We believe that Sime Darby’s (SIME) 9M14 Core Net Profit (CNP) is likely to miss both consensus and our estimate as our estimate shows that its 9M14 CNP is expected to make up only 69% of consensus (RM3.19b) and 63% of ours (RM3.49b). Reason for the underperformance is likely due to lower than expected FFB production so far in 9M14 which has declined 12% to 7.13m MT. Nevertheless, the 3Q14 CNP should still be better both YoY and QoQ as CPO prices has improved. We have reduced our FY14E CNP by 12% to RM3.06b after reducing our FY14E FFB production by 16% to 9.42m MT. FY15E CNP is also cut by 9% to RM3.67b as we have lowered our FY15E FFB production by 6% to 11.37m MT. Separately, SIME is selling its 9.9% stake in E&O and we are overall neutral on the deal. Our recommendation on SIME has been downgraded to MARKET PERFORM with unchanged Target Price of RM10.00. Despite our earnings estimate reduction, we maintain our Target Price of RM10.00 as we have rolled over our Sum-Of-Parts valuation to FY15E earnings (from CY14E earnings previously). Although SIME Fwd. PE of 15.6x is still lower than IOICORP’s 20.6x and KLK’s 19.1x, the stock is lacking near term catalyst due to the expected 7% FFB volume decline for FY14.

Earnings likely to miss. SIME is expected to release its 9M14 result before end of May and we believe that its 9M14 CNP is likely to miss both consensus and our estimate. Overall, we expect 3Q14 CNP to be in the range of RM850m to RM900m and this should bring 9M14 CNP to be between RM2.17b and RM2.22b. As a result, SIME 9M14 is expected to make up only 69% of consensus (RM3.19b) and 63% of ours (RM3.49b).

Tree stress impact worse than expected. Based on SIME announcement to Bursa, its 9M14 FFB productions is lower than expected as it declined 12% to 7.13m MT. This is significantly lower than the initial target of 2% decline for FY14 given during its last briefing in Feb-2014. It is also lower than our estimate of 3% FFB growth for FY14.

But we do expect improvement YoY and QoQ. We believe that 3Q14 CNP should still be better YoY and we expect 30% growth to due to higher CPO prices which has improved 15% to RM2681/MT based on MPOB data. QoQ, SIME 3Q14 CNP should grow 7%, again due to higher CPO prices which has improved 7% QoQ to RM2681/MT based on MPOB data. The earnings growth QoQ is limited due to seasonally lower FFB volume (-18% to 2.10m MT).

Selling 10% stake in E&O. Separately, SIME has announced that it is selling 110m shares in Eastern & Oriental (E&O) or 9.9% stake for RM319m. While we believe that the move is strategically good, it does not change SIME long term fundamental which still depend more on CPO prices and FFB production volume. Hence, we are overall neutral on the deal. (More details at Page 2) Overall, earnings are revised down. We have reduced our FY14E CNP by 12% to RM3.06b after reducing our FY14E FFB production by 16% to 9.42m MT. Effectively, we are now assuming FY14E FFB decline of 7% (against our earlier estimate of 3% growth). However, FY14E net profit is reduced by only 11% to RM3.17b after imputing the one-off RM56m gain from the sale of E&O stake. FY15E CNP is cut by 9% to RM3.67b as we have lowered our FY15E FFB production by 6% to 11.37m MT. FY15E CNP is same as net profit as we expect the one off E&O gain to only boost FY14E earnings but not FY15E.

Downgrade to MARKET PERFORM with unchanged Target Price of RM10.00. Despite our earnings estimate reduction, we maintain our Target Price of RM10.00 as we have rolled over our Sum-Of-Parts valuation to FY15E earnings (from CY14E earnings previously). In our Sum-Of-Parts valuation, the plantation division is valued at 18.7x Fwd. PER which is in line with big cap planters’ valuation. At current share price, we expect total return of 7.7% (4.7% upside and 3.0% dividend yield). Although SIME Fwd. PE of 15.6x is still lower than IOICORP’s 20.6x and KLK’s 19.1x, the stock is lacking near term catalyst due to the expected 7% FFB volume decline for FY14. Consistent with our house definition, we have downgraded the stock to MARKET PERFORM as it now offers less than 10% total return.

Details of E&O deal. The deal values E&O at RM2.90 per share. The block of shares will be sold to Morning Crest Sdn. Bhd. (MCSB) which is a Company substantially owned by Datuk Terry Tham Ka Hon (DTKH). Post the disposal, SIME will still retain 22% stake in E&O. SIME is expected to record a one off gain of RM56m from this disposal. Justification for the deal is because the deal will further align the interests of DTKH and key senior personnel with that of E&O. We believe that the move is strategically good as SIME is able to lock in gain of 28% since it first invested in E&O in Sep-2011. Adjusted for the holding period of 2.75 years, the annual return of 9.4% seems attractive in our view. Additionally, SIME can still participate in E&O long term growth through its 22% stake in the Company. However, it does not change SIME long term fundamental which still depend more on CPO prices and FFB production volume. Hence, we are overall neutral on the deal.

Source: Kenanga