Sime’s organised analyst meetings with its different division headswere enlightening. We make no change to our NEUTRALrecommendation and MYR7.60 TP (7% upside). While we are upbeat onsome positive news for the industrial unit, this was offset by the stillsombre outlook for the motor division. Meanwhile, its plantation segment will be hit by the impact of El Nino on FFB production.

• Over the last two days, Sime Darby (Sime) held a series of meetingsfor analysts with the heads of its different divisions including Alan Hamzah (managing director, energy and utilities (E&U) division – NonChina operations), Timothy Lee (managing director, E&U Division –China operations), Datuk Franki Anthony Dass (managing director, plantation division), Scott Cameron (managing director, industrial division) and Dato’ Lawrence Lee (managing director, motor d ivision).
• We break down our update into the different divisions. The only missing division was property, thanks to to the ongoing changes in its management owing to the resignation of previous managing director Tan Sri Dato' Seri Dr Abdul Wahab Maskan, due to health reasons.
• Some positives, some negatives. Overall, while we were encouraged with the more positive outlook for the industrial division, this was offset by the weak outlook anticipated for the motor division as well as the drastic impact on FFB production from the current El Nino phenomenon. Earnings forecasts relatively unchanged. After we tweaked our replanting targets and profit projections for the E&U division, our earnings forecasts are relatively unchanged (+1-2% for FY16-18).
• Maintain NEUTRAL. Our SOP-based TP of MYR7.60 is alsounchanged. We highlight that every MYR100/tonne change in the CPO price could affect Sime’s earnings by 4-6%. We maintain our NEUTRAL recommendation on the stock. Despite the positive impact of higher CPO prices and a slow recovery of the industrial division, we believe Sime’s earnings would continue to be held back by the still-sombre outlook for its motor and property divisions.

Key briefing highlights Over the last two days, Sime held a series of meetings for analysts with the heads of the different divisions of the company including Alan Hamzah (managing director, E&U division – non-China operations), Timothy Lee (managing director, E&U division – China operations), Datuk Franki Anthony Dass (managing director, plantation division), Scott Cameron (managing director, industrial division) and Dato’ Lawrence Lee (managing director, motor division). We break down our update into the different divisions. The only missing division was property, due to the ongoing changes in its management stemming from the resignation of its previous managing director Tan Sri Dato' Seri Dr Abdul Wahab Maskan due to health reasons.

Plantation division Datuk Franki proved to be relatively bearish on his production outlook for Sime, but relatively bullish on the CPO price outlook for the coming months. For FY16, Sime expects the compound effect of the haze and El Nino to reduce productivity relatively significantly. For its Malaysian plantation business, Sime is expecting a 6% YoY decline in productivity. For Indonesia, it expects an 8-10% YoY decline, and for Papua New Guinea (PNG), a 6-8% YoY decline. Put together, this is expected to translate to total FFB production of 10.1m tonnes in FY16, which translates to agrowth of about 5% YoY. The growth comes from the full-year contribution of New Britain Palm Oil Ltd, which was acquired in Feb 2015. As this is close to our FY16 FFB output forecast of 10.2m tonnes, we are leaving our FY16 projection unchanged for now.

For FY17 however, management expects El Nino to continue to negatively impactproductivity, and is projecting Malaysia to see another 4-6% YoY decline in production, and Indonesia another 8-10% YoY drop. This is in addition to the effect from the significant replanting activities that Sime is intending to do of 20,000ha per year. Sime highlighted that its Kalimantan Selatan plantation area, which makes up 20% of its total planted area is in a rain shadow area, ie does not receive much rain. We highlight, however, that this does not take into account a possible La Ninaweather phenomenon happening in 2H16. Should a La Nina emerge, Sime expects productivity for FY17 to improve towards 2HFY17 (Jun). Our forecast pegs Sime to post FFB production of 5% in FY17, which we are leaving unchanged for now –although we are wary of the potential for a downside adjustment.

On an annual basis, Sime intends to replant 5% of its planted areas in Malaysia and 7% of its areas in Indonesia. By 2020, Sime is targeting to have 30% of its areas replanted, to bring its average age down to 11 years from 13-14 years currently. We have raised our replanting targets to 20,000ha per year from 10,000ha for FY16-18.As a result of the weak production outlook, Sime has a relatively bullish view on prices, expecting spot CPO prices to rise from March onwards to hit MYR2,500-2,60 per tonne in 2H16. Should a La Nina phenomenon emerge, it will result in dryness in the soybean-producing regions – which would help push vegetable oil prices higher. Management believes that this could result in CPO prices rising to MYR2,500-2,700 per tonne in May/June, particularly if biodiesel starts being produced according to the mandates in Indonesia.

As for costs, Sime is going all out to reduce costs during this FY16. Currently, its costof production stands at MYR1,300 per tonne, but it is targeting to bring this down to MYR1,200 per tonne by increasing mechanisation in Indonesia, reducing overheads and possibly human capital. As we have already projected unit costs at MYR1,200-1,300 per tonne, we are leaving our forecasts unchanged.

Industrial division Scott Cameron sounded relatively upbeat about the prospects of the industrial division, surmising that the industry has already hit a bottom and has been bumping along the bottom for some time now. Sime highlighted that the market for industrial machines had already shrunk considerably, going to 22,000 machines in 2014 and 16,000 machines in 2015 from 38,000 machines in the market globally in 2011. This massive reduction in orders is coming to an end, however. The group is seeing increases in coal export volumes already (+2% YoY to 220m tonnes in 2015), while machines have been worked hard over the last few years and are in need of replacing. With this, management believes that the outlook for 2HFY16 is going to be better than 1H. This belief stems from several factors:

i. China’s order cycles – during the Chinese New Year festive period, Sime usually sells about 40% of its products. ii. Australia is seeing a rebuild of its orders coming through, and Sime expects to secure more of this work in 2HFY16. This is also applicable to Bucyrus’rebuild work, which is being brought back in-house. iii. Sime is already seeing some new contract flow for equipment sales, which should start being recognised over the next year and a half. One of the main projects it expects to receive orders for in Malaysia is the MYR11bn Pan Borneo Highway in Malaysia, which it is already tendering for. iv. Sime has retrenched c.260 people in YTD FY16. Costs for this have been paid in 1HFY16. As a result, it should benefit from this exercise in 2HFY16.

In order to grow, Sime’s strategy for this division includes plans to : i) grow its market share (which is already happening in Australia and China), ii) minimise costs via retrenchment and outsourcing of some shared services from Jan 17, iii) improve its balance sheet, as well as iv) building new businesses. It recently acquired some new smaller businesses including Haynes Mechanical and Packet Jet which may help it to grow profits from new businesses. It is also on the lookout for new Caterpillar dealerships – but will only buy if it is a cashflow- and earnings-accretive acquisition. In 1QFY16, Sime recorded a 50% YoY decline in EBIT, while we have assumed a 47% YoY decline in EBIT for FY16. While we believe this could be a tad low, given management’s expectations of a stronger 2H, we prefer to remain conservative for now and maintain our forecasts.

Motor division Dato’ Lawrence Lee’s outlook for the motor division was a lot more subdued, with no hint of any silver lining to come in the near future. Sales volumes overall continue to be weak on the back of muted consumer sentiment and tough competitive conditions. In Malaysia, which makes up the biggest portion of its business (20% of total), Sime’s internal volume target is flat or lower for FY16 . Although management expects some volume growth in markets like Singapore and China, margins continue to be under pressure.

In 1QFY16, its motor EBIT margins fell to 1.9% (from 2.9% in 4QF15 and 4.7% in 4Q14), due to competitive price discounting in China as well as the impact of the weak MYR. In Malaysia, when Sime puts in an order for new vehicles, it locks in thefbased on the rate at which delivery is made – which could be higher. On this basis, Sime’s margins for the Malaysian business could be at risk if the exchange rate weakens further.

In order to grow the business, Sime intends to look at the possibility of reaching new markets, particularly in Indochina, to increase its after-sales service business (currently accounting for 50% of revenue) as well as to expand its Inokom assemblybusiness to regional markets. It is also looking at the possibilit y of M&A opportunities in China although this has to be looked at carefully, given that a lot of dealerships in China are highly in debt.

In our forecasts, we have assumed Sime’s motor division to record a 30% YoY decline in EBIT in FY16 (1QFY16: down 24% YoY), which we think should be achievable, provided margins do not decline too much from current levels.

E&U division The outlook for the E&U division as outlined by Timothy Lee and Alan Hamzah waspositive for China and rather unexciting for non-China operations. In China, the demand for Sime’s Jining and Weifang port services continues to grow with the population, and has by double digits for the last 10 years. The next big increment in earnings from this division (which makes up the bulk of the E&U division’s profits) will come in from FY18 onwards. This is due to the expansion of eight new berths in Weifang port, which will come into place by mid-2017. By the time capacity utilisation is ramped up for these new berths in 2019-2020, management expects profits from this division to triple (from EBIT of MYR77m in FY15). Currently, Sime’s port capacity in China is 25m tonnes, while utilisation is at 70-75%. The new capacity will take this to 80m tonnes. With the expansion of capacity, Sime will be able to expand its international business (now at only 10% of total), and expand its product mix to include more liquid cargo and cater to the petroleum-based and chemical industries. By 2020, Sime is targeting to have a container capacity of 1.2m twenty-foot equivalent units (TEUs) – it is currently at 0.4m – with bulk cargo capacity at 60m tonnes (currently at 20m) and liquid cargo at 20m tonnes (currently at 5m). In terms of capex, this expansion will cost Sime MYR1.4bn, with MYR0.8bn spent so far. In total, Sime would have invested about MYR3bn of capex on this port business in China, with estimated IRR of around 10%.

We have projected this division to post an EBIT growth of 40% in FY16 (1Q: +66%) With the rosy outlook, we are now hiking up our projections for this division to reflect a 60% EBIT growth in FY16, followed by 10% growth for FY17 and a 50% growth for FY18, to take the expansion into account.

Risks The main risks. These include: i) a convincing reversal in the crude oil price trend that results in a reversal of CPO and other vegetable oil prices, ii) weather abnormalities resulting in an oversupply or undersupply of vegetable oils, iii) a change in the emphasis on implementing global biofuel mandates and trans-fat policies, and iv) a slower-than-expected global economic recovery, resulting in lowerthan-expected demand for vegetable oils.E&U division