SDPL’s 3QFY18 results are below our expectation as we had underestimated sukuk expenses, but operating performance is within expectation. The weaker qoq and yoy net profit was mainly due to weaker FFB production and CPO ASP. We maintain our FFB production growth assumption of 10% yoy for FY18. We have reduced our FY18-20 net profit forecasts by 8.0%, 10.2% and 8.4% respectively to factor in higher sukuk charges. Maintain SELL with a lower target price of RM4.30.

RESULTS

• Results below expectations. Sime Darby Plantation (SDPL) reported a core net profit of RM227m (-47.1% qoq, -44.6% yoy) in 3QFY18, bringing 9MFY18 core net profit to RM904m (+2.7% yoy). Core net profit was lower than expected as we had underestimated sukuk charges. Operating performance was within expectations.

• Net profit was weaker qoq in 3QFY18 due to a weaker upstream performance on: a) lower fresh fruit bunch (FFB) production in Indonesia and Malaysia; and b) weaker realised CPO prices. Meanwhile, downstream operation results are on a par with 2QFY18’s, supported by improved refining margins due to lower feedstock costs.

• Weaker yoy earnings in 3QFY18 were mainly due to lower FFB production in Indonesia and Papua New Guinea (PNG) and weaker realised CPO prices. The lower FFB production in Indonesia was largely due to aggressive replanting efforts in Kalimantan and with harvesting activity in Sumatra impacted by floods.

STOCK IMPACT

• Maintain FY18 FFB production growth assumption. As of 9MFY18, FFB production was at 7.796m tonnes (+6.4% yoy), accounting for 72% of our FY18 FFB production assumption. We maintain our FFB production growth assumption of 10% yoy for FY18. FFB growth in FY18 will be driven by a yield recovery as the lagged impact from the severe drought in 2015 is weakening. Malaysia FFB production is likely to meet our expectation for FY18, but Indonesia’s and PNG’s FFB production could come in lower than our expectations if FFB production does not pick up in May-Jun 18. With every 1ppt reduction in FFB production growth, FY18 net profit will see a 0.2% adjustment.

• High rainfall in Indonesia affects harvesting activity. We understand that the adverse weather in Indonesia, especially in Sumatra, had led to flooding which affected the harvesting activity as well as impacted estate roads. Infrastructure costs are expected to increase and most of the costs will be capitalised.

• Impact from new government:
  • Potential increase in minimum wages. The current minimum wage is RM1,000 for Peninsular Malaysia and RM920 for Sabah and Sarawak. If Malaysia’s new government raises the minimum wage to RM1,500, we understand that this will increase SDPL’s labour expense to RM650m or 35% of total operating costs from RM450m or 26% of total operating costs. This will affect our 2018 net profit forecast by 11%. Pakatan Harapan (PH) has also promised in its manifesto to help alleviate the burden of employers by subsidising half of the additional wage cost. If this materialises, the increase in minimum wage will affect our 2018 net profit forecast by 5.5%
  • Potential reduction in foreign worker supply. In its manifesto, PH also indicated that it will reduce the foreign worker supply from 6m people to 4m people. The plantation sector heavily relies on foreign workers. Foreign workers consist of more than 75% of SDPL’s workforce. The cut in foreign worker supply is expected to negatively impact SDPL’s operations. On a positive note, mechanisation covers 85% of SDPL’s estates in Malaysia which helps reduce dependency on foreign workers.
  • Implementation of SST. The implementation of the sales and services tax (SST) could increase operating costs. However, it is too early to determine the actual impact to earnings.
• Divestment of non-profitable assets. Management continues to review non-core, nonprofitable assets as part of the group restructuring process. Management indicated that SDPL will cease further investment in Verdenzyne (VDZ) due to uncertainties and significant risk relating to VDZ’s new business plan. SDPL could record impairment of RM206m (carrying amount fo RM177m and other potential liability) in 4QFY18.
• Net gearing ratio reduced. With the improved operating cash flow arising from higher profits and capex control, SDPL’s net gearing ratio decreased to 0.35x as of 31 Mar 18 from 0.57x as of 30 Jun 17. Management plans to reduce gearing further to an ideal level of 0.25-0.30x.

EARNINGS REVISION/RISK

• Changes to FYE. SDPL will change its financial year-end (FYE) from 30 June to 31 December, and this will be implemented after FY18 (Jun 18). The next audited financial statements of SDPL shall be from 1 Jul 18 to 31 Dec 18 (a period of six months).

• We have reduced our FY18-20 net profit forecasts by 8.0%, 10.2% and 8.4% respectively to factor in sukuk charges (RM30-RM32m each quarter). Our FYE for FY18- 20 net profit forecasts are still at 30 June. We would only make FYE changes after the close of FY18. We forecast net profits of RM1,352m, RM1,064m and RM1,351m for FY18-20 respectively.

VALUATION/RECOMMENDATION

• Maintain SELL with a lower target price of RM4.30 (from RM4.70) post earnings forecast adjustments. We value SDPL at 2019F PE of 24x, or +1SD of SIME’s 5-year mean PE.

Source: UOB Kay Hian Research - 1 Jun 2018