Powering Energy & Utilities forward?

By Khairie Hisyam

Sime Darby Energy & Utilities is much smaller from other, bigger divisions in terms of contributions. But its RM2 billion loss in FY10 is a lesson in how big an effect one division’s performance can have on how the collective group is doing. That episode could have been prevented by independent listing.

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Like Sime Darby’s other divisions such as Motors and Industrial, Sime Darby Energy & Utilities division is a multinational operation spread across Asia Pacific.

Unlike other divisions, however, E&U is on a much smaller scale, consistently the smallest core division in terms of revenue and earnings contribution to group income. For FY13 this division made up 2.9% and 4.7% respectively in terms of group revenue and pre-tax earnings.

In terms of overall growth performance across the six full financial years that has followed since the Synergy Drive merger, the E&U division has seen mixed results.

Over the years its revenue has grown by 43.7% since recording RM959 million in FY08 to hit RM1.38 billion in FY13, but at the same time its pre-tax earnings have dropped slightly from RM242.9 million in FY08 to RM229.9 million in FY13 — a 5.4% decline.

As previously examined in this series 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.

Therefore in comparison the division has slightly outperformed the group but not by much. And looking at the overall decline in pre-tax earnings, the division is seeing margins pressure.

Could FY10 disaster have been prevented by separate listing?

While the E&U division’s contribution had been relatively small over the years, in FY10 the division incurred some RM2 billion in losses, which played a major part in dragging down group pre-tax profits by some 43% compared to the previous financial year.

The losses stem from the group’s Oil & Gas and Engineering units, two major businesses under the E&U division at the time, due to cost overruns in its Qatar Petroleum (QP), Maersk Oil Qatar (MOQ) and Bakun dam projects.

This led to the group posting some RM1.75 billion in pre-tax losses, although this figure had been restated to RM687.2 million in subsequent annual reports. According to a regulatory filing to Bursa Malaysia, the total provisions made for foreseeable losses and impairments for FY10 amounted to RM2.1 billion.

To put the losses in perspective, Sime Darby group’s collective pre-tax profit for FY10 was RM1.7 billion. Had the group not needed to provision for E&U division’s RM1.75 billion in pre-tax losses, the collective pre-tax profit would be double the amount at RM3.4 billion.

“We have identified the problems in the Oil & Gas business and are addressing them to turn around the business. Furthermore, we are collaborating with strategic partners to strengthen our capabilities,” said then-newly appointed Sime Darby president and group chief executive Mohd Bakke Salleh in 2010 over the losses.

Interestingly Mohd Bakke’s predecessor, Ahmad Zubir Murshid, was asked to leave in May 2010 following the results. His contract would have expired in November that year.

Two months later, in July 2010, Zubir was arrested on criminal breach of trust (CBT) charges involving Sime Darby’s acquisition of Native Customary Rights land in Sarawak, which was worth some RM80 million. The case is still in court at the time of writing.

The question at the time was whether E&U had gotten ahead of itself in terms of undertaking risks disproportionate to its size. Correspondingly, would E&U would have been able to undertake such big projects had it been independently listed, which in turn would have evaluated the division’s individual capacity for the projects separately from the group’s collective financial muscle?

With much more scrutiny and accountability from being separately listed, it would not stretch the imagination to envision more prudent risk management in terms of projects and ventures, which in turn would have avoided such a financial disaster.

Following the RM2 billion in losses, the E&U division was segregated into China and non-China operations with two different executive vice presidents to oversee each sub-division, which is the current structure today.

While this would have improved governance and transparency by adding more management depth, this exercise would have been more efficient if the extra layers between investors and the E&U division’s management be removed by separately listing the division. This would have imposed more accountability on the E&U division management more directly.

Realigning focus — should Sime Darby exit energy?

In any case, the oil and gas operations under the E&U division were subsequently discontinued. The division’s non-China operations’ exit from the sector was marked by the sale of the Kebabangan Project to Malaysia Marine and Heavy Engineering Berhad.

“During FY12/13, the (E&U) division realigned its focus on areas where it could achieve a better leadership position,” said Sime Darby in its 2013 annual report over the discontinuation.

As for the Bakun hydroelectric dam project, FY13 saw it achieve substantial completion status, which meant Sime Darby’s subsequent involvement is limited to managing the rectification list, documentation and overseeing the end of the defects liability period.

More recently, Sime Darby sold its only Malaysian power plant to Malakoff Corporation Berhad for RM300 million in cash. According to Mohd Bakke, the sale is consistent with its long-term strategy to be a leader in its core business: plantations, industrial equipment, motors, property and energy and utilities.

“The power purchase agreement for PDP expires in 2016. Since we are focusing on our five core businesses, the decision was made not to scale up our investments in the power industry,” said Mohd Bakke in announcing the sale.

An analyst KiniBiz spoke to said the sale makes sense as the returns from power generation is declining throughout the world, not just in Malaysia.

“In contrast Sime Darby has other core businesses with better returns on investment (ROI) such as plantations at 15%,” said the analyst who declined to be named.

The analyst added that this applies to the entire E&U division, noting the possibility of Sime Darby hiving off its entire energy and utilities operations in favour of expanding its plantation and motors divisions, for example.

That said, the question that arises is whether such a disposal is desirable given the division is currently profitable. In addition having a foothold in energy and utilities offers Sime Darby a facet of diversification, although governance and transparency can always be improved further.

At present, Sime Darby’s E&U division is currently engaged in trading services, power and engineering services for its non-China operations while in China the division is involved in water management and ports and logistics. Both seem to be facing industry headwinds in recent times.

The non-China sub-division saw pre-tax earnings of RM170 million in FY13, 23% lower than FY12. E&U China saw its pre-tax earnings drop 15.3% in FY13 compared to FY12, recording RM53.1 million last year.

One possibility for E&U division in boosting its earnings growth is to move for oil and gas in terms of Petronas’ risk-sharing contracts (RSCs). The industry boomed last year and this may well continue to be the case this year.

However, Sime Darby had already exited the sector and going back raises a question on strategy consistency, argued another analyst, especially after burning its hands so badly in FY10.

In any case, given the division is facing challenging market conditions for both sub-divisions, it would arguably more prudent to list the division separately so as to give investors a more accurate risk profile in terms of investment. It would also reduce the risk of the FY10 debacle from occurring again.

Yesterday: Sime Darby’s industrial machinery

Tomorrow: How much value would a break-up of Sime Darby create?