HSPLANT has proposed to acquire a 55% stake in KRETAM for RM1.78b, with a subsequent MGO for the remaining stake. We are short-term NEGATIVE on the deal given stretched valuations and potential CNP dilution. We maintain FY17-18E CNP pending shareholders’ approval and further details from management. However, we downgrade our call to UNDERPERFORM with lower TP of RM2.30 in anticipation of a negative short-term investors’ reaction.

Acquiring 55% stake in KRETAM. Hap Seng Plantations Holdings Berhad (HSPLANT) has proposed to acquire a 55% stake in Kretam Holdings Berhad (KRETAM) for a cash consideration of RM1.18b, or RM0.92 per share (11% premium to 5-day VWAP). Subsequently, HSPLANT plans to extend a mandatory general offer (MGO) for the remaining KRETAM shares at the same offer price. We gather that KRETAM’s assets include 23,865 hectares (ha) of land bank in Sabah, of which 19,623 ha are planted area. Of its planted area, 18,425ha are mature (<4 years old) trees. KRETAM also owns three palm oil mills, a 1.5k metric ton (MT)/day refinery, a 300MT/day biodiesel plant, and a 30k MT/year fertilizer plant. Note that despite the MGO, HSPLANT plans to maintain the listing status of KRETAM and may consider placements to maintain the public shareholding spread requirement.

Short-term dilution… We are short-term negative on the deal, as the incremental earnings contribution of c.RM45m/year would fail to offset additional interest cost of c.RM50-100m/year, depending on the final acquired stake. Valuation-wise, we calculate an EV/ha of RM92.8k and EV/planted ha of RM112.8k for the landbank, which we consider in line with the average EV/planted ha of integrated planters at RM103.1k. However, we note the relatively low utilization of KRETAM’s refineries at only 10-20% of full capacity, which explains the losses seen in the downstream division. We calculate that the proposed purchase price implies a huge Fwd. PER of 77x, far exceeding the small cap average of c.18x. We estimate that HSPLANT’s net gearing post-acquisition could jump to 0.5-1.0x, severely limiting expansion capabilities of the company should this deal go through.

…long-term synergies? Management noted that upon completion of the deal, HSPLANT landbank and planted area will increase by a substantial 59% and 54%, respectively. While the new area should have a limited effect on HSPLANT’s average age (at c.14.2 years for HSPLANT vs. c.13.6 years for KRETAM in FY16), we expect to see short-term FFB yield dilution (at c.20.7MT/ha for HSPLANT vs. 16.2MT/ha for KRETAM in FY16), although this should be resolved in the longer term. The deal would also mark HSPLANT’s entry into downstream palm oil processing, with the possibility that improved utilization at the KRETAM refinery and biodiesel plant could reduce, or reverse, the current loss-making status of KRETAM’s downstream segment.

Earnings unchanged given that the deal is conditional upon shareholders’ approval, while the final stake in KRETAM is dependent upon the acceptance level of the MGO.

Downgrade to UNDERPERFORM with lower TP of RM2.30 (from RM2.60). While we maintain our earnings outlook, we lower our applied Fwd. PER to 15.5x (from 17.5x) as we lower our valuation basis to -0.5SD (from mean valuation basis). We believe this is fair given the expected earnings dilutive implications of the deal, coupled with the softer CPO price outlook in 2018, to negatively impact shareholders’ sentiment in the next 12 months. As such, we lower our call on HSPLANT to UNDERPERFORM (from MARKET PERFORM).

Source: Kenanga Research - 22 Feb 2018