We believe earnings prospects for TSH will remain bleak for the next 1-2 years, on the back of: (i) adoption of MFRS 141 and 116 (effective Jan-2018) and (ii) rising production cost. Cut FY18-19 core net profit forecasts by 0.3-7%. Post earnings revision and rolling forward of valuation, we cut our TP to RM1.39 (from RM1.42). We maintain HOLD recommendation on the stock, as valuations have become more compelling following the recent sell-down.

Below are the key takeaways from our recent meeting with TSH’s management:

FFB production growth trajectory continues. TSH’s FFB production grew 18.5% to 706k tonnes in FY17, on the back of FFB yield recovery in Malaysia and larger area attained maturity in Indonesia. We are projecting FFB production to grow further (albeit at a slower rate) in FY18-20 (see Figure #1), underpinned mainly by more areas attaining maturity in Indonesia.

Impact of MFRS 116 & 141 adoption. The adoption of MFRS 141 and 116 (effective 1 Jan 2018) will result in TSH’s depreciation charges increasing by c.50% (or RM25m, based on our estimates). Apart from higher depreciation charges, the migration to MFRS 116 and 141 will result in TSH’s net gearing increasing marginally to 0.9-1.0x (from 0.88x in end-FY17). Under the MFRS 116 and 161, plantation companies (including TSH) will capitalise replanting expenses during the course of planting and commence depreciation charges once the planted area graduates to mature bracket. This, in short, means plantation companies with large amount of planted land bank with young age profile (which FFB yields have yet to attain optimal level) will be hit with higher depreciation charges.

Production cost remains on uptrend. Higher depreciation charges aside, management highlighted that cash production cost remains on the uptrend (on blended basis), mainly on the back of higher finance cost (as more areas move into mature bracket, resulting in higher amount of finance cost being expensed), minimum wage hike, higher fertiliser cost in Indonesia.

Effective tax rate to normalise from 2018. Recall, TSH’s effective tax rate skyrocketed to 38.7% in 4Q17 (from 28.9% in 3Q17) and this was due mainly to under provision in prior year’s taxable income. Management views this as non-recurring and expects effective tax rate to normalise to 25-26% from FY18 onwards.

Minimal new planting in FY18. Despite its sizeable unplanted area (circa 57,000 ha in end-FY17), new planting will likely remain minimal given TSH’s high net gearing level. We believe TSH would resume in more aggressive new planting programme from FY20 onwards (based on our estimates, mature area will increase by circa 10,000 ha from 29,000 ha in end-FY17, and this will result in higher FFB production and hence better financial position).

Forecast. We cut our FY18-19 core net profit forecasts by 7% and 0.3%, largely to reflect higher depreciation charge and finance cost assumptions, but partly offset by higher FFB production and lower effective tax rate assumptions.

Maintain HOLD, TP: RM1.36. SOP-derived TP adjusted lower by 2.1% to RM1.39, to reflect: (1) Downward adjustment in our core net profit forecasts; (2) The roll forward of our valuation base year (from FY18 to FY19), and (3) The latest market price of 22%-owned associate (Innoprise). Maintain HOLD recommendation. Valuations have become more compelling following the recent sell-down. At RM1.37, TSH is trading at FY18-19 P/E of 19.1x and 18.1x respectively.

Source: Hong Leong Investment Bank Research - 18 Apr 2018