Can I learn to love this small-cap palm oil stock?

MP Evans (LSE: MPE) is a small stock that catches my eye for many good reasons. The £456m market capitalization company has grown profits by an average of 27% a year over the past five years. An average operating margin of 24% is impressive. Cash flow and earnings on a per-share basis grew 33% and 44% on average annually over half a decade.

The company continues to impress with its balance sheet. Liquidity appears to be good as current assets are at least twice the current liabilities. A debt-to-equity ratio of 0.35 means low leverage. So far so good. But the business that MP Evans is doing gives me pause for thought.

The problem of palm oil production

In 2015 I was in Penang, Malaysia. The air was hazy and smelled of smoke. This smog has crossed the ocean from Indonesia where forests are burning. The World Resources Institute suggests most of the fires are human-caused and linked to the agricultural industry, particularly palm oil, of which Indonesia is the world’s largest exporter.

MP Evans is an Indonesian palm oil producer. However, make a case for doing this sustainably. All palm oil produced from company-owned plantations is certified sustainable according to the Roundtable for Sustainable Palm Oil standards. The same goes for small managed farmers. But the company also receives oil palm fruit from non-verified independent farmers for its factories. By 2020, the date of the last independent sustainability report, 27% of total production could not be confirmed as sustainable.

The plan is to increase that figure to 100% next year. That will be reassuring. But why accept unverified products? Why not just take it from small farmers where the company is satisfied producing sustainably? Yes, because the company can process more oil palm fruits than and verified small farmers can grow.

Small stock watch list

MP Evans is also now exiting property development operations in Malaysia. It divested 70 hectares of land from its wholly-owned subsidiary to a joint venture in 2021. It currently owns 200 hectares. I may be cynical, but this adjustment suggests that there is room for selling parcels when group earnings are not expected to match forecasts. However, I like MP Evans’ plan to focus on one thing: palm oil.

Palm oil is the most popular and most traded vegetable oil in the world. The demand has increased by 7% every year since 1990. According to one report, about half of the products in British supermarkets contain palm oil. Looks like a decent business. And the company’s operating numbers support this.

However, it should be noted that the company’s operating margin tends to decrease when the average annual price of crude palm oil decreases and increases when it increases. It is because it is the price taker in the commodity market.

All things considered, even if MP Evans now deserves to be on the watch list, it will not end up in the Stocks and Shares ISA just yet. The next independent sustainability report will follow shortly. I would like to see what progress has been made on this front and see how I feel about this small-cap stock then.