Hi Mal, EmDe is right. The biological assets (the trees) need to...

Hi Mal,

EmDe is right. The biological assets (the trees) need to be recorded at 'fair value' as part of accounting rules each year and the gain/ loss on these assets treated as (non-cash) profit.

The inputs which determine the gain/ loss are the tree specific inputs (e.g. heartwood x oil content x price), the USD:AUD rate as the trees are valued in USD, and the discount rate applied to work out the NPV of these future anticipated profits.

This does not incur a cash tax liability. Any taxes are deferred until the trees are harvested and revenue received from them. Adjustments are then made between the estimate and reality to determine the actual amount of tax to pay.

It is very complicated and likely one reason why some investors steer clear of TFC.

The current parameters that the trees are valued at, on average are:

Heartwood 19.6kg per tree (reduced from an assumption of 20.8kg last year)
Oil content of the heartwood 3.7% (same as last year)
USD:AUD 74.2c
Oil price: US$2,800kg (held constant for years)
Discount rate: 11 - 14% depending upon age of tree

As EmDe discussed, if TFC can maintain a high price for the sandalwood oil (currently c. US$4,500kg) as they increase supply then these assets are massively undervalued on the balance sheet as the oil is currently commanding a c. 60% premium above the current plantation valuation.

By vertically integrating its business model to move into very high value products (e.g. pharma and health) TFC (or should I say Quintis) is creating markets that it anticipates will be able to absorb its increased supply in the years ahead.

Whilst this has increased risks (growing trees vs. pharma development) it has massive upside for TFC as they will potentially capture much more of the value added component. This is a model used by Comvita in NZ with manuka honey based products.

TFC's business is hugely capital intensive and has relied heavily on external investor funds for it to grow its business. It is great to see that TFC is just now starting to step up to larger harvest sizes and be able to earn more operational  revenue from the sale of its products.

The fact that it has largely forward sold its harvests until 2021 suggests that there is strong demand.

Progress also looks good in the pharma/ health market with Galderma having produced 2m units of Benzac and this product being recognized as the most efficacious acne treatment on the market.

TFC's debt is high at US$250m and it incurs a high rate of interest at 8.75%, although not as high as the 11% notes it formerly had - these were entered into a time when things were a lot tougher for TFC and when their bank (CBA) pulled the pin on them around the time of the MIS failures of other forestry schemes. It is also not high when compared to the IRR on the plantations.

The fact that TFC have been able to push back the maturity date of these notes from July 2018 to August 2023 hugely derisks the company as this maturity date now falls after it makes the next serious step up in plantation harvests.

Another feature is that land that has been harvested can then be recycled into new plantations, reducing the future costs of plantation establishment, where previously TFC had to purchase and develop the land (e.g. drip irrigation).

I have looked very closely at TFC to try and work out why it is the 9th most shorted company on the ASX with 9.9% of the shares outstanding shorted:




I can't see a reason why this high level of shorts is justified. Because of the high level of insider ownership of TFC this 9.9% short position is actually much higher when compared against the free float. In trying to work out why there are only a few things that came to mind;

(1) Having a USD denominated loan may cause a blowout if the USD climbs vs. the AUD. However, given that the end product is forward sold and priced in USD will mitigate the interest servicing costs somewhat.

Additionally, whilst the principal of the USD loan would blow out, the valuations of the trees owned by TFC would increase by a much greater amount so the balance sheet would actually improve and the debt coverage metrics would also improve.

(2) TFC's operational revenue is limited over the next 3 years based upon its plantation sizes of c. 15 years ago. Whilst the company has ramped up 10-fold from last year this now plateau's for the coming 3 years before it steps up massively again.

(3) TFC is thus still very reliant on 3rd party investment to plant more ha. and fund its operations. If this should drop off for any reason their cash flows could be at risk.

However, I would think that this is less risky than previous as the business model is now proven, sales are increasing, value added products are being developed and products such as Benzac are showing excellent sales results. If anything, you'd think that institutional investors would be more keen to invest in these plantations.

The fact that TFC was able to raise the establishment fee by 29% last year for these plantings is signs that demand is high amongst investors.

(4) There are c. 54m warrants that were issued as part of the previous secured notes issue. These have a strike price of $1.28 and expire in 2018. This could provide an anchor to the SP. Dilution would be 'only' c. 14% and the funds, if and when received, would certainly be able to either generate a strong IRR or alternatively reduce the debt burden.

The only thing I can think of here is the shorters are relying on a lack of patience required by investors (3 years) before the next big visible step up in operational production.

I am keen to hear why others think the shorts are so high in TFC and if there is something I have missed.

Cheers
John