Initiating coverage on Sime Darby Plantation Berhad (SIMEPLT) with a MARKET PERFORM call and TP of RM5.50 based on Fwd. PER of 26x to CY18E EPS of 21.2 sen. Its market leadership position, emphasis on sustainable palm oil production, FFB production recovery, R&D efforts and integrated operations justify the premium. However, past production setbacks have escalated unit costs while previous expansions limit future M&A given stretched net gearing.

Best in class integrated planter. As the largest plantation company (by planted area), SIMEPLT ranks in the top three globally in milling capacity, FFB production and refining capacity as a premier palm oil player producing c.4% of global palm oil production. 98% of its production is certified sustainable palm oil (CSPO), affording it a pricing premium which we estimate at c.USD20/metric ton (MT) or more depending on oil grade. As a fully integrated planter with both upstream plantations and downstream manufacturing, earnings are less affected by CPO price movements as lower CPO prices lead to lower downstream feedstock cost.

Recovering from “super El Nino”. In the aftermath of the severe droughts in 2015-16, production was flat in FY16-17, leading to slow earnings recovery and high production cost/MT. Going forward, we expect yields to improve in line with the industry of c.8%, for higher FY18-19E FFB production of 4-7%. Given sector-wide production recovery, we expect SIMEPLT’s CPO prices to soften by 10-6% to RM2,569-2,417/MT but believe that better economies of scale and lower tax expense should lead to CNP increasing by 7-6% to RM1.40- 1.49b in FY18-19E.

Positive long-term productivity outlook. With its “Mission 25:25” aim of 25MT/hectare (ha) FFB production and 25% OER target by year 2025, we think that long-term productivity outlook should be positive, implying a CAGR of 6%/year based on our CPO production estimates. Our projections indicate the targets should be achievable, with estimated FFB yield of 24.6MT/ha and OER of 24.8% by 2025 through the use of high-yield planting material and technological improvements.

50% minimum dividend policy. Its strong FY18-19E free cash flows of RM1.70-1.65b should easily support management’s minimum dividend policy of 50%. Based on historical payout ratio (ex-FY17 which saw a large one-off land transaction boosting net profit), of 66%, we anticipate FY18-19E payout ratio at 65% for DPS of 13.0-14.0 sen/share, which translate to a decent dividend yield of 2.4-2.6% (vs. sector average of 2.6%).

Initiate with MARKET PERFORM call with TP of RM5.50 based on Fwd. PER of 26.0x applied to CY18E EPS of 21.2 sen. Our Fwd. PER of 26.0x represents a 5% premium to its integrated peers’ (IOICORP and KLK) average valuation of 25.0x. We believe the premium is justified given SIMEPLT’s market leadership position, majority CSPO production, FFB recovery track and productivity push. However, its high net gearing at 0.56x may preclude M&A while previous production setbacks have pushed up unit production cost. Given that its current valuations appear competitive against its closest peers, we initiate our coverage on SIMEPLT with a MARKET PERFORM call. Our TP of RM5.50 implies a total return of 2.8% (share price upside: 0.4%, dividend yield: 2.4%).

Source: Kenanga Research - 29 Dec 2017