FGV’s 9M14 core net profit missed expectations  due to larger losses at its  downstream  operations  as  well  as  higher  depreciation  and  tax charges.  We reduce our TP  to MYR2.80  from MYR3.68  (20% downside) and  downgrade  our call  to SELL.  We believe FGV’s outlook will remain bleak  unless  it  is  able  to  boost  earnings  via  earnings-accretive acquisitions and extract synergy from its previous acquisitions.  

Below expectations. Felda Global Ventures‟ (FGV) 9M14 core net profit was  below expectations, comprising  70%  of our and  60% of  consensusFY14 forecasts respectively, mainly due to  higher-than-expected losses recorded  at  its  manufacturing  division  on  the  back  of  negative  refining margins,  lower  crush  margins  in  Canada,  higher-than-expected depreciation  charges  arising  from the consolidation of its acquisition of Pontian United, as well as  higher-than-expected effective tax rates due to  deferred  taxes  not  recognised  on  loss-making  subsidiaries.  FGV recorded  an  EI  of  -MYR105.5m  from  unrealised  losses  on  commodity contracts. 

9M14  core  net  profit  fell  39%  YoY  on  the  back  of  a  36%  rise  in turnover. We highlight that comparing earnings on a  YoY and QoQ basis may  be difficult,  as  FGV completed  its  acquisition  of the 51%  stake  in Felda Holdings Bhd (FHB) at end-2013, and revenue and profits for the plantation and downstream divisions would now include FHB. In  9M14, FGV‟s  FFB  volumes  dropped  1%  YoY,  which  was  better  than  our projection  of  -5%  for  FY14,  while  CPO  price  was  9%  higher  YoY  at MYR2,506/tonne, above our FY14 projection of MYR2,400/tonne. 

Forecasts  lowered.  We  lower  our  earnings  forecasts  by  15-21%  for FY14-15,  after  taking  into  account  larger  losses  at  its  downstream division, higher depreciation charges and higher effective tax rates. We introduce our FY16 forecasts.

Downgrade to SELL. Post-earnings revision, we cut our SOP-based TP to  MYR2.80  (from  MYR3.68),  after  taking  into  account  our  recent increase  in  MSM  Malaysia‟s  (MSM  MK,  BUY)  TP  to  MYR5.74  (from MYR5.23)  and  updating  FGV‟s  latest  net  cash.  We  believe  FGV‟s outlook will remain bleak unless it is able to boost earnings via earningsaccretive acquisitions and extract synergy from its previous acquisitions. In  terms  of  earnings  sensitivity  to  CPO  prices,  every  MYR100/tonne change in CPO price could affect FGV‟s earnings by 4-6% per annum. 

Key briefing highlights: i) Production outlook is flat, ii) production costs fell in 9M14,and iii) the downstream division returned to losses in 3Q14. In  9M14, FGV recorded a 1% YoY  drop in FFB production,  an improvement from a  3% decline in 1H14,  as production improved in 3Q14 due to the peak production cycle.  Management  is  now  projecting  flat  FFB  for  FY14  (up  from   its  previous guidance  of  -3%).  Therefore,  we  also  raise  our  FFB  production  target  to  reflect  a larger 0.7% decline in FY14, followed by zero  growth for FY15. This is on the back of continued replanting activities of 15,000ha per year (9M14: 13,531ha)Lower production costs in 3Q14. Production costs in 3Q14 fell 14% QoQ and 15% YoY  to  MYR1,261/tonne,  bringing  9M14  cost  to  MYR1,385/tonne.  As  management highlighted that approximately  82% of  its  fertiliser  requirements have  already  been applied  in  9M14,  production  costs  in  4Q14  are  likely  to  remain  relatively  low. Therefore, we maintain our flat production costs estimates for FY14.

Downstream  division  back  into  losses  in  3Q14.  FGV‟s  downstream  division reversed back into  the red  in 3Q14, recording  -MYR117.2m PBT (from +MYR18.2m in  2Q14  and  +MYR16m  in  3Q13).  However,  we  highlight  that  this  loss  included MYR52m  unrealised  commodity  contract  losses  from  its  Canadian  crushing operations due to mark-to-market losses on its forward purchases of soy and canola oil.  Management  highlighted  that  these  losses  have  since  reversed  in  Oct  2014. Operationally, FGV‟s downstream operations were also affected by negative refining margins  at  its  Malaysian  operations,  with  a  refinery  utilisation  rate  at  about  60%, although this was offset by improved biodiesel contributions. We have  adjusted our FY14-15 earnings forecasts to reflect the larger losses at the refinery sub-division.

Risks
Main risks  to  the plantation division  include: i) a convincing reversal in crude oil price  trend,  resulting  in  a  reversal  of  CPO  and  other  vegetable  oils  price  trend,ii)  weather  abnormalities  resulting  in  an  over-  or  undersupply  of  vegetable  oils, iii) changes in the emphasis on implementing global biofuel mandates and tran s-fat policies, and iv) a faster- or slower-than-expected global economic recovery, resulting in higher- or lower-than-expected demand for vegetable oils.

Main  risks  to  the  sugar  division  include:  i)  significant  changes  in  the  Malaysian sugar  industry  caused  by  changes  in  government  regulations,  ii)  adverse  weather conditions  which  could  affect  the  supply  and  prices  of  raw  sugar  globally,  iii) significant  changes  in  global  trade  policies  affecting  sugar,  which  may  have  an impact on refined sugar prices, iv) major fluctuations in the MYR/USD exchange rate, which  would  have  an  impact  on  raw  material  costs,  and  v)  increasing  competition from domestic or global players.

Forecasts
Forecasts  lowered.  We lower  our earnings forecasts by 15-21% for FY14-15, after taking  into  account  larger  losses  at  its  downstream  division,  higher  depreciation charges and higher effective tax rates. We introduce our FY16 forecasts  with CPO price assumption at MYR2,500/tonne.

Valuation and recommendation
Downgrade to SELL. Post-earnings revision, we cut our SOP-based TP to MYR2.80(from  MYR3.68),  after  taking  into  account  our  recent  increase  in  MSM  Malaysia‟s (MSM  MK,  BUY)  TP  to  MYR5.74  (from  MYR5.23)  and  updating  FGV‟s  latest  net cash. We believe FGV‟s outlook will remain bleak unless  it is able to boost earnings via earnings-accretive acquisitions and extract synergy from its previous acquisitions. In terms of earnings sensitivity to CPO prices, every MYR100/tonne change in CPO price  could  affect  FGV‟s  earnings  by  4-6%  per  annum.  We  downgrade  our recommendation to SELL (from Neutral).

Source: RHB