News    Ta Ann announced that its 88%-owned subsidiary, Ta Ann Tasmania (“TAT”) had agreed to surrender partially its peeler wood supply entitlement held under contracts with Forestry Tasmania. In return, the Australian Government agreed to a conditional compensation of AUD28.6m (equivalent to RM85.8m). 

We gather that TAT is surrendering 108,000 m3 per annum of its native forest veneer peeler billet supply. As its original supply entitlement is 265,000 m3, this will reduce its supply to 157,000 m3 

As for the AUD28.6m payment, we understand that it will be paid in two tranches. The first tranche of AUD22.33m will be paid upon signing of the Agreement with the balance to be paid after TAT complies with its Substantive Obligations under the Agreement (expected by 1 Sep 2014).

For FY13E, Ta Ann expects its earnings to increase by RM51.38m due to the first tranche compensation payment.

Comments    We are neutral on the deal as Ta Ann’s core earnings will not change significantly. Our estimate shows that its FY14E core earnings may increase by only 2% due to the higher interest income from the cash received.

Outlook   We believe the high cost issue to maintain its Tasmania veneer mills will continue to persist for Ta Ann. As explained in Ta Ann’s announcement, the reduction in billet supply will result in its veneer mills operating at below capacity, which would lead to a higher unit overhead cost. However, this is neutralised by the fact that the compensation payment will be sufficient to offset the higher unit fixed cost for the next 10 years.

Forecast   Maintaining FY13E-FY14E core earnings of RM57mRM103m. However, we have raised our FY13E-FY14E net profit numbers by 91%-18% to RM109mRM122m to account for the compensation payment. 

Rating    Downgrade to UNDERPERFORM

Cost escalation may continue due to the lower supply of billet to its veneer mills. Hence, the risk of a potential earnings miss remains.

Valuation    Maintaining our TP of RM3.55 based on an unchanged Fwd. PER of 12.8x on our CY14E EPS of 27.7 sen.

Risks   Lower than expected CPO price.

Lower than expected timber products price.

Higher than expected cost.

Source: Kenanga