By Khairie Hisyam
Overall, Sime Darby Industrial has outperformed the group since the Synergy Drive merger. But its business is cyclical and more volatile than most other divisions. KiniBiz looks at why it needs to stand alone.
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At the heart of it, Sime Darby Industrial is simply a franchise business. But an apparently successful one at that, spread across Asia Pacific from China in the north to Australia down south.
The division boasts more than 140 Caterpillar dealerships across 10 countries throughout Asia Pacific, making it the world’s third largest Caterpillar dealer. In addition Sime Darby Industrial also supplies a wide variety of equipment and services for construction, forestry and mining, among others.
Following the Synergy Drive merger, Sime Darby’s Industrial Division has seen its revenue nearly double in the six full financial years since. In FY08 its revenue was RM7.22 billion and this nearly doubled over six years to hit RM14.06 billion in FY13.
Over the same period, its pre-tax earnings had improved tremendously as well, rising by nearly 90% from RM696 million in FY08 to RM1.3 billion in FY13.
In comparison, the Sime Darby group as a whole has seen its revenue and pre-tax earnings grow by 38% and shrink by 15% respectively over the same six financial year period.
This means the Industrial Division, which is consistently among the top three contributors to group revenue along with Plantation and Motors, has outperformed the collective group in terms of revenue and profit growth after the merger.
Perhaps even more impressive is that the division had also consistently been the second largest contributor to group earnings behind Plantation, hitting a high of 30% contribution in FY13, the same year in which its revenue contribution hit a record 30%.
A cyclical business
Despite impressive overall performance, however, a closer look at year-on-year performance reveals the cyclical nature of Sime Darby Industrial’s operations (see Table 1).
Revenue-wise, the Industrial division saw single-digit percentage growth over FY09 and FY10 before seeing 24% and 28% revenue growth in FY11 and FY12 respectively. However the growth rate dropped to 6.8% in FY13.
In terms of pre-tax earnings, the division’s pre-tax profits rose 24% in FY09 before shrinking by 12% the following financial year. However the earnings then rose by 41% and 27% respectively over FY11 and FY12 before declining by 3.8% in FY13.
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Last year’s decline was primarily attributed to lower equipment sales in Australia’s mining sector as coal prices dropped, while Malaysia and Singapore saw weak market conditions.
The industry follows the mining boom and in Australia, Sime Darby Industrial’s top contributing market, “is ending”, said an analyst KiniBiz spoke to.
“The slowdown started sometime in 2012, but it takes some time for the supply and demand dynamic to respond,” said the analyst. “But it’s now the end of the boom and Sime Darby Industrial’s order book is depleting.”
For a snapshot, the division’s order book as of 2Q14 ended December last year stood at RM2.13 billion, a steep drop from RM3.28 billion as at June 30, 2013.
Going forward Sime Darby has said in February this year that it expects growth for Australia’s mining sector to continue slowing down as coal producers seek to save on costs of new machinery.
The division’s other major markets are Malaysia, Singapore and China. For the first two, things are still looking positive for Sime Darby Industrial, said an analyst.
“Malaysia’s ongoing Economic Transformation Programme (ETP) means Sime Darby Industrial is still doing okay in terms of demand for its products,” said the analyst, adding that in Singapore the division is doing well on the back of a growing oil and gas sector.
As for China, however, Sime Darby Industrial still has room for growth. Its market share in the world’s most populous country was not affected by Beijing’s measures to curb inflation and slow down investment on certain infrastructure projects, although this move led to lower earnings in FY13.
Going forward, it appears Sime Darby Industrial would have to reposition itself from a weakening Australian market to focus more on other markets with more room for growth such as China.
Room to do better?
Can Sime Darby Industrial perform better as an independently listed entity?
In seeking an answer, it is worth remembering that the division is involved in a cyclical industry as highlighted above, and going forward the division needs to be able to ride the wave in either direction.
“Being cyclical is the nature of the industry, can’t do much about it,” said an analyst to KiniBiz.
Therefore there exists an argument for increased transparency and quality of governance that can be expected from the division being listed on its own — as argued in previous parts of the series, risk management would improve.
In the Industrial division’s context, better risk management would translate into improved advanced planning on the management’s part to prepare for the inevitable down cycles in the industry in such a way as to minimise the impact of the bad times.
As highlighted in previous parts of the series, Sime Darby’s current structure carries the risk of individual divisions overextending themselves in terms of taking on new risks, which Sime Darby’s own history has shown to have happened before — among others, Sime Darby Energy & Utilities posting RM1.75 billion in losses in FY09, the RM1 billion in cost overruns in 2010 for the Bakun dam project and the RM1.57 billion in pre-tax loss for Sime Bank for the six-month period ended Dec 31, 1997.
That said, it is worth noting that Sime Darby Industrial has been implementing a three-year Business Transformation Programme (BTP) since 2011 through which the division is investing in technology in order “to deliver leaner processes and seamless standardisation of the industry’s best practices across the Division’s operations”.
While this is positive, as highlighted in the previous article on Sime Darby Motors there is always room for improvement where transparency and governance is concerned.
In contrast, under KiniBiz’s proposed restructure discussed in Part 2 of the series, not only would Sime Darby Industrial’s senior management be subject to direct shareholder scrutiny and be accountable to them but also to the management of Sime Darby’s holding company, which adds a second layer of oversight.
Another side of a spin-off would be removing Sime Darby Industrial’s cyclical factors from the conglomerate’s collective risk factor, where valuations of other less volatile divisions such as Property are dragged down by the volatility of other more volatile segments such as Plantation.
This effect was examined in Part 3 of the series on Sime Darby Plantation.
Mergers before listing?
There is no immediate catalyst to boost the Industrial division, said an analyst to KiniBiz.
“Unless the mining boom comes back, that is,” added the analyst, saying that may not happen for another few years.
However, one way to boost the Industrial division going forward is through mergers and acquisitions (M&A), suggested the analyst.
“There are mining assets at cheap prices at the moment,” said the analyst, declining to elaborate.
One recent example of such a deal for Sime Darby Industrial was the acquisition of its Bucyrus business in FY12, which contributed RM57.6 million in profit within its first six months of operations.
Such a move — bulking up the division with good mergers — in preparation for a corporate spin-off of the Industrial division would make sense as listing it during the current down cycle would mean lower valuations for the business.
Yesterday: Revving up the marques
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