• U/G BUY from Neutral, new MYR2.50 TP from MYR2.15, 19% upside, as we lift valuations to account for Sime Darby’s proposed UMW (UMWH MK, NEUTRAL, TP: MYR5) acquisition, which is earnings-accretive. If it acquires 100% of UMW, we model its FY24F earnings to rise 15%. The deal still requires shareholders and principals' approvals. Though earningsaccretive, we are neutral on the proposed transaction, as we think it lacks synergies, lowers dividend payouts, and adds non-core assets to SIME.

• The proposal. SIME is proposing to buy Permodalan Nasional’s (PNB) 61.18% UMW stake for MYR3.57bn, which will trigger a mandatory general offer (MGO). As we recommend UMW’s minority shareholders to accept the MGO in this eventuality, we assume SIME will acquire 100% of UMW. Its offer price of MYR5/share implies 14.4x FY24F (Dec) P/E, at a premium to UMW’s 5-year historical mean of 13x and our ascribed 11x. We are not in favour of the valuation premium, given the lack of synergies.

• We think the acquisition is largely orchestrated by PNB, which is a 50.3% shareholder of SIME and holds a 61.18% stake in UMW. Nevertheless, management believes SIME’s acquisition of UMW will allow it to diversify into the automotive mass market, and have a more balanced revenue exposure between Malaysia, China and, Australasia while expanding local market share. In 7M23, SIME and UMW held a 57% market share.

• Funding. In an all-cash deal, SIME will fund the acquisition with 85% debt and 15% internally generated cash. Accounting for the 50% debt-funded acquisition of Cavpower, SIME's gearing ratio could reach 0.84x (Figure 3), above its desirable 0.6x limit. Consequently, it would use proceeds from its future healthcare unit and Malaysia Vision Valley land sales to pare down the debt. This significantly reduces the odds of special dividends. SIME will also have a lower dividend payout ratio (DPR) (FY21-23: c.66%) in the coming years, but will maintain it above its 50% DPR policy.

• Potential hurdles. Neither SIME nor UMW have engaged their principals on the potential transaction. Aside from shareholders, the principals' views on the transaction could make or break the deal, as the deal involves competing brands, eg Caterpillar and Komatsu.

• Post proposal, we maintain our earnings estimates but lower FY24F-25F DPS on lower DPR.

• Upgrade to BUY with higher MYR2.50 TP (SOP). As we currently have yet to bake in UMW contributions to SIME's estimates, we tactically raise its SOP components' valuations to reflect the anticipated earnings accretion to SIME post acquisition. The new TP is the equivalent to ascribing 14x P/E to FY24F post-acquisition earnings. While we have our reservations on the acquisition, we think investors should BUY SIME, as the market may react positively to its earnings-accretive acquisition. Key downside risks include weaker-than-expected margins, softer-than-expected car sales, and a longer-than-expected economic downturn in China.

Source: RHB Securities Research - 25 Aug 2023