Investment Highlights

• Maintain HOLD on TSH Resources with a lower fair value of RM1.40/share (vs. RM1.70/share previously). Our fair value is based on an FY19F PE of 20x. We have reduced TSH’s FY19F net profit by 17.7% to account for a lower EBIT margin for the palm division.

• TSH has implemented the MFRS141 accounting standard in its 1QFY18 results. This resulted in the depreciation expense increasing by 63.5% from RM14.1mil in 1QFY17 (before restatement) to RM23.0mil in 1QFY18. We have already imputed the effects of the higher depreciation expense in our earnings forecast.

• In spite of this, TSH's 1QFY18 results were still below our expectations and consensus estimates. This is due to three reasons. First, palm EBIT margin came in weaker than estimated due to the fall in CPO prices. Second, we believe that TSH’s production cost per tonne increased YoY in 1QFY18 as costs are high for new areas coming into maturity. Third, TSH’s effective tax rate rose from 19.2% in 1QFY17 to 34.3% in 1QFY18 due to under-provisioning in prior years.

• Hence, we have reduced TSH's FY18F net profit by 23.2% to account for a weaker-than-expected palm EBIT margin and a lower average CPO price assumption of RM2,450/tonne vs. RM2,650/tonne previously. We have also cut TSH's FY19F net profit by 4.5% to account for a CPO price assumption of RM2,500/tonne vs. RM2,750/tonne originally.

• On the back of a lower CPO price and higher expenses, TSH's operating profit margin slid from 14.8% in 1QFY17 to 11.2% in 1QFY18. Apart from the higher upkeep and maintenance costs for young mature areas, we believe that the decline in operating profit margin in 1QFY18 was due to increases in fertiliser and minimum wages. We reckon that fertiliser costs climbed by single-digit percentage YoY in 1QFY18 while minimum wage went up by more than 8% in Indonesia.

• Although TSH's FFB production expanded by 21.8% YoY in 1QFY18, this was not enough to offset the negative impact of a decline in CPO price. Average CPO price realised was RM2,316/tonne in 1QFY18, 22.4% lower than the RM2,985/tonne recorded in 1QFY17.

• TSH's FFB output growth of 21.8% in1QFY18 was led by the Indonesia unit. The Indonesia division recorded a 24.1% YoY increase in FFB production in 1QFY18 while the Malaysia unit registered a 10.3% rise. Indonesia accounted for 84% of group FFB production in 1QFY18.

• Net gearing rose from 94.8% as at end-December 2017 to 102.4% as at end-March 2018 as shareholders’ funds shrank on a decline in foreign exchange reserves. About 22.4% of TSH's borrowings were denominated in foreign currencies as at end-March 2018.

Source: AmInvest Research - 24 May 2018