Will the data center boom be a new catalyst for the plantation sector?

This article first appeared in Capital, The Edge Malaysia Weekly on June 10, 2024 – June 16, 2024.

Analysts say land-dense growers who are capitalizing on the current data center boom by using farmland for solar farms can expect FASTER and bigger profits. Their observation is due to moderate growth in the plantation sector but growing interest in data centers in Malaysia.

The latest beneficiaries of the data center boom could be the biggest players in the plantation sector, as the growing sector’s demand for renewable energy (RE) could pave the way for growers to earn multiples of operating profit compared to oil palm.

“Plantation companies should strike while the iron is hot. This is an excellent opportunity for them to use a new source of income. It all depends on the value that can be achieved on the land, and we know that plantation companies have significant amounts of agricultural land that can be easily converted into solar farms,” TA Investment Management Bhd chief investment officer Choo Swee Kee tells The Edge .

The rental rate for solar farms is believed to far exceed the average return from planting oil palm, with a June 3 Maybank Investment Bank Research report estimating that large-scale solar power (LSS) projects could allow growers to generate up to 54 times more operating profit per mature hectare compared to planting crops.

SD Guthrie Bhd (KL:SDG) (formerly Sime Darby Plantation Bhd) is the only planter to have publicly announced its RE ambitions.

In search of “less productive land for solar projects and more productive land for oil palm cultivation,” the company, which owns 240,309 hectares of land in peninsular Malaysia, said last month that it plans to further engage in LSS projects through land leasing and equity stakes in order to own assets that can generate up to 1 GW of power. Such a venture would require an investment of up to RM2.5 billion over the next three to five years and believes it can deliver an ROI of 8-9% on a project-based basis.

SD Guthrie has leased sites under the LSS1, LSS4 and Corporate Green Power Programs and is bidding on three more sites under the upcoming LSS5 program.

Maybank IB Research recognizes Kuala Lumpur Kepong Bhd (KL:KLK), IOI Corp Bhd (KL:IOICORP), Genting Plantations Bhd (KL:GENP), TH Plantations Bhd (KL:THPLANT) and United Plantation Bhd (KL:UTDPLT) as other potential beneficiaries of the LSS5 project as their Johor estates are close to the putative location of the national power grid in the state.

Further details about LSS5 are yet to be revealed to the market, which is anxiously awaiting information on the long-awaited third-party access (TPA) to the national power grid, as well as how renewable producers can export power, particularly to Singapore.

“Some growers lease their land to RE operators from LSS farms at a rental rate of two to three times the average oil palm return on a mature hectare basis. Such moves have helped growers earn an immediate return on rent compared to the typical seven-year gestation period for oil palm, in order to generate a maiden profit after replanting. Leasing less productive land or land earmarked for replanting therefore makes financial sense as it also helps to defer the huge capital expenditure (capex) that would otherwise be required for replanting, which is approximately RM20,000-30,000 per hectare over three years,” the research house explained.

The average oil palm operating profit per mature hectare in FY2023 was estimated to be RM5,027, after an average profit of RM4,444 over the past 10 years.

“According to the latest guidelines from SD Guthrie, which aims to enter the renewable energy sector with a capacity target of 1 GW within five years, each megawatt (mW) of solar power will cost RM2.5 million and require an area of ​​1. 5 to 1.7 ha of land. SD Guthrie expects a return of 8-13% on this RE project,” noted Maybank IB Research.

“Based on our estimated calculations, 1gw of renewable capacity could generate recurring revenue of RM134 million to RM266 million per year using only 1,500-1,700ha of land. This translates into returns ranging from 24 to 54 times higher than the sector’s average oil palm operating profit of RM4,444 per hectare achieved over the past 10 years. To put it another way, each megawatt of investment can result in a net gain of RM134,000 to RM266,000,” he added.

However, Fortress Capital Asset Management (M) Sdn Bhd founder and CEO Datuk Thomas Yong cautions that land use demand for solar projects under LSS may not be significant compared to the total land ownership of listed solar players plantations. Therefore, only a small part of plantation land is affected. In fact, the bigger game is being an RE producer.

The Bursa Malaysia plantation index rose 1.49% to 7,500.86 points since early May, but fell to 7,137.12 points last week.

Yong is neutral on the sector’s outlook in the second half of the year, although he anticipates earnings for plantation companies will likely improve on the back of higher fresh fruit brunch production, as well as stable or higher margins resulting from improved cost structure due to uncertainties arising from geopolitical tensions. as well as demand from major economies such as China.

Developers have been quick to jump on the data center trend, especially those who own land near proposed data center locations.

“As the data center ecosystem supply chain starts with landowners, we see many developers with a land bank being the first to benefit. As more applications are expected to be introduced for data center operators over the next 10 years, the most likely opportunity to strike such deals will be (landowners) in the right locations. There may also be joint venture models where the landowner will benefit in the long run,” Areca Capital Sdn Bhd CEO Danny Wong tells The Edge.

In recent months, UEM Sunrise Bhd (KL:UEMS), Mah Sing Group Bhd (KL:MAHSING) and Sunway Construction Group Bhd (KL:SUNCON) have announced partnerships with data center solutions companies, highlighting such opportunities in the rapidly growing sector industrial member

“These are developers with a significant land bank in Johor and the Klang Valley, as well as strong balance sheets. UEM Sunrise, Sime Darby Property Bhd (KL:SIMEPROP), SP Setia Bhd (KL:SPSETIA), Mah Sing Group, Eco World Development Group Bhd (KL:ECOWLD) and AME Elite Consortium Bhd (KL:AME) are potential developers, who can benefit from the demand for data centers given the location, amenities and infrastructure of the existing land bank. Since data centers need to be located away from residential and commercial property areas for security reasons, developers may choose to set up data centers in existing industrial parks,” says RHB Research senior analyst Loong Kok Wen.

Apart from playing in the data center, it favors companies in the so-called Johor fun.

“We are positive about these companies, even without the data center factor,” he says, adding that UEM Sunrise, Eco World Development and AME Elite played an important role in the Johor theme show given Iskandar Malaysia’s long-standing development history.

Sime Darby Property “is experiencing very strong property sales and (currently) has strategic exposure to the industrial segment,” he notes.

Loong notes that Malaysia’s data center segment has benefited from US-China trade tensions, with companies looking to better manage geopolitical risks.

Fortress Capital’s Yong believes that in addition to land sales, developers can benefit from serving as project managers for data center development, with positions ranging from construction to data center management. The developer may also participate in joint ventures as an asset owner, with the intention of generating stable revenues in the future.

“However, some of them (prospects) may not materialize (as quickly) and may require high initial investment costs. Investors must remember that demand for data centers will only grow gradually,” he warns.

Noting renewed interest in the real estate sector, Yong points to the development of infrastructure projects aimed at improving interconnectivity in the country, as well as favorable government policies such as the Malaysia My Second Home program, as potentially attracting foreign participation in the sector.

“The affordable housing segment is likely to continue to attract demand from young families in urban areas. We believe that residential properties in Penang and industrial properties in Johor can continue to perform well in the second half of the year thanks to favorable policies and FDI inflows,” he says.

Apart from construction, utilities, RE and real estate companies, technology and tech counters have also benefited from the data center boom.

Areca Capital’s Wong points to growing interest in data centers as the government continues to actively promote Malaysia as an ideal location for such land- and energy-intensive investments.

“Demand continues to grow, and data from the April 2023 Knight Frank Malaysia Data Center Report indicates that in 2022 there will be a total of over 900 mw of IT capacity for key data centers in Greater Kuala Lumpur (211 mw) and Johor ( 712 mw). Nasional Bhd (KL:TENAGA) estimates that potential peak energy demand by 2035 will be over 5,000mW, with many data center applications requiring a total of over 10GW. Although not all projects are planned to be implemented, I must admit that this megatrend will continue for many years,” he says.

“The next issue is the capital expenditure for building the data center. Construction companies/contractors, consulting firms, power cables, substations, infrastructure (e.g. power, network, transfer switch), mechanical engineering, ventilation and cooling systems, fixtures and air conditioning… many of which will benefit even before the data center is operational.

“Even the later parts of the supply chain such as UPS (uninterruptible power supply), equipment and servers, transceivers, HDD (hard disk drive) components, etc. are largely linked to the high demand for the data center. They drive the components above and below.

“With strong demand and the potential for a much larger total addressable data center market, power will be the next topic. With careful monitoring of environmental, social and governance criteria, RE is the best alternative, focusing on the huge plantation land bank.

“With much higher potential profits and a better approach to ESG issues, it makes sense for the grower to diversify into renewable energy sources, just as plantation land is earmarked for residential and industrial construction. I believe this will help the lagging plantation sector catch up with this hot topic.”

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