Maintain NEUTRAL and MYR4.20 TP, with 9.3% expected total return. While we like SA’s undervalued assets, we continue to highlight the key risk of the “value trap” proposition, as the value-unlocking timeline is still hazy. We recently brought clients to visit its Klang oleochemical plant and came away impressed with its profitability despite its small size. We noted that, during recent site visits to local downstream plants, while refineries faced tight margins, oleochemical players were reporting decent profits. This was due to customisable products and longer sales contracts.

We brought clients to visit Southern Acids Malaysia’s (SA) oleochemical plant in Klang recently. The plant is 38 years old and has an annual capacity of 100,000 tonnes. It is currently running at ~90% utilisation, of which 90% of its output is in the form of fatty acids and 10% is in the form of glycerine.

Despite being a relatively small sized plant, SA’s oleochemical division is quite profitable, recording operating profits of between MYR15-20m over the last couple of years. This is in comparison to the MYR250-300m operating profits from Kuala Lumpur Kepong’s (KLK) (KLK MK, NEUTRAL, TP: MYR24) manufacturing division, which comprises mainly its oleochemical operations, despite having a capacity size 30x (or 3m tonnes pa) that of SA’s.

We believe this is due to several factors, including :

i. Age of the plant, with all machineries fully depreciated;

ii. Minimal logistics costs, as it is surrounded by a refinery and CPO mill nearby that belong to the private arm of SA’s majority shareholders.

Nevertheless, we note that its oleochemical plant could do with better maintenance and organisation – the machineries and buildings looked slightly run-down, based on our cursory observation.

Based on our recent round of visits to several refineries, oleochemical plants and cooking oil packing plants in and around Malaysia (as per our 8 May report titled Downstream Excursions), we noted that most plants are running at relatively high capacities. However, we highlight that most refineries are facing tougher competitive conditions on the back of Malaysian export tax suspensions (although this has been reinstated). Notably, downstream products have an edge due to the customisation of products and longer sales contracts with customers. We also expect the margins to improve on lower feedstock prices like CPO, PK and PKO, as well as less volatile and more stable raw material prices.

We maintain our forecasts and SOP-based TP of MYR4.20. This is based on an unchanged target of 15x 2018F P/E for the plantations division, 12x for the oleochemical wing, and an EV/bed of MYR1.7m for the healthcare business. We have also used RHB’s TP for Paramount Corp (PAR MK, BUY) of MYR2.40 to account for SA’s 4.6% stake in the company, included its latest net cash position of MYR174.3m, and applied a 25% holding company discount.

Source: RHB Securities Research - 1 Jun 2018