Money Growing on TFS' Trees
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Indian sandalwood is running scarce, having been over-harvested almost to extinction in the traditional source areas of India, Timor and Indonesia, where wild harvesting is now illegal. Enter Australia, and TFS Corporation, which produced its first commercial harvest of Indian sandalwood in 2014.
It’s one of Australia’s agribusiness success stories – or should that read, one of Australia’s biotech success stories? Both, if recent developments at forestry company TFS Corporation (TFC) are any indication.
TFS owns and operates the world’s largest plantations of Indian sandalwood, a hardwood that happens to be the world’s most expensive tropical hardwood. Sandalwood has been prized for centuries in Asia for its role in Buddhist and Hindu religious ceremonies – in which sandalwood joss-sticks are burned as incense – and in Ayurvedic and Chinese medicine, as well as a high-quality carving wood.
These days the wood is mainly used as incense – about one billion incense sticks are burnt each day throughout Asia – and as an ingredient in fragrances, cosmetics, toiletries and essential oils, and in Indian consumer products. If you have ever smelled the perfumes “Obsession” by Calvin Klein and “Opium” by Yves St Laurent, sandalwood is a major part of the scent.
While the traditional uses of sandalwood alone guarantee it a growing market, the pharmaceutical industry is getting increasingly excited about the bio-active qualities of sandalwood oil.
But Indian sandalwood is running scarce, having been over-harvested almost to extinction in the traditional source areas of India, Timor and Indonesia, where wild harvesting is now illegal. With the virtual disappearance of the natural stands, there is not nearly enough wood to satisfy the enormous worldwide demand – particularly from China, where demand is growing at 60 per cent a year – and prices are skyrocketing for what wood there is available.
Enter Australia, and TFS Corporation, which produced its first commercial harvest of Indian sandalwood in 2014, 15 years after planting its first trees.
In the early 1980s, Western Australia's Forest Department was looking for crops that could be grown in the Ord River Irrigation Area, in the north of the state. They tried tropical Indian sandalwood, and it worked. Perth lawyer Frank Wilson – who came from a timber-growing family – saw the potential, and founded Tropical Forestry Services (TFS) in 1997 with a group of investors, employing a team of WA Government foresters who had gained years of sandalwood growing experience on the ORIA.
TFS planted its first Indian sandalwood plantations near Kununurra in 1999, on the tax-effective managed investment scheme (MIS) model, which was later to become notorious with the high-profile collapses of Timbercorp, Great Southern Plantations and several others. Under that model, the agribusiness promoters offered managed investments for investors looking to lower their tax bill through a tax ruling that deemed them to be eligible for tax deductions as primary producers, investing in forestry to earn future income, on which they would be taxed.
TFS is one of the few operators left in that space, but its operations have moved well past MIS investors. TFS now manages the largest area of Indian sandalwood plantations in the world, with more than 10,000 hectares planted in northern Western Australia, the Northern Territory and Queensland, of which TFS owns (directly and indirectly) nearly 3,200 hectares. The rest of the TFS plantations are managed on behalf of investors, the bulk of which are institutional and high-net-worth investors. For example, in May, Harvard University’s endowment fund was confirmed as a co-investor in one of TFS’ Northern Territory plantations. Harvard has been a pioneer in investing in ‘timberland’ as a portfolio diversifier, which gives it returns uncorrelated with the stock and bond markets.
What these investors see is what set TFS apart from the other MIS plantation companies – the unique attributes, and market position, of its crop.
Last year – the year that TFS completed its first commercial crop of Indian sandalwood – the company, through its 50% subsidiary Santalis Pharmaceuticals Inc., struck a supply agreement for pharmaceutical-grade oil with Galderma, a leading global dermatology company owned by Nestlé. The long-term agreement is at a price of US$4,500 a kilogram.
Galderma launched the first products containing TFS’ pharmaceutical-grade sandalwood oil, the Benzac acne treatment range, in the US and Australian markets earlier this year. In June, TFS announced that it would buy Santalis and its other US-based pharmaceutical partner, ViroXis Corporation, for a combined minimum price of US$23.4 million, comprising US$1.5 million in cash and US$21.9 million in TFC shares. ViroXis and Santalis are well-advanced in the formulation, testing and commercialisation of other dermatology products containing TFS’ pharmaceutical-grade sandalwood oil, and TFS wanted to directly control and benefit from the distribution of these products, and secure 100% of the royalty and licence fees generated. New products are being developed for common skin conditions that respond well to sandalwood oil, including eczema, HPV (human papilloma virus) warts and psoriasis.
TFS has been building toward this outcome since 2008, when it bought WA company Mount Romance, the world's largest distiller of Sandalwood oil, and started working with bio-medical researchers in the US to develop pharmaceutical uses for its oil. TFS set up a processing facility at Kununurra, and produced and sold its first distillations of sandalwood oil from its own trees in 2013. Back then, the company’s plan was to be vertically integrated from “soil to oil.” But TFS has taken that idea further by buying out its pharmaceutical partners – the mantra is now “soil to oil to shelf.”
TFS could not have done this without 16 years of experience of growing the trees, and seven years of learning how to distil the oil. It is a significant bank of intellectual property that sets the company apart. Capitalised at $523 million TFS is virtually a monopoly in both the large-scale commercial production of Indian sandalwood timber, and pharmaceutical-grade sandalwood oil: the business is fully integrated, from the genetic research to the production of seedlings to the distillation of oil. The tree heartwood is processed into oil and the oil, wood and finished products are distributed to more than 30 countries. The operation is the only large-scale sustainable source of Indian sandalwood timber and oil in the world.
It is very early days in terms of production for TFS, but it is poised to scale-up significantly as its years of planting start to mature. In its second year of harvesting, the tally was just 200 tonnes of sandalwood timber, but the company expects 10 times that in 2016, and 10 times that again in 2017. It is planning 15,000 hectares of new plantations around Katherine in the Northern Territory and Ayr in north Queensland, in slightly milder climate than the Kimberley. By 2025 TFS expects to have 25,000 hectares of cultivated sandalwood under ultra-efficient drip irrigation, with nearly a million trees being harvested annually.
Also in the blueprint is a second $15 million oil distillation plant, either at Katherine or Kununurra. By then the company expects to have its own retail brand for its planned line of skincare and oil products aimed at the ¬Indian and Chinese markets.
TFS CEO Wilson has stated that the company expects to generate exports of $1 billion over the next decade. In FY2014 TFS reported a record net profit of $82.5 million, up 48%, on the back of revenue that rose by 13% to $212.2 million (revenue comes from establishment of plantations on behalf of investors, sales of product and revaluation of biological assets)
TFS reports FY15 results on August 28. The company expects to report results in line with its previous guidance, with cash EBITDA (earnings before interest, tax, depreciation and amortisation) up by approximately 10% on FY14, and net profit of at least $90 million, which would represent a rise of 9%. But after a 42 million share placement in 2014, that is expected on market consensus to represent a 39% fall in earnings per share (EPS). The market expects the fully franked dividend to be maintained at 3 cents a share. More importantly, UBS analysts have a target price of $2.60 on TFS – that is a cool 62% higher than the current market price of $1.60.
James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au