Investment Highlights

• We are downgrading our recommendation on Sime Darby Plantation (SDP) to SELL from HOLD with a lower fair value of RM3.60/share vs. RM4.40/share previously. Our fair value is based on a FY23F PE of 18x compared with 22x originally. The PE of 18x is a rough 20% discount to the PE of 22x that we have assumed for the big-cap plantation companies such as KL Kepong and IOI Corporation.

• We have assumed a weaker PE for SDP to account for the risk of a loss of customers and higher valuation discount for ESG concerns. Although we have reduced SDP’s rating for migrant workers welfare to 2 stars from 3 stars, SDP’s overall ESG rating continues to be 3 stars due to its positive contribution to corporate social responsibility and transparency.

• Last Friday, SDP announced that the US CBP has filed a Notice of Finding on the company. Under the Notice of Finding, the US CBP has determined that certain palm products were produced using forced, convicted and indentured labour. Essentially, we believe that the US CBP has received other evidence of wrongdoing by SDP.

• The latest development on SDP is expected to hit the sentiment on the rest of the companies in the plantation sector. ESG concerns will continue to be a drag on valuations.

• Although SDP has not lost any major customer since its Malaysian palm products were banned by the US in lateFY20, there is a risk that the group’s European customers may be concerned by the latest development and start cancelling orders. The EU accounted for a much larger share of 23.8% of SDP’s revenue in FY20 while the US accounted for only US$5mil of SDP’s sales.

• We believe that SDP will take a long time to resolve its current predicament. SDP has appointed an independent ethical trade consultant to carry out a full scale and independent assessment of its operations in Malaysia.

• In the meantime, we are keeping our FY22F net profit forecast of RM1.4bil for SDP. We reckon that SDP would be providing updates and assurances to its customers on it efforts to resolve the ban on its Malaysian palm products in the USA.

Source: AmInvest Research - 31 Jan 2022