Although  Sime  Darby’s  9MFY14  results  were  in  line,  we  are downgrading our recommendation to Neutral  (from Buy) with a revised FV  of MYR10.40 (from MYR10.15).  We highlight that the weaknesses at its  heavy  equipment  and  motor  division  could  pose  as  a  threat  to earnings  growth,  despite  the  group’s  sensitivity  to  CPO  prices.   We advocate investors to shift focus to more pure-play planters instead.

• In line.  Sime Darby‟s 9MFY14 core net profit was  at  70-71% of our and consensus  FY14  forecasts. We deem this in line, as we expect stronger earnings  in  4QFY14  from  higher  fresh  fruit  bunches  (FFB)  production and better contributions from its property business. It recorded an EI gain of MYR162.4m in 3QFY14, bringing 9MFY14 EI gains to MYR204.4m.
• Briefing  takeaways:  i)  Dry  weather  impact  on  Sime‟s  Kalimantan  and Malaysian estates is over, as FFB  production is recovering; ii) a strong showing at its downstream division; iii) a cautious outlook for its industrial division; iv) its property division is expected to see marked improvements in  4QFY14;  and  v)  there  is  not  much  more  colour  on  the Eastern  and Oriental (EAST MK, BUY, FV: MYR3.12) stake sale.
• Forecasts lowered. We trim  our forecasts by  -1%  for FY14 and  -6.5% for  FY15,  after  taking  into  account  a  lower  FFB  production  target  of -6.3%  for  FY14  (from  -4.4%),  as  well  as  lower  earnings  for  the  heavy equipment division for FY14-15. We have also lowered our effective tax rate assumption for FY14 to 21% (from 24%), after taking into account the deferred tax assets recognised this quarter following the changes in real property gains tax.
• Downgrade to Neutral.  Post earnings revision and after rolling forward our valuation targets to CY15 (from CY14), as well as updating for Sime Darby‟s  latest  net  debt,  our  SOP-based  FV  rises  to  MYR10.40  (from MYR10.15). Although we are still positive on the plantation sector as a whole, the weaknesses at its  heavy equipment and motor division could be  a  threat  to  earnings  growth,  despite  its  sensitivity  to  CPO  prices. Hence, we advocate  shifting  away from the more integrated players to the purer planters, which would benefit more significantly from CPO price movements.  We downgrade  our recommendation  to  Neutral  (from Buy) and  advise  investors  to  switch  to  our  new  top  big-cap  pick,  Genting Plantations (GENP MK, BUY, FV: MYR13.25).

Key briefing highlights

Core net profit fell 16% y-o-y in 9MFY14 on the back of a 6% drop in revenue. The fall  in  profit  was  due  to  a  weaker  performance  at  its  plantations  (due  to  FFB production and higher unit costs), heavy equipment (lower sales volumes and weaker margins,  which  fell  0.3ppts  y-o-y)  and  motor  division  (flattish  sales  volumes  but margins  dipped  0.8ppts  y-o-y);  property  (due  to  lower  profit  recognition  from  three mature  townships  and  new  launches  in  other  townships)  and  energy  &  utilities divisions (from weaker margins in all its three sub-divisions).  

Key  briefing  takeaways.  i)  Dry  weather  impact  on  Sime  Darby‟s  Kalimantan  and Malaysian  estates  is  over,  as  FFB  production  is  recovering;  ii)  it  saw  a  strong showing at its downstream division; iii) its outlook for the industrial unit is cautious; iv) its property  business  is  expected  to see  marked  improvements  in  4QFY14;  and  v) there is not much more colour on the Eastern & Oriental stake sale.

Dry weather  impact on  Kalimantan  and Malaysian estates is over.  In  9MFY14, Sime  Darby  saw  a  12%  y-o-y  drop  in  FFB  production,  due  mainly  to  continued disappointing output in Indonesia  (-20.4%)  and Malaysia (-6.6%, mainly caused by weakness  in  Peninsular  Malaysia).  Management  continues  to  attribute  this  to:  i)  a shift  in  cropping  patterns in  Kalimantan  and  certain parts  of  Malaysia;  ii)  biological tree stress; as well as  iii)  the impact of extreme weather conditions in 1Q14. Going forward,  although  it  saw  better  productivity  in  April  (+14.5%  y-o-y)  which  brought YTD-April production to  -10%,  this has  reduced its FFB production growth target  for FY14 by  5% (from  -2% previously). We are,  therefore,  also revising our FFB growth projection for FY14 to –6.3% (from -4.4%). For FY15, we maintain our annual growth projection at 3-4%.

Strong showing at downstream division. In 9MFY14, Sime Darby recorded a 53% y-o-y  rise  in  EBIT  at  its  downstream  division,  driven  by  higher  margins  at  its oloechemicals division and lower losses from its refinery in Europe.  As this is within expectations, we are leaving our forecast for this division unchanged.

Cautious outlook for industrial unit.  The industrial division recorded an 18% y-o-y decline  in  EBIT  in  9MFY14  mainly  due  to  lower  equipment  deliveries  and  product support sales from the Australasian region (-35% y-o-y). While its orderbook remains relatively healthy at MYR2.6bn (+24% q-o-q), there is a likelihood that the recognition of  this  orderbook could  be  stretched  a  bit  longer  than  the usual  12-24  month  time period.  Nevertheless,  projects  are  still  being  approved,  like  the  recent  Adani Carmichael  coal  mine  project  in  the  Galilee  Basin  worth  AUD16.5bn,  while  the Government continues to remain committed to supporting the industry. We are,  thus,reducing our EBIT margins for this division to reflect a 15% decline in EBIT for FY14 (from -5% previously), while maintaining our projected 3-4% growth for FY15.Property  division  to  see  marked  improvements  in  4Q.  The  property  division 
recorded a 26% y-o-y  decline in EBIT in 9MFY14 due mainly to  timing differences. Management is expecting this division to post a strong recovery in 4QFY14, given its still-high unbilled sales as at end-March  of  MYR1.68bn  (+45% y-o-y) as well as its impressive  average  take-up  rate  of  76%  of  gross  sales  value  of  MYR1.35bn  in 9MFY14. Management continues to aim for FY14 earnings to at least match that of FY13, which we think may even be surpassed based on the positive response from its current launches. We maintain our projected 0.3% dip and 4-5% increase in EBIT contributions from the property division for FY14 and FY15 respectively.

Not  much  more  colour  on  Eastern  &  Oriental  stake  sale.  Not  much  was  said about Sime  Darby‟s  sale of a 9.9% stake in Eastern &  Oriental  (EAST MK, BUY, FV: MYR3.12).  Management  reiterated  that,  strategically,  the  rationale  behind  the  sale was  to  “cement”  the  management  (ie  managing  director  Mr  Terry  Tham)‟scommitment  to  the  company.  It  added  that  the  disposal  would  not  make  much difference to earnings, while it would still get to equity account the smaller 22% stake and hold two board seats in the company. As it was never Sime  Darby‟s intention to take-over this company completely, this sale would not have affected  any of its longterm plans. 

Risks
The main risks  include:  i) a  convincing reversal in crude  oil price trends, resulting ina reversal of CPO and other vegetable oil prices; ii) weather abnormalities resulting in an over-  or under-supply of vegetable oils; iii) change in 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 lower our forecasts by  -1% for FY14 and  -6.5% for FY15, after  taking  into  account  a  lower  FFB  production  target  of  -6.3%  for  FY14  (from  -4.4%), as well as lower earnings for the heavy equipment division   for FY14-15. We have  also  lowered  our  effective  tax  rate  assumption  for  FY14  to  21%  (from  24%), after taking into account the deferred tax assets recognised this quarter following the changes in real property gains tax.  

Valuation and Recommendation
Downgrade  to  Neutral.    Post  earnings  revision  and  after  rolling  forward  our valuation targets to CY15 (from CY14), as well as updating our numbers to impute its latest  latest  net  debt,  our  SOP-based  FV  is  adjusted  slightly  higher  to  MYR10.40 (from MYR10.15).  Although we are still positive on the plantation sector as a whole, we highlight that the weaknesses at the conglomerate‟s  heavy equipment and  motor division could pose a threat to earnings growth, despite its sensitivity to CPO prices  –where every  MYR100/tonne change in the price of CPO would affect  earnings by 5-7%  annually.  We  are  therefore  advocating  a  shift  of  focus  away  from  the  more integrated  players  in  the  market  to  the  purer  planters,  who  would  benefit  more significantly  from  movements  in  CPO  prices.  As  such,  we  are  downgrading  our recommendation on Sime to  Neutral (from Buy). We advise investors to switch to our new top big-cap pick, Genting Plantations (GENP MK, BUY, FV: MYR13.25).

Source: RHB