We recently attended Sime Darby (SIME)’s Plantation segment’s first commercial field planting of its new Genome Select (GS) Seeds at Dusun Durian Estate, Banting. Although we are positive on the long-term contribution from the new planting material on production growth, we kept our UNDERPERFORM call on SIME as we believe short-term earnings prospects will be subdued due to negative FY16-17E FFB growth forecast and weak performance from non-Plantation segments. Our Target Price of RM7.15 is unchanged, based on Sum-of-Parts with the Plantation segment valued at 24.0x, in line with its bigcap planter peers.

Genome Select Seeds Commercial Planting. We recently attended SIME Plantation segment’s first commercial field planting of its new Genome Select (GS) Seeds at Dusun Durian Estate, Banting. According to management, the GS seedlings are screened for high yield with potential of producing more than 11.0MT CPO/ha (c.45MT FFB/ha), which is at least 15% above its current best planting material, Calix 600. We gather that SIME targets to ramp up its GS screening capacity to fully meet its Malaysian replanting requirement of 5% of planted area annually, which translates to about 15k ha/year, by 2023.

Positive long-term prospects for Plantation… We are long-term positive on SIME’s R&D efforts, which should lead to continuous yield improvements over the long-run. Management mentioned that for the typical breeding cycle, production grows 8-10% every 10-14 years. However, using the GS material, SIME expects production to grow by 16% in the next production cycle. Based on this, we estimate a compound annual growth rate (CAGR) of 0.7% in a normal breeding cycle, compared to a CAGR of 1.2% with the GS material. Assuming SIME replants 5% of its planted area as well as plants 2k ha of new area annually, we expect the new planting material to yield 7.4m MT FFB/year in Malaysia by 2030, compared to ordinary material, which will likely yield 7.0m MT FFB/year.

…But short-term pain will continue. While we are positive on the Plantation segment’s long-term prospects, we note that last years’ dry weather has negatively impacted FFB production throughout the region, including SIME which has exposure in all key palm oil producing regions. In FY16-17E, we expect FFB growth of -10% and - 1% due to the lagged impact of dry weather. Meanwhile other segments are likely to see weak near-term performance as well. Property and Motors segments are currently seeing weak domestic demand due to tighter lending policies, while Industrial segment upside is limited given weak commodity prices and slower Chinese growth.

Maintain UNDERPERFORM with higher TP of RM7.75 based on Sum-of-Parts with an unchanged Plantation segment PER of 24.0x. Our Plantation segment target PER is in line with other large-cap planters. We update our TP to RM7.75 (from RM7.15) as we roll forward our valuation base year to FY17E for EPS of 33.3 sen. Our TP implies a Fwd. PER of 23.3x, or slightly below -0.5SD valuation. We believe this is fair, given SIME’s short-term negative FFB growth prospect as well as its weaker non-Plantation segments’ outlooks.

Source: Kenanga Research - 26 Apr 2016