While Sime Darby’s earnings will most definitely be negatively affected by the prevailing low CPO prices (as plantation makes up 50-55% of earnings), this will be partially offset by the still growing earnings at its motor division (comprising 12-15% of earnings) and stable earnings at the industrial (comprising 20-25% of earnings) and property (6-8% of earnings) divisions. In addition, Sime’s valuations, which are at an unjustified 2-3x PE discount to its peers, are undemanding.

¨      Key highlights. Sime Darby was one of the companies showcased at our Asean Corporate Day recently. Some of the key points gathered: (1) CPO price for 9MFY13 likely to be in the MYR2,400-2,500/tonne range; (2) Potential new landbank acquisition and subsequent listing in Indonesia; (3) Property division the weak link, but pressure is on to perform; (4) No significant weakness seen at industrial division, despite weak 1QCY13 Caterpillar results; (5) Motor division to be best performer in FY06/13; and (6) Healthcare division to expand footprint with Ramsay JV.

¨      Forecasts unchanged at this juncture, pending CPO price review. Note that every RM100/tonne change in CPO prices would affect Sime’s earnings by 4-6% p.a.. As such, should CPO prices average MYR2,400/tonne in FY06/13, our earnings would be revised down by 12.3%.

Buy rating maintained. We are leaving our Buy recommendation unchanged at this juncture. We are, however, rolling forward our valuation base to CY14 (from CY13), which has resulted in an upward revision to our SOP-based target price to MYR10.60 (from MYR10.20). Sime is currently trading at an FY13 PER of 15.9x and FY14 PER of 14.4x, which is a 2-3x discount to its large-cap peers’ valuations of 17-19x. Even at our target price, Sime’s implied FY13 and FY14 PER would be 18x and 16x, respectively, which is still below its peers. We believe this discount is unjustified, given Sime’s large-cap market weighting and relatively stable earnings profile, compared to its peers, who are heavily reliant on plantation earnings and CPO price movements

Asean Corporate Day Notes

Sime Darby was one of the companies showcased at our Asean Corporate Day recently. While the company’s earnings will most definitely be negatively affected by the prevailing low CPO prices (as plantation makes up 50-55% of earnings), this will be partially offset by the still growing earnings at its motor division (comprising 12-15% of earnings) and stable earnings at the industrial (comprising 20-25% of earnings) and property (6-8% of earnings) divisions.  

Some of the key points gathered: (1) CPO price for 9MFY13 likely to be in the MYR2,400-2,500/tonne range; (2) Potential new landbank acquisition and subsequent listing in Indonesia; (3) Property division the weak link, but pressure is on to perform; (4) No significant weakness seen at industrial division, despite weak 1QCY13 Caterpillar results; (5) Motor division to be best performer in FY06/13; and (6) Healthcare division to expand footprint with Ramsay JV.

CPO price for 9MFY06/13 likely to be in MYR2,400-2,500/tonne range. As expected, earnings from the plantation division are expected to weaken in FY06/13, due to the weak CPO price environment. For 9MFY06/13, Sime’s average CPO price is expected to be around MYR2,400-2,500/tonne, in line with the MPOB spot price, while 4QFY06/13 is not expected to much better, based on current prices. Given this scenario, our CPO price assumption of MYR2,700/tonne is not likely to be achieved for FY06/13. While we are keeping our forecasts unchanged for now, pending a sector-wide review of CPO prices, we highlight that every MYR100/tonne change in CPO prices would affect SIme’s earnings by 4-6% p.a.. As such, should CPO prices average MYR2,400/tonne in FY06/13, our earnings would be revised down by 12.3%.

Potential new landbank acquisition and subsequent listing in Indonesia. Management continues to look for new landbank acquisitions overseas, to boost its asset base and grow its plantation earnings, as production growth is slated to remain relatively flat during the next few years, with no new landbank coming into maturity. We believe Sime would want to focus more on Indonesia for this expansion, as this would be more synergistic in nature, given its new 825,000-tonne refinery coming up in Indonesia by end-FY06/13. Management also highlighted that there is a possibility of listing its Indonesian estates in Indonesia in the longer term, particularly once it is able to secure a sizeable piece of landbank in Indonesia. This would help the company should the Indonesian government implement the proposal to limit ownership to no more than 100,000 ha of plantation landbank per company, due to the indication that this new ruling would not be applicable to listed entities (presumably listed in Indonesia). We note that this proposal has not been gazetted as a law at this juncture, and is not applicable retroactively to companies who already own more than 100,000ha of landbank.   

Property division the weak link, but pressure is on to perform. Sime’s property division has not performed up to expectations over the last few years, as can be seen by its 6-year average ROIC of just 9%, compared to the other divisions in the group (Figure 1). Management admitted that this is definitely something that needs to be improved and could have resulted from aggressive landbank conversion activities (from plantations to property) over the last few years as well as a laidback management style. The previous Head of the property division has since left the group (in 2011), and the Chief Operating Officer, Dato’ Abdul Wahab Maskan, is now the head of the division. Meanwhile, there are no more major landbanking activities to be done, as Sime now has about 12,000 acres of undeveloped landbank. Management believes earnings will play catch-up in the second half, as more progress billings would be recognised towards the financial year-end, resulting in flat yoy earnings from this division in FY06/13. Given that up to 1HFY06/13, Sime’s property division recorded a 34% yoy decline in EBIT, we think this may be difficult to achieve. We are therefore leaving our projected 20% yoy decline in property earnings for FY06/13 intact for now. In terms of sales strategies, Sime is focusing more on medium-cost housing now, which is still seeing strong demand prospects, even in the current economic environment. In the long term, management aims to better manage its product mix and product pipeline in order to ensure steady cashflow and stable income. This, together with improving on cost efficiencies and discipline, should help Sime achieve its long-term target of doubling its EBIT by 2016 and increasing its ROIC to hit 15%.        

No significant weakness seen at industrial division, despite weak 1Q13 Caterpillar results.Caterpillar reported a 17% yoy decline in sales in 1QCY13, due to weaknesses in the construction and mining industries. Despite this, Sime continues to expect stable contributions from its industrial division in 3QFY06/13. This is on the back of a still decent orderbook size (likely to have increased from last quarter’s MYR3.7bn), as any contractions/ delays in new capex would only affect orders for the medium term (ie. after a 15-18 month period).  In addition, a slowdown in new equipment orders, would be offset partially by higher contribution from its parts and services sub-segment. Sime’s rental and parts and services sales sub-segment has already been growing, as evidenced by the higher operating profit contribution of 83% to the division in 2QFY13, up from 57% in 1QFY13. Sime continues to target flat earnings contribution from this division in FY06/13 (1HFY06/13: +2% yoy), which is higher than our projected 3-4% yoy decline.  We are leaving our forecasts unchanged, to be conservative.

Motor division to be best performer in FY06/13. Surprisingly, the best performer for FY06/13 is likely to be the motor division, which is still seeing strong volumes in most of its major markets. Sales volumes in China have also improved in the last few months, although margins continue to be under pressure, due to the fierce competitive environment. In 1HFY6/13, Sime recorded a 6% yoy decline in EBIT from this division, but is expecting this to turn around to a positive 5-10% growth for the whole of FY06/13.  Our forecasts continue to reflect an 8-10% decline in EBIT from this division for FY06/13, which we will likely revise up post the release of 3QFY06/13 results. 

Healthcare division to expand footprint with Ramsay JV. The healthcare division, which recently entered into a JV with Ramsay Healthcare (RHC AU) in Australia, is planning on expanding its footprint across Asia in the long term. New target markets include China, Vietnam and Myanmar. For the first two years, this JV would focus on integration of its operations, leveraging on synergies and expanding its footprint in existing markets of Malaysia and Indonesia. Subsequently, the JV would enter new markets, with the aim of doubling its invested capital within five years. We are positive on this move, although the impact on Sime’s bottomline is not expected to be significant in the medium term. 

Forecasts

Forecasts unchanged at this juncture, pending CPO price review. We are leaving our forecasts unchanged at this juncture, although we highlight that we are in the midst of reviewing our CPO price assumptions with a downward bias. As noted above, every MYR100/tonne change in CPO prices would affect Sime’s earnings by 4-6% p.a.. As such, should CPO prices average MYR2,400/tonne in FY06/13, our earnings would be revised down by 12.3%.

Risks

Main risks include: (1) A convincing reversal in crude oil price trend resulting in reversal of CPO and other vegetable oils price trend; (2) Weather abnormalities resulting in an over or under supply of vegetable oils; (3) Increased/decreased emphasis on implementing global biofuel mandates and trans-fat policies; and (4) A slower-than-expected global economic recovery, resulting in lower-than-expected demand for vegetable oils.

Valuation and Recommendation

Buy rating maintained. We are leaving our Buy recommendation unchanged at this juncture. We are, however, rolling forward our valuation base to CY14 (from CY13), which has resulted in an upward revision to our SOP-based target price to MYR10.60 (from MYR10.20). Sime is currently trading at an FY13 PER of 15.9x and FY14 PER of 14.4x, which is a 2-3x discount to its large-cap peers’ valuations of 17-19x. Even at our target price, Sime’s implied FY13 and FY14 PER would be 18x and 16x, respectively, which is still below its peers. We believe this discount is unjustified, given Sime’s large-cap market weighting and relatively stable earnings profile, compared to its peers, who are heavily reliant on plantation earnings and CPO price movements.

Source: RHB