Sime  Darby’s  1QFY14  core  net  profit  was  below  both  our  and consensus estimates, no thanks to  weaker earnings contributions from the plantation and motor divisions.    We adjust lower our SOP-based FV to  MYR10.46  (from  MYR10.73)  but  maintain  our  BUY  recommendation on the stock for now, as we are in the midst of reviewing our CPO price assumptions with an upward bias.

• Below.  Sime  Darby‟s  1QFY14  core net profit  was  below  both  our and consensus estimates, coming in at  13-14% of both  FY14 forecasts.  The main  variance  was  in  the  weaker  earnings  contributions  from  the plantation and motor divisions. This was due to lower-than-expected FFB production  in  1QFY14  (-16%  y-o-y  vs  our  projected  4.8%  growth  for FY14), mainly  owing to  disappointing output in Indonesia (-28.3%). The motor division posted weaker than expected top-and-bottomline numbers on the back of weaker sales in Singapore, Australia, Thailand and China.
• The group recorded a net EI gain of MYR42m in 1QFY14 comprising a gain on sale of property incurred in the industrial division segment. Briefing  takeaways:  i)  Production  recovery  expected  in  the  upcoming months; ii) CPO price view more optimistic, held back some inventory; iii) Production costs flat to slightly higher  for  FY14; iv) Property division still holding up; v)  Orderbook decline at industrial division; vi)  motor division disappointed; vii) Capex budget of MYR4bn; and viii) KPI net profit target of MYR2.8bn.
• Forecasts revised lower. We are revising  down our forecasts by  -8.5% for FY14 and -1.7% for FY15.
• Maintain Buy.    Post-earnings revision and updating  of Sime‟s latest net debt,  we adjust our SOP-based  FV to MYR10.46 (from MYR10.73). We maintain our BUY recommendation on the stock for now, as we are in the midst of reviewing our CPO price assumptions with an upward bias. We continue to highlight Sime‟s undemanding valuations, which are at a 2-3x  P/E  discounts  to  its  peers,  and  its  earnings  sensitivity  to  CPO prices, where every MYR100/tonne change in CPO price would affect its earnings by 5-7% p.a. 

Key briefing highlights
Core net profit fell  55% y-o-y in  1QFY14  on the back of a  9% decline in revenue. The fall in profit was due to weaker performance at its plantations (due to lower CPO prices  and  FFB  production),  heavy  equipment  (lower  sales  volumes  and  weaker, margins,  which  fell  1.1ppts  y-o-y)  and  motor  divisions  (flattish  sales  volumes  but margins  fell  1.3ppts  y-o-y),  as  well  as  higher  effective  tax  rates  (+8.3ppts  y-o-y); offset  by  slightly  stronger  contributions  at  the  property  (due  to  higher  profit recognition from three mature townships  and new launches in other townships) and energy & utilities divisions (due to the improved performance of the ports sub-division in China).

Key briefing takeaways. i) Production recovery expected in coming months; ii)  CPO price  view  more  optimistic,  held  back  some  inventory;  iii)  production  costs  flat  to slightly higher in FY14; iv)  property division still holding up;  v)  orderbook decline at industrial division; vi)  motor division disappointed; vii)  capex budget of MYR4bn;  and viii) KPI net profit target of MYR2.8bn.

Production  recovery  expected  in  upcoming  months.  In  1QFY14,  Sime  saw  a 16% drop in FFB production due mainly to disappointing output in Indonesia (-28.3% y-o-y), caused by a delay in peak cropping pattern in Kalimantan  and in certain parts of Malaysia. In Malaysia, Sime also recorded an 8% drop in production, mainly at  its Sabah estates. Going forward, management has seen production bounce back in Oct (+7% m-o-m) and Nov and believes there is a possibility that Dec could be the peak month  for  the  CY2014.  Given  this  scenario,  management  believes  production  will recover to a +2-3% y-o-y growth in FY14 (Indonesia:  -6-8%, Malaysia +5%). While we  believe  a  recovery  is  on  its  way,  we  prefer  to  be  more  conservative  in  our estimates, trimming our production growth projection to  1.5%  (from 4.8%)  for FY14. In YTD-Oct, Sime‟s FFB production fell 14.4% y-o-y. For FY15, we maintain our 2-3% growth projection.

CPO price view more optimistic, held back some inventory. Management is more positive  on  CPO  price  direction  now,  and  expects  CPO  prices  to  range  between MYR2,600-2,800/tonne over the next six months, higher than current levels. Given this  view,  Sime  has  held  back  more  CPO  inventory  than  normal  (74,000  tonnes versus end-June‟s 32,000 tonnes) as at end-Sept, in order to wait for higher selling prices.  According  to  management,  selling  this  additional  inventory  would  have garnered an additional PBT of MYR90m during the quarter.    

Production costs  flat to slightly higher in FY14.  Sime‟s  unit  production cost  (exmill)  in  1QFY14  was  about  MYR1,150/tonne  (up  from  c.  MYR1,050/tonne  in  FY13 and  MYR1,000/tonne  in  1QFY13),  due  to  lower  production.    Going  forward, management  expects  production  costs  for  FY14  to  remain  in  the  MYR1,000-1,100/tonne range, in line with  our projections. Sime expects higher labour costs to be offset by lower fertiliser costs in FY14. Sime has already tendered for its fertiliser requirements for FY14, at prices which are 15% lower y-o-y.

Property division still holding up. The property division recorded a 3% y-o-y rise in EBIT in 1QFY14  due to higher recognition of billings from  Elmina East, Bandar Bukit Raja  and  Putra  Heights.  Although  there  are  some  concerns  over  the  tightening measures imposed  on the property sector, Sime believes it will not be significantly affected, as 60% of its property products are in the affordable segment, which are not usually  the  target  of  speculators.  Sime‟s  unbilled  sales  as  at  end-Sep  was  at MYR1.6bn, while it achieved an average take-up rate of 70% of its gross sales value of MYR482m in 1QFY14.  Going forward,  management  is looking to at least match FY13‟s earnings in FY14. We maintain our projected -0.6% dip  and +6.7% increase in EBIT contributions from the property division for FY14  and FY15, respectively.  

Orderbook  declines  at  industrial  division.  Sime  recorded  a  -16%  yoy  decline  in sales at its industrial division in 1QFY14 and a larger -26% decline in EBIT. Sime has seen a decline in its orderbook to MYR2.8bn (from MYR3.28bn as at end-FY13), due mainly  to  lower  contributions  from  its  Australasia  market,  offset  slightly  by  higher contributions from China.  Management expects FY14 contributions from this division to  be  relatively  flat  y-o-y,  coming  from  stronger  demand  from  China  and  stable demand for Sime‟s after-sales support and services.  Despite this optimism, we have trimmed our projections for the industrial division to reflect a -2-3% decline in EBIT for FY14 (from -0.5%).  We project a slight recovery (+5.7%) in FY15.

Motor division  disappointed.  The motor division recorded a 34% y-o-y dip  in EBIT in  1QFY14, on the back of a  1% rise in revenue, as margins deteriorated further on the  back  of  stricter  regulations  for  car  owners  in  Singapore,  stiff  competition  in China‟s  luxury  car  market  and  in  Australia‟s  mass  brand  market  (Citroen  and Peugeot).    Management  is  now  guiding  for  a  double  digit  decline  in  EBIT contributions from the motor division as a result of these market conditions, although it  is  hoping  for  some  relief  in  the  form  of  early  contributi ons  from  Sime‟s  newly secured Kia dealership in Taiwan and BMW/Mini distributorship in Vietnam.  We are therefore  lowering  our forecasts for the motor division,  to reflect a  larger 13.6% y-o-y EBIT  decline  (from  -5-6%  previously)  for  FY14.  We  maintain  our  projected  2-3% EBUT growth projection for FY15, however.   

Capex  budget of MYR4bn.  Sime is budgeting capex of MYR4bn for FY14,  half of which  would  go  to  the  plantation  division.  We  understand  planting  in  Liberia  is progressing  well,  with  2,000-3,000ha  planted  in  1QFY14,  bringing  total  planted  to 10,100ha. Management is targeting to plant up 20,000ha by end-CY14. KPI net profit target of MYR2.8bn.  Sime has set a KPI net profit target of RM2.8bn and an ROE target of 10% for FY14. Its net profit target is 15% below our original net profit projection of RM3.3bn and 20% below consensus‟ profit projection of RM3.5bn, while  the  ROE  projection is 1.8ppts  below  our  original  12%  projection  and  2.6ppts below  consensus‟  ROE  projection  of  12.6%  for  FY06/14.  However,  against  our revised  earnings  projections,  Sime‟s  net  profit  KPI  is  just  8%  below  our  forecasts, while its ROE is 0.9ppts below.    Sime‟s net profit target is based on CPO price of RM2,500/tonne and CPO production growth of  2-3% y-o-y for FY14,  which is in line with our CPO price assumption, but  above  our revised  production growth estimate of 1.5%. We highlight that Sime seemingly always declares low KPI targets, possibly in order not to raise expectations and to be able to beat them comfortably. Over the last two years, the group has beaten its KPI targets by a comfortable 27-47% margin p.a.

Risks
Main  risks  include:  i)  a  convincing  reversal  in  crude  oil  price  trend  resulting  in reversal of CPO and other vegetable oils prices; ii) weather abnormalities resu lting in an over-  or under-supply of vegetable oils; iii) increased emphasis on implementing global biofuel mandates and trans-fat policies; and iv) a slower-than-expected global economic recovery, resulting in lower-than-expected demand for vegetable oils.

Forecasts
Forecasts  lowered.  We  have  revised  down  our  forecasts  by  -8.5%  for  FY14  and -1.7% for FY15, after taking into account the above-mentioned changes.

Valuation and Recommendation
Maintain  BUY.  Post-earnings  revision and  updating  for  Sime‟s  latest  net debt,  our SOP-based fair value has been adjusted  down  to MYR10.46  (from MYR10.73). We maintain our  BUY  recommendation on the stock  for now, as we are in the midst of reviewing our CPO price assumptions with an upward bias. We continue to highl ight Sime‟s undemanding valuations, which are at a 2-3x P/E discount to its peers, and its earnings sensitivity to CPO prices, where every MYR100/tonne change in CPO  price would affect its earnings by 5-7% p.a.

Financial Exhibits

SWOT Analysis

Company Profile
Sime  Darby  is  the  largest  listed  plantations  company  on  Bursa  Malaysia,  with  six  core  businesses  of  plantations,  property,  he avy equipment, auto, energy & utilities, and healthcare

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Source: RHB