We are issuing a “Trading Buy” on SOP with a fair value of RM4.56 (ex-rights FV: RM3.76) based on Target PER of 15.6x. SOP is acquiring 47.0k ha of plantation land for RM873m, partly funded by a 2-for-7 rights issue. Despite some earnings dilution post-rights, we think long-term prospects are good given the young age and substantial land bank gains. Short-term outlook is positive as well on supportive CPO prices (+17% YoY).

Acquiring Shin Yang plantation assets for RM873m. On 4th July 2016, Sarawak Oil Palms Berhad (SOP) proposed to acquire the entire equity interest in Shin Yang Oil Palm (SYOP) for RM873m. We gather that SYOP owns 47.0k hectares (ha) of plantation land in Sarawak of which 23.8k ha is planted; as well as one 60TPH palm oil mill. Valuations-wise, we believe the price tag of RM38.5k EV/planted ha is relatively cheap compared to historical transactions ranging between RM40-95k/ha in Sarawak. We estimate the deal to increase SOP’s FY17E net gearing from 0.4x to 0.6x, post-rights. The deal is expected to be completed by 4Q16.

Expect EPS dilution post-acquisition…To fund the acquisition, SOP has proposed a 2-for-7 rights issue which is expected to raise c.RM350m, implying a rights issue price of RM2.70-2.80/share or at 24-27% discount to current prices. However, we understand that the SYOP acquisition will be minimally earnings accretive in the next 1-2 years. Pre-acquisition, we estimate FY16-17E CNP of RM104-129m or FD EPS of 23.5-29.2 sen. Post-acquisition, we estimate FY16- 17E CNP of RM104-137m (+0-6%) or lower FD EPS of 18.2-24.1 sen, reflecting the dilutive effect of the rights issue.

…but long-term positive prospects. Despite the relatively small near-term earnings impact, we believe the long-term effect of the deal is positive as SOP’s gross land bank will be increased by 64% to 119.7k ha while planted land bank will increase by 36% to 89.9k ha. With SYOP’s average tree age of 7.0 years old, we estimate SOP’s post-acquisition average age to be reduced from 11.1 years to 10.1 years. We believe the young age profile of the acquisition and maturing area of c.2.2k ha between 2017 and 2019 should contribute to above-average FFB growth from FY17E onwards.

Good short-term outlook. With supportive CPO prices and QoQ production jump of 22%, we expect to see a solid 3Q16 improvement over 2Q16. YoY, we expect 9M16 earnings to improve as well because the 9M production decline of 12% to 725.6k MT is offset by CPO prices which rose 17% YoY to RM2,549/MT.

Trading Buy with fair value of RM4.56 (ex-rights TP: RM3.76) based on an applied PER of 15.6x on FY17E EPS of 29.2 sen (exrights FV: RM24.7 sen). Our applied PER of 15.6x is based on a 35% discount to large-cap planters’ PER of 24.0x. We select largecap planters as our benchmark given SOP’s downstream capabilities but apply a 35% discount due to its smaller market cap of RM1.6b (against the large-cap average of c.RM20b). Our valuation is undemanding, at under -1.0SD to the 3-year average Fwd. PER of 30.7x, implying that the market had since priced in the dilutive effect of the rights issue. Our Fair Value (excluding rights and acquisition) of RM4.56 implies a Total Return of 24.8% (upside: 23.2%, dividend yield 1.6%). With its long-term positive FFB growth potential, extensive downstream capabilities and undemanding valuation against is peers, we rate SOP as a Trading Buy

Source: Kenanga Research - 28 Oct 2016