TSH Resources Berhad (TSH)’s 1Q18 Core Net Profit (CNP*) came in at merely RM4.8m, far below consensus and our forecast on lower CPO prices and sharply higher depreciation charge. No dividend was announced, as expected. We slash FY18-19E CNP by 39-25%, accounting for higher depreciation and thinner margins. Cut to UNDERPERFORM with lower TP of RM1.10 (from RM1.60).

1Q18 below expectations. CNP at RM4.8m fell far short of expectations, making up only 4% each of consensus’ RM117.8m and our RM106.6m forecast. With FFB production of 181.2k metric tons (MT) coming in within our expectations at 23%, we think the abysmal performance was due to the drop in CPO prices (-22% to RM2,316/MT) leading to narrower margins, and sharply higher depreciation charge (+73% to RM21.3m). The increase in depreciation was due to the accounting change in MFRS 116 and 141 where most of TSH’s Biological Assets were restated into Property, Plant & Equipment (which increased by 1.4x to RM1.97b) and therefore subjected to straight-line depreciation charge. No dividend was announced, as expected.

Drastic drop. YoY, CNP plunged 83% as revenue declined 22% due to lower CPO prices (-22%), compounded by higher depreciation as mentioned. We also note higher tax charges (+17%) for the quarter, which we expect should normalize going forward. Production-wise, both Sabah and Indonesia saw FFB volume improvement of 10% to 29.3k MT and 24% to 151.7k MT, respectively. QoQ, CNP fell 75% on lower CPO prices (-12%) and higher depreciation charge (+44%), which could not be offset by production improvement (+7%). As a result, EBIT margin fell to 11.2% from 19.6%.

Earnings to normalize; setbacks remain. Management expect production to continue improving in the current year on higher maturities. We gather that c.8% of its Indonesian planted area are maturing this year. Although FFB production would increase, the low startup yields will still lead to high unit costs. While we maintain our above-average FFB growth assumption of 11-14% (vs. sector average of 8-8%), we reckon that the significant earnings setback seen in 1Q18 would impact full-year earnings and accordingly adjust our earnings downwards. We expect subsequent quarters to see improvement with better seasonal yields to reduce unit cost and tax rates to normalize.

Cut FY18-19E CNP by 39-25% to RM65.3-82.4m as we increase our depreciation estimate by 30% to RM85.3-86.4m. We also adjust our unit cost assumptions slightly higher by 7-1%, reflecting higher cost associated with startup yields.

Downgrade to UNDERPERFORM with lower TP of RM1.10 (from RM1.60) based on unchanged Fwd. PER of 20.8x applied to lower FY18-19E EPS of 5.3 sen (from 7.8 sen). Our Fwd. PER is unchanged at 20.8x based on +0.5SD valuation basis. This is in line with planters with above-average FFB growth expectations. However, earnings setbacks in this quarter will negatively impact full-year earnings, and we do not expect to see significant recovery until 2H18 at the earliest. Given the weak near-term earnings prospect, we downgrade our call on TSH to UNDERPERFORM.

Risks to our call include: higher-than-expected CPO prices, better- than-expected production growth, and lower-than-expected cost of production.

Source: Kenanga Research - 24 May 2018