Southern Acids (M) Berhad (SAB) 9M19 Core Net Profit (CNP) of RM16.2m came in below our expectation at 61% of forecast but in line with consensus’ RM21.6m at 75%. The lower-thanexpected 9M19 CNP was dragged by oleochemical division margins due to unfavourable operating costs. No dividend was declared as expected. We cut FY19-20E CNPs by 19-12% to RM21.5-26.1m to reflect thinner oleochemical margins. Maintain UNDERPERFORM with a lower TP of RM2.50 (from RM2.60).

Below expectations. 9M19 CNP of RM16.2m after excluding one-off unrealised forex loss (RM4.2m), bad debt written-off (RM0.12m), came in below expectations, making up 61% of our RM26.5m estimate but in line with consensus’ RM21.6m at 75%. The lower-than-expected 9M19 CNP was dragged by oleochemical division margins due to unfavourable operating costs, as its FFB production at 67.4k metric tons (MT) was well above our estimate, making up 91% of our full-year estimate. No dividend was declared as expected.

Improved plantation weaker Oleochemical. YoY, 9M19 CNP dropped (-41%) largely dragged by losses before tax (LBT) from Oleochemical segment on lower production capacity utilization and lower ASP of fatty acids that led to margin erosion. However, healthcare saw improvement in its pre-tax profit (+14%) underpinned by margin expansion to 27% (vs. 24% in 9M18) that was boosted by higher complex surgeries performed; but bed occupancy rate remains flattish, which was marginally down by 0.7% from 56.9% in 9M18. Similarly, its plantation upstream registered higher pre-tax profit (+9%) on higher FFB own production (+26.2%) positively affecting its cost structure that led to better margins. QoQ, 3Q19 CNP decreased (-34%) largely owing to Oleochemical division, which saw LBT widening to RM2.7m (from RM0.5m in 2Q19) mainly due to lower ASPs of fatty acids and exacerbated by drop in sales volume. Healthcare business remains resilient as it recorded better PBT margins of 28% (vs. 26% in 2Q19) likely on the better number of complex surgeries, while bed occupancy rate improves by (+7ppt).

Headwinds ahead. We think its oleochemical segment will continue to be under pressure amidst high operating cost and stiff competition in the market. Given relatively smaller production size in the market, unit cost will potentially be higher as a result of lower economies of scale. We note that the segment’s top-line performance is weakening due to lower sales volume. Improvement in CPO production output should improve unit costs through economies of scale. Meanwhile, its healthcare division will continue to register robust growth driven by improvement in average revenue per patient (ARPP). This is lifted by higher complex surgeries performed as a result of the company continuous effort in recruiting more specialists.

Reduce FY19-20E CNPs by 19-12% to RM21.5-26.1m as we update our assumptions for oleochemical segment to reflect thinner margins on higher operating costs.

Maintain UNDERPERFORM with a lower TP of RM2.50 (from RM2.60) post earnings adjustment on Sum-of-Parts valuation based on average of FY19-20E EPS of 17.4 sen (from 20.6 sen). In our Sum-of- Parts (SoP) valuation, we maintain our average Fwd. PER of 14.5x, applying a 25% discount to upstream segment to reflect the challenging near-term cost environment. Meanwhile, we maintain oleochemical segment at 11.0x Fwd. PER (average of small-mid cap planters), ascribing 40% discount to the Fwd. PER to account for its challenging business prospect. For healthcare division, we maintain our assumptions with unchanged 18.0x PER as well as our conglomerate discount of 15% to arrive at our SoP TP of RM2.50. Our TP implies a Fwd. PER of 15.9x, which is -0.5SD of 3-year average.

Risks to our call include: (i) higher-than-expected CPO prices, (ii) lower-than-expected cost of production, and (iii) higher-than-expected CPO output.

Source: Kenanga Research - 28 Feb 2019