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StockStalk  |  JANUARY 19, 2016 11:30PM

Sime Darby: Night gets darker before dawn

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StockStalk instory imageWith turbulence across most fronts likely to remain in 2016, Sime Darby may see things worsen unless a dash of good fortune sparks some changes in business environments it operates in.

Business model: Sime Darby is a conglomerate with five core businesses, although two of them – plantation and industrial – contribute the bulk of its earnings. The cumulative performance of these two divisions is usually mirrored at the group level.

Traditionally, Sime Darby Plantation contributes more than half group pre-tax profit every year, while industrial usually makes up upwards of 25%. However, recent years have seen a decline in terms of percentage with plantation making up just 38.2% in financial year 2015 (FY15) ended June 30, 2015, while industrial only contributing 17% for the same financial year due to prolonged turbulence in respective sectors.

The other three divisions are motors, property, and energy & utilities (E&U). One is Sime Darby Motors, a regional automotive distributor with roughly 30 brands that includes some of the world’s most recognisable marques. Motors was previously up for a listing exercise but this was put on hold as the sector is slowing down in the division’s various markets across the Asia-Pacific – FY15 division earnings fell 25.4% year-on-year.

In turn, Sime Darby Property is seen as among the big property development brand names in Malaysia and able to leverage on Sime Darby’s vast plantation land bank, which gives it a strong edge over other developers. However, its projects rollout is not as aggressive as other entrepreneur-driven developers.

On the other hand, the E&U division is primarily involved in engineering through Mecomb Group in Malaysia, Thailand, and Singapore, as well as several ports in China, among other activities.

Shareholders and management: As of its 2015 annual report released on Nov 20, 2015, the largest shareholder is bumiputera equity fund Permodalan Nasional Bhd, which holds 54.5% through direct and indirect shareholding. The Employees Provident Fund is the only other substantial shareholder with 13.1%.

Other notable shareholders below the 5% threshold include Retirement Fund Inc, Lembaga Tabung Haji, Federal Land Development Authority and Khazanah Nasional.

The group’s management is lead by Mohd Bakke Salleh as president and group chief executive, taking over from predecessor Mohd Zubir Murshid first in acting capacity and later confirmed in mid-2010. In turn, Zubir oversaw a disastrous RM2 billion loss for the E&U division in FY10.

Formerly of Felda Global Ventures among other places, Mohd Bakke’s time has not seen a stable long-term growth trajectory for Sime Darby both in terms of revenue and bottom line, although this is more due to the inherent volatility in the group’s business activities.

In FY15, in particular, the group’s earnings fell sharply and it missed a nett profit target of RM2.5 billion. In the first quarter ended Sept 30, 2015 (1Q16), Sime Darby posted RM10.2 billion in quarterly revenue, a marginal 0.5% growth year-on-year, as nett profit fell by 34% year-on-year to RM328.4 million.

An ongoing drive for Sime Darby is to pare down its borrowings after seeing its gearing rise to 58% in FY15 compared to 38% in FY14. Management indicated this is intended to maintain its rating among various ratings agencies.

A major push factor for the group’s gearing was its RM6 billion acquisition of Papua New Guinea-based planter New Britain Palm Oil Ltd (NBPOL), which was concluded in March 2015.

On Aug 26, 2015, Mohd Bakke said a more desirable gearing level would be between 30% and 35%. By KINIBIZ rough calculations at the time, this may involve slashing roughly RM7 billion of its RM18 billion in total borrowings, presuming the total equity figure remains constant at RM31.37 billion as per its unaudited FY15 financial statements.

On Nov 26, Sime Darby announced plans to issue a perpetual sukuk of RM3 billion as part of is debt-reduction initiative. The group told analysts it had not dismissed the possibility of a cash call but only as a last resort.

sime darby 1 yr price chart 190116Share performance: The counter had fallen by more than a fifth over the past year, according to Bloomberg data as at Jan 18, 2016. It has traded between RM6.70 per share and RM9.66 per share over the past 52 weeks.

On Jan 19, the counter ended at RM7.24 per share, up 15 sen. It hit at least a five-year low at RM7.02 per share on Aug 24, 2015 after news broke that it is looking to raise cash to pare down debts.

As at Jan 18, Reuters put the counter’s beta coefficient value at 1.06 – as a benchmark, a value of 1 indicates the average volatility of the entire stock exchange.

What analysts think: CIMB Research and AmResearch both maintained a “hold” rating on Sime Darby following analyst meetings with several divisional managing directors earlier this month.

“Overall, we are slightly negative as the group expects El Nino to impact output and is targeting FY16 ending June 2016 fresh fruit bunch (FFB) output of 10 million to 10.1 million tonnes, which is lower than the 11 million tonnes target without El Nino,” said CIMB Research in a report dated Jan 17, 2016.

Sime Darby further expects FFB output on an annual basis to fall further in FY17, said Amresearch. Of note, the effects of dry weather would be felt in Papua New Guinea for the first time, AmResearch noted.

Lower output will likely mitigated by higher crude palm oil (CPO) prices and cost management on the group side, added CIMB Research. Between January and June 2016, Sime Darby expects CPO prices to range between RM2,500 and RM2,600 per tonne.

“It hopes to bring down current costs of production (ex-replanting costs) of RM1,300 to RM1,200 per tonne by lowering overheads and administrative costs,” added CIMB Research. “We maintain our ‘hold’ call as share price is supported by its rich assets.”

One interesting development, however, is Sime Darby’s plan to plant nearly 100,000ha of rubber estates over the next few years, which includes replanting on some oil palm estates in Malaysia. If this move is successful then the group would become a significant rubber producer, said CIMB Research.

Earnings forecast:

sime darby earnings forecast 19012016

StockStalk: At present, FY16 looks like another challenging year for Sime Darby on most fronts as most divisions are still grappling with sector challenges. Across most its divisions, outlook does not look promising in the near term.

sime darby divisional PBIT 19012016While fundamentals remain intact, there are some uncertainties especially after 1Q16 results where all divisions bar plantation saw profit before interest and tax fell year-on-year.

Two key considerations are foremost in considering this counter at this point. The first is Sime Darby’s previously stated eventual end-game of spinning off its divisions into listed entities in their own right, unlocking value that is currently depressed due to a conglomerate discount.

With much turbulence in its respective sectors, valuations may be depressed and present entry opportunities. On the other hand, it is unclear if Sime Darby has struck bottom at this point. This means investors may be well advised to stick to a fundamental-driven evaluation of the counter and look at very long term if they choose to enter.

What remains unclear here is how the eventual spin-off strategy will unfold and what the eventual group structure will be like. The timing of spin-off listings also remains uncertain.

The second consideration is its next move in paring down its borrowings as the proposed perpetual sukuk may not be sufficient. Already higher interest costs from its borrowings undertaken to finance the NBPOL acquisition had bitten into earnings, alongside effects of commodity rout and general economic turbulence in its operating regions.

While TA Securities expects a lower risk of a cash call ahead for Sime Darby shareholders, the group had not totally dismissed the option, although it seems it as a last resort at this point. That said, it remains uncertain what other options are being mulled by management.

All things considered, despite some uncertainties Sime Darby has strong resilience against headwinds in its operating sectors and a steady dividend policy to boot. This bodes well for investors looking for a more defensive addition to their portfolios with a flavour of good fortune when things start to look up again for the conglomerate.

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Important Note and Disclaimer: This article should NOT be taken as a cue to either buy or sell the stock. The intention is to highlight the key factors you might want to think about before plunging in or scrambling out. While KINIBIZ makes every endeavour to ensure facts are right and opinion is fair, no liability can be assumed for anyone relying on this information. In other words let the buyer (or seller) beware — a reflection of Bursa Malaysia, we say.



 
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