INVESTMENT HIGHLIGHTS

• FGV is disposing its 100% stake in its loss-making entity in China for a total cash consideration of RM100m

• The rationale is to grow FGV into a leaner organisation via disposal of its non-performing assets

• Banking on operational efficiency and higher margin downstream products to drive profit growth

• Earnings revised upwards for FY20 and FY21 assuming completion of the disposal in 1QFY20

• Upgrade to BUY with a revised TP of RM1.40

Disposal of FGVCO. FGV Holdings Berhad’s (FGV) is divesting its 100% stake in FGV China Oils Ltd (FGVCO) to Grand Industrial Holdings Co., Ltd (GIH) for a total cash consideration of RMB165.0m (approximately RM100.0m). FGVCO is principally involved in the processing, refining, storage and marketing of edible oils for the China markets. Completion of the disposal is expected to be between end of 2019 and 1QFY20. Proceeds raised will be utilised as general working capital.

Consideration. The disposal consideration is comprised of two items: (1) purchase price for FGVCO’s 100% equity interest and (2) an intercompany loan of USD12.5m owing to FGV Capital Sdn Bhd which is a wholly owned subsidiary of FGV. This has effectively meant that the 100% stake is worth approximately RM50.0m.

View. We are positive on the news as the disposal is in line with FGV’s transformation plan to streamline its performing core business portfolio while rationalising its non-performing assets. Note that, FGVCO has always been in a loss-making position ever since it was acquired in 2015 as a result of the intense competition from major regional suppliers in China. Thus, we are of the view that the disposal would help to contribute positively towards FGV’s profitability moving forward as well as bringing the group closer to its targeted asset monetisation plan. We are also guided that FGV is expected to dispose assets worth about RM100-150m in FY19.

Impact. In FY18, FGVCO has incurred a loss of approximately RM15.0m in FY18. Taking this as a benchmark, we expect FGV’s bottom line to improve instantly upon the completion of disposal. We also understand that the loss on disposal incurred is very minimal. Thus, we would most likely observe a slight improvement in profit margin for the group.

Lining up its strategic initiatives. While we expect the group’s operational efficiency initiatives to further strengthen, the group is also looking to sweat its other untapped assets. With an approximate unused land banks of 87k ha, the group is contemplating to utilise it by growing cash crops such as durians and pineapple through JV or partnership to diversify its upstream plantation segment. Other than that, FGV’s seeds business is growing with a domestic market share of circa 40.0% and planning to further expand its prowess to Indonesia. Meanwhile, the group plans to plant more of its high-yielding Yangambi oil palm seeds which currently occupying approximately 13.0% of its planted area or 45k ha driving FFB yield to be higher. On the sugar business, the group is mitigating the excess capacity of its Johor sugar refinery by looking at strategic partners.

Downstream segment to reduce dependency on upstream business. As part of its diversification plan, FGV is expected to launch 4 new FMCG products starting in 2QFY19 namely, Mass Blended Oil, Industrial Margarine, Premium Blended Oil and Coconut Milk. Taking advantage of the current low input costs, we expect higher margin to be coming from its downstream segment to partially cushion the impact earnings weakness from upstream segment. We opine this is a positive development for strengthening FGV’s foothold in its downstream business. In addition, the group is looking to expand further its animal feed business, which garners a healthy profit margin. Another initiative would be venturing into baby milk products into China which has a potential double digit profit margin, as compared to the average downstream margin of 4-5%. We are of the view that FGV might be on the lookout in undertaking potential synergistic M&A to achieve inorganic growth at the downstream level.

Earnings estimate. We are revising our FY20 and FY21 earnings forecast upwards by +19.0% and +21.8% respectively. Our earnings adjustment also takes into account the above-mentioned earnings accretive development which we expect to be completed in early 2020 and better prospects from its downstream segments.

Target Price. Subsequent to our FY20 earnings upward revision, we are deriving a higher target price of RM1.40 (previously RM1.26). This is achieved by pegging its FY20BVPS of 1.27 to PBV of 1.1x which is the group’s 2-year historical average.

Upgrade to BUY. The disposal of the loss-making entity marks the progressive execution of its asset monetisation exercises which is an earnings accretive development for group. With its relentless operational improvements well on track as reflected by the enhanced operational statistics in 1QFY19, we opine that the group would continue to observe better profit margin going forward given there is still much headroom for improvement. Coupled with its investment into the downstream segment by launching higher margin products in 2H2019 and FY20, we expect the group to be able to partly cushion the current subdued CPO price environment and contribute positively to the group’s earnings trajectory in the long run. All factors considered, we are upgrading our recommendation on FGV to BUY (previously NEUTRAL).

Source: MIDF Research - 12 Jul 2019