMS) lost 81 percent of its customer base in 2014 to 2015. Nonetheless, it has been able to continue operations and marginal profitability. SSMS restructured contested land bank assets while securing new clients in the ‘leakage market’.
- Unilever is among SSMS’ new buyers, and its importance of has grown in Q1 2017. Unilever awaits the outcomes of an independent review on sourcing policy compliance to decide on next steps following SSMS’s alleged continuing deforestation and peatland. Next steps could include suspension of sourcing, posing further material risks to SSMS. Unilever’s trading relationship with SSMS commenced after large SE Asian palm oil traders suspended SSMS for non-compliance with their NDPE policies. Notwithstanding the outcomes of the independent review, Unilever’s trading relation might damage its sustainability reputation.
- SSMS transition to supplying the ‘leakage market’ resulted in substantial losses for its shareholders. Chain Reaction Research analysis points to a 17 to 20 percent underperformance versus peers from May 2015 to April 2017. Although SSMS has been able to recover the loss in sales and EBIT from buyers’ suspensions, this recovery was substantially exceeded by the negative impact from SSMS resulting higher net debt due to portfolio changes and increasing capex to finance the ‘leakage market’.
- SSMS’ valuation premium versus peers has declined, but remains above its peers. If SSMS lose Unilever as a customer, further underperformance of SSMS shares might occur. Risks to shareholders remain high.