We recently met up with the Managing Directors at Sime Darby Berhad (SIME), namely Plantation MD Datuk Franki Anthony Dass, Energy & Utilities (China) MD Mr Timothy Lee, Energy & Utilities (Non-China) MD Mr Alan Hamzah, Industrials MD Mr Scott Cameron, and Motors MD Dato’ Lawrence Lee in a Q&A session to discuss their respective divisions' outlooks. We came away with our bearish mid-term view on SIME intact as we gather that the Industrials and Motors segments may continue to see headwinds on weaker global economies. Hence, we slightly lower our TP to RM7.80 (from RM8.00) based on Sum-of-Parts with lower Industrials and Motors segment earnings outlook. However, we upgrade our call to MARKET PERFORM (from UNDERPERFORM) as we believe the recent share price correction has largely priced in the softer earnings outlook for FY16. Below are the key takeaways from the meeting.

Weakening FY16-17E FFB production outlook. Management reiterated their recent comments that its FY16E FFB production is estimated at 10.05-10.11m MT, although they expect declines in Malaysia (-4 to -6%) and Indonesia (-8 to -10%). However, management expects FY17E production and replanting in Malaysia (4% of planted area) and Indonesia (7% of planted area) to result in production decline for the year. This is contrary to our 4% growth forecast. Thus, after accounting for replanting, we estimate a potential FY17E FFB decline of 1%, resulting in production of 10.20m MT.

Optimistic on CPO prices. Management appears optimistic that CPO prices should appreciate from March onwards to about RM2,500-2,600/MT in Apr-May 2016, and potentially higher in May-Jun due to weaker production. Although we agree with management, we think prices could decline strongly in 3Q16 due to seasonal production pickup, while 4Q16 prices could rebound in line with seasonal decline and potential soy production weakness due to poorer weather in the Americas seen in 1Q16. With potentially soft CPO prices in 1Q16/3Q16 likely to offset a stronger 2Q16/4Q16, we maintain our FY16E CPO forecast at RM2,400/MT.

Expecting soft long-term Industrial outlook. Management observed that coal prices are likely to be stable at current levels for the next few years as prices have fallen close to marginal cost of production. We understand that with coal prices at this level, there is little room for new equipment expenditure, although supporting services should remain stable due to maintenance of existing equipment. Management also mentioned that their strategy looking ahead is to preserve or gradually expand market share, but we believe this may come at the expense of margins, which were declining in FY15 (4.9%, or -3.7% YoY). We believe this trend is likely to persist so long coal prices remain near ten-year lows, and hence expect margins to further fall to 2.7% through FY16-17E.

Motors outlook is challenging too. With the weaker consumer sentiment and tighter lending conditions, management thinks that the short-term outlook for Motors will be challenging. We understand that sales volume should nevertheless be sustained as Singapore’s lower Certificate of Entitlement (COE) premiums should boost vehicle demand. However, we believe group margins are likely to weaken in FY16 due to the stronger USD, combined with poor consumer sentiment in other countries resulting in stronger competition. Thus, we expect FY16-17E EBIT margin to range between 2.1- 2.3%, slightly softer than the 2.5% in FY15.

Ports' growth trajectory intact. We gather that SIME's Weifang Port expansion is on track with 8 new berths to expand capacity by 3.5x to 80-85m MT by end-FY17. Management explained that the expansion will be carried out in stages with 3 container and 3 bulk berths to be completed by end-FY16, and 2 liquid berths to be completed by end-FY17. This is in line with our expectation; hence, we maintain our forecast that Utilities subdivision should double its EBIT contribution to RM154m by FY18.

Upgrading to MARKET PERFORM with lower TP of RM7.80. We lower our TP to RM7.80 (from RM8.00) as we account for weaker Industrial and Motors segment outlook, but slightly better Plantation earnings due to lower cost. Our TP is based on Sum-of-Parts with Plantation segment PER pegged to 22.0x, in line with our target PER for other big-cap planters. Despite lowering our TP, we upgrade our call to MARKET PERFORM (from UNDERPERFORM) as we believe the share price correction of 21% year-to-date (YTD) has more than accounted for the earnings weakness in SIME’s non- Plantation segments. Risks to our call include lower-than-expected CPO prices, and weaker-than-expected non-Plantation segment performance. 

Source: Kenanga Research - 19 Jan 2016