- Pending greater clarity from the Sarawak state government of its policy on existing timber concessionaires – including two companies under our coverage Jaya Tiasa Holdings Bhd and Ta Ann Holdings Bhd – we are downgrading the sector to NEUTRAL, and the two stocks to HOLD.

- While we do not believe Jaya Tiasa and Ta Ann would be affected by the probe on illegal logging activities, we understand from industry players that a seeming overhaul of the industry may see a reduction of existing quotas held by the concessionaires. We understand a decision on the quota could be finalised within the next 2 months.

- In an unprecedented move, the Malaysian Anti-Corruption Commission (MACC) has frozen 400 individual and corporate bank accounts involving RM600mil, and conducted simultaneous raids at 48 log ponds, sawmills and business premises. We understand from industry players that the raids had over the last two days virtually affected all the timber players across the board.

- The state government itself is working with the concessionaires towards adopting a more sustainable forest management practice. It has been reported that the top six logging firms – Samling, Rimbunan Hijau (including Jaya Tiasa), Ta Ann, KTS, Shin Yang and WTK – have signed corporate integrity pledges, while their owners have given their personal undertakings to the state CM Adenan Satem to assist in tackling timber corruption.

- In an announcement yesterday, Ta Ann said it was cooperating fully with the MACC on its investigation into illegal logging, and that it was not affecting the group’s operations. It offered assurance the legality and certification of its raw material input, while its financial statements have all had unqualified audit opinions.

- In the meantime, we are told that state efforts could potentially include the cutting of log production quota. Other administrative measures that have already been implemented include the need for marking of logs (for royalty payments and enforcement purposes) to be done at the points of harvest, instead of at central collection ponds.

- There will likely be short-term pain for the timber players in view of the stricter enforcement of regulations, including facing delays in the delivery of logs as a result of the new marking requirements at harvest points.

- The exact negative impact on Jaya Tiasa and Ta Ann is still unclear. We believe the impact on Ta Ann will be limited given its already small concession of less than 500,000 cu per annum. Furthermore, as per earlier guidance, we have earlier already factored in a 19% reduction in log sales to 150,000 cu m for each of FY15FFY17F from 177,058 cu m in FY14.

- However, we have cut Jaya Tiasa’s monthly logging quota of 92,000 cu m by 24% to 70,000 cu m or from 1.1mil cu m to 840,000 cu m per annum for each of FY16F-FY17F vs. ~900,000 cu m (-10% from 1.1mil cu m previously) for FY15F.

- Given that much of its concessions are in the deep interior of the state, we understand that Jaya Tiasa has also seen delays in bringing logs downstream as a result of the location marking requirements. However, we expect the log delivery to normalise within the medium term.

- Accordingly, we have cut Jaya Tiasa’s timber aggregate earnings by 7% and 33% for FY15F and FY16F, respectively to RM56mil and RM39mil. On the structural issues at Jaya Tiasa’s plantation division, we have earlier already factored in low FFB yields for the next 2-3 years.

- Mitigating factors to come out of the overhaul of the industry could be the sustaining of international log prices given the shrinking of supply, as well as the weak ringgit. In line with our earlier reports, we understand that log supply in Sarawak has shrunk by 25%-30% since the start of state operations.

- We downgrade both Jaya Tiasa and Ta Ann from BUY to HOLD. We cut Jaya Tiasa’s fair value to RM1.57/share from RM2.13/share previously, with an implied FY16F-FY17F calendarised PE of 16x, while our fair value for Ta Ann is cut to RM3.98/share based on a PE of 14x (vs. 16x previously) on FY15F EPS.

Source: AmeSecurities Research - 15 May 2015