We recently met with Tuan Haji Tifli (Executive Vice President & Chief Financial Controller) and came away feeling more comfortable with Felda Global Ventures (FGV)’s long-term prospects. We gather that FGV has recently reorganized its plantations-related businesses which should result in fairly significant reporting changes and potential improvement in operational efficiency. However, material financial impact may take 1-2 years to be felt. We also gather that FGV is planning to divest its smaller legacy businesses though earnings impact is limited to <1%. Meanwhile, the company is still looking at immediate earnings-accretive acquisitions and we do not rule out higher net gearing of up to 0.5x for either transport- or plantation-related acquisitions to reach its targeted 12 year average tree age by 2019. We maintain our MARKET PERFORM call on FGV with a higher TP of RM2.97 (from RM2.30) as we raise our valuation basis to -1.5x SD on 3- year historical PER of 26.5x Fwd. PER applied on unchanged FY15E EPS of 11.2 sen. We upgrade our valuation basis in recognition of company reorganization efforts which we think should improve sentiment on the back of longer term operational improvements. However, overall upside is limited as we expect CPO prices to weaken to RM2,200/MT in 2H15.

Reshuffling divisions to achieve operational efficiency. FGV has recently reorganized its upstream, downstream and trading divisions, which we think will result in a fairly significant change in reporting figures, although its bottom line should see limited impact, at least in the near term. Recall in late-2013 that FGV acquired the remaining 51% in Felda Holdings Bhd (FHB). Due to legacy issues, the plantations, mills and refineries under FHB were previously operated as separate for-profit businesses. With the current 100% ownership of FHB, FGV is now able to reorganize its business model to achieve more operational efficiencies and synergies within its plantation value chain (see Page 2-3 for the old and new plantation business model and resulting changes). The main reporting change was the reorganization of the Manufacturing, Logistics and Others (MLO) segment into the Trading, Manufacturing, Logistics and Others (TLMO) segment. Going forward, we think intersegment revenues could rise significantly in the Plantation and Downstream segments as CPO and Processed Palm Oil (PPO) sales will be made to the TLMO segment. Theoretically, we think the reorganization should result in some margin expansions although it may take 1-2 years to see the full impact.

Out with the old... We gather that FGV is planning to divest its non-core businesses such as its travel, IT and smaller property operations back to the government (FELDA) at cost. We estimate that divestment proceeds could amount to RM100m-RM150m and will likely be retained for potential acquisitions instead of being paid out as special dividends. Despite the potential divestments, we expect FGV to remain in a net debt position in FY15E of RM370m-RM470m, lower than the previously assumed RM520m. This will result in an unchanged FY15E net gearing position of 0.1x. Also, the sale of non-core businesses is unlikely to have a significant impact on earnings as these are smallish legacy businesses which came with the Felda Holdings takeover in 2013 and make up <1% of total revenue.

…in with the new. Meanwhile, the company is still actively seeking acquisitions and has mentioned that they are concentrating on immediate earnings accretive acquisitions. Although its planned Century Logistics buy did not pan out, FGV is still on the lookout to strengthen its transport businesses, which may still involve M&As. About RM400m remains from FGV’s IPO proceeds, and the company is open to raising Sukuk debt to fund acquisitions. Management mentioned that their ideal gross gearing level would be below 1x (currently about 0.6x) – this may imply that FGV is comfortable with raising up to another RM2.7-RM3.0b of new borrowings which would translate to potential net gearing up to 0.5x. Guided FY15E capex is RM120m-RM130m or 18-20% higher due to upgrading for GST and new SAP systems. Beyond FY15, capex should return to about RM100- RM110m annually.

Plantation acquisitions spree not over yet? To achieve its targeted 12 year average tree age by 2019, we think FGV will have to maintain its replanting and acquisition momentum. FGV’s annual replanting of 10-15k ha since 2008 (totalling 120k ha between 2008 and 2014) should start coming into maturity in 2015. We expect replanting cost of RM250m-RM275m yearly to continue for the foreseeable future in line with FGV’s stated target to reduce average age to 12 years by 2019. As of 2014, about 42% of planted area is <9 years old and management expects average age to decline to 16.5-15.5 years in 2015- 2016. We project average age to decline to a more conservative 16.3-16.0 years in FY15-16E (above the sector average of 10.4 years). Note that a lower average age implies better FFB growth potential. For now, we expect FGV’s FY15-16E FFB growth to be 0%-3% vs. sector average of 6%-6%. However, in order to achieve the targeted 12 year average age by 2019, we think FGV would have to continue acquiring about 15k ha annually in addition to its on-going 15k ha replanting scheme. Based on its current momentum, we do not rule out the possibility of FGV increasing its net gearing or embarking on fund raising exercises in the next 4-5 years in order to achieve its target average age. However, for the next 2-3 years we are comfortable that the company should be able to proceed with its growth strategy while maintaining its net gearing below 0.5x.

Look to 4Q14 downstream improvement. We are optimistic that the coming 4Q14 results should see improvement QoQ and YoY, especially in the downstream segment. QoQ, we gather that the 3Q14 unrealised commodity contract losses of RM52m have been mostly reversed in 4Q14. Meanwhile, on a YoY basis, we understand that weather conditions in its Canadian operations have been more favourable compared to 4Q13 when operations were disrupted due to a deep freeze in North America. Hence, we expect to see recovery in the downstream segment in 4Q14 against 4Q14 LBT of RM38m and 3Q14 LBT of RM117m. In light of the expected downstream segment’s improvement, we think FY14 has a better chance of meeting our FY14E Core Net Profit (CNP) of RM433m (note that 9M14 CNP is RM248m). However, we maintain our FY15-FY16E earnings pending the actual results from the reorganization in coming quarters.

Maintain MARKET PERFORM on FGV with higher TP of RM2.97. We upgrade our TP to RM2.97 (from RM2.30) based on a higher Fwd. PER of 26.5x against an unchanged Fwd. EPS of 11.2 sen. Our 26.5x Fwd. PER is based on a slightly higher valuation basis of - 1.5SD (from -2.0SD previously) which is indicative of FGV’s reorganization efforts which should improve sentiment on the back of longer-term operational improvements.

The media has recently speculated a potential change in FGV’s leadership. On 14-Feb-15, The Star reported that “Tan Sri Ismee Ismail [MD & CEO of Lembaga Tabung Haji] is expected to replace FGV’s current group president and CEO Dr Mohammed Emir Mavani Abdullah, whose contract comes to an end this July”. This may have contributed to the recent share price rally seen in FGV.

However, fundamentally, we reckon that our valuation basis of -1.5SD for FGV is decent as: (i) we prefer to wait for confirmation of better numbers from reorganization efforts, (ii) we are applying mean valuation basis on most planters under our coverage with decent FFB growth, (iii) sector dynamics remains unappealing as we expect CPO prices to weaken to RM2,200/MT in 2H15. We may consider applying a higher valuation basis if FGV’s downstream operations see sustainable recovery.          

Source: Kenanga