By Khairie Hisyam
A conglomerate driven by turbulent and cyclical industries, Sime Darby’s earnings still rely on plantation and industrial businesses which make up two thirds of its profits. And when both falter, the plunge in profits can be drastic, as seen in its latest results. Should investors run?
Business model: A conglomerate employing over 100,000 employees in 20 countries, Sime Darby Group was born out of the Synergy Drive merger in 2006, which delisted three main listed companies — Sime Darby, Guthrie, and Golden Hope — and combined them into Synergy Drive Sdn Bhd in November 2006.
The company returned to Bursa Malaysia a year later as Sime Darby Group Bhd with a market capitalisation of RM59.5 billion. Its five core businesses are plantation, industrial equipment, motors, property, and energy and utilities.
The plantation division makes up around half its earnings every year with industrial contributing some 25% to 30% since the 2009 financial year (FY09). Notably, any major movements in plantation have always been mirrored by group-level earnings.
The group also has the motors division, a regional automotive distribution powerhouse tied-up with some 30 brands across the Asia Pacific, among its distributed brands are some of the world’s most recognisable carmakers. In addition, Sime Darby Property is also recognised as among the big boys of the Malaysian property market.
The fifth division is the energy and utilities (E&U) division, which has been subjected to some fat-trimming in recent times as Sime Darby sharpens its focus on core businesses.
Shareholders and management: Sime Darby’s biggest shareholder is Permodalan Nasional Bhd (PNB) with about 52%, while the Employees Provident Fund is the only other substantial shareholder with just under 14%, based on the group’s latest annual report.
Heading the conglomerate’s executive leadership is president and group chief executive Mohd Bakke Mohd Salleh, whose career includes stints at several PNB subsidiaries. He first took over from predecessor Ahmad Zubir Murshid in an acting capacity on July 15, 2010 and was later made permanent.
Ahmad Zubir, previously, oversaw a disastrous divisional loss of RM2 billion for Sime Darby’s E&U division in financial year 2010 ended June 30, 2010, dragging down group net profits. Sime Darby eventually filed criminal breach of trust charges against Ahmad Zubir. In June 2014, both the group and the defendants, which include four other former senior executives of the group, agreed to a consent judgment.
Under Mohd Bakke, formerly of Felda Global Ventures among others, Sime Darby had seen growing revenue for three consecutive financial years, though this run ended with a dip in FY14 and likely another dip when FY15 concludes end-June.
While consistently profitable, there has not been a stable growth momentum in earnings, though this can be attributed to the cyclical nature of some of the group’s businesses, especially plantation and industrial.
Share performance: Up to the 5pm bell on May 26, 2015, Sime Darby shares had declined by 6.55% in value over the preceding year, closing at RM8.57 per share compared to RM9.53 per share on May 26, 2014 based on Bloomberg data.
Over that 12-month period, its share prices have ranged between RM8.50 and RM9.79 per share, according to Bloomberg.
The counter has been less actively traded recently with a beta coefficient of 0.86, according to Reuters, compared to 0.93 in December 2014. A value of 1.0 reflects the average volatility of the overall stock market.
Sime Darby maintains a policy of paying out at least 50% of reported net profit as dividends to shareholders.
Between FY10 and FY14, dividends have averaged 29 sen per share, though this was dragged down by FY10 earnings, which took a tumble following a disastrous divisional showing by Sime Darby’s E&U division as mentioned above. FY10 dividends aside, the four-year average up to FY14 comes to roughly 33 sen per share.
However, analysts surveyed by KINIBIZ expect much lower dividends in FY15 due to a drastic drop in profits seen in the nine-month period to date. Maybank expects net dividend per share to come in at 18 sen, while Public Investment Bank expects 20.6 sen.
What analysts think: Five research houses surveyed by KINIBIZ agree that the group’s earnings fell far below expectations when its third-quarter results were announced on May 22, 2015.
For that quarter, its net profit fell by more than half year-on-year. For the nine-month period up to March 31, 2015 (9M15), Sime Darby posted 39% lower net profit compared to 9M14, while revenue only fell by a slight 1.6%.
This was mainly due to prolonged turbulence in its major divisions — plantation and industrial. Contribution from both fell 46% and 51% respectively in 9M15 compared to 9M14 as crude palm oil (CPO) prices fell and a prolonged slowdown in the Australian mining sector hurt the Industrial division.
The motors division also saw continuing slowdown in its various markets, slashing profits, and causing its proposed spin-off listing to be put on hold indefinitely. Meantime, the gains by property and E&U were driven by one-off gains from selling property, according to a regulatory filing.
Maybank expects Sime Darby to show its strongest earnings in the final quarter of FY15 (4Q15), which ends on June 30, and tips both plantation and property divisions to drive the figures. AllianceDBS agrees.
“We anticipate 4Q15 earnings to rebound on seasonal uptick in fresh fruit bunches output, lower plantations costs, and higher property and New Britain Palm Oil Ltd (NBPOL) contributions,” said AllianceDBS, referring to Sime Darby’s newly acquired plantation asset based in Papua New Guinea.
Overall, analysts seem to feel the group lacks near-term catalysts given the motors listing is now on hold. However, the share price may have scraped the bottom of the barrel, said TA Securities.
“Despite the roundly disappointing 3Q15 results, we believe the underlying earnings had reached the trough. A strong rebound in FFB production will boost 4Q earnings — we estimate RM759 million in net profit for the quarter,” said TA Securities.
An encouraging takeaway from the briefing with Sime Darby’s senior management on May 22 is that Mohd Bakke has stated outright of the group’s plan to list its major business divisions separately, starting with motors and then property, with plantation in the pipeline too. This line of development would eventually catalyse the counter and unlock value, said UOB Kay Hian.
Meantime, the counter remains a decent dividend play, said analysts.
Earnings forecast:
Stockstalk: The two key divisions to consider when it comes to Sime Darby are plantation and industrial. Together, they make up at least half of the group’s revenue and two thirds of earnings for the past five financial years.
For plantation, lower CPO prices pose a concern. Last year, CPO prices fell below the RM2,000 per tonne mark for the first time in years, though it seems to have stabilised in 2015 so far. This year, CPO prices have largely ranged between RM2,000 and RM2,250 per tonne, occasionally breaking slightly above RM2,350.
The low CPO prices is reflected in the plantation division’s falling earnings. Mohd Bakke had previously estimated a RM250 million shift in net profit for every RM100 movement in CPO prices.
However, the plantation sector has always been a long-term play. With uncontrollable factors such as weather and disasters in the mix, the group has solid fundamentals behind its staying power as seen over the years. Firmly the pack leader, its estates account for 5% of global CPO output and this isn’t likely to change soon.
Meanwhile, the NBPOL acquisition has contributed RM7.5 million to group earnings so far and while this seems small, more important is the intangible gains from acquiring NBPOL’s expertise and experience as it is among the better-run plantation outfits in the world over the years. Already NBPOL bigwigs are joining Sime Darby’s headquarters in Kuala Lumpur.
Overall, while there are better planters out there in terms of efficiency, Sime Darby remains a solid plantation play.
Things are less clear-cut with the industrial division however. The group has been cutting costs including measures such as retrenchments — which have reduced its manpower costs which is the biggest cost component — by more than 20% so far in Australia. This region used to make up nearly 70% of divisional earnings but now contributes just under 40%.
However, the group has demonstrated strong staying power in the mining sector, another highly cyclical industry, keeping itself in the black despite falling margins.
In the larger picture, global coal consumption is projected to increase by up to 30% by 2020, according to think tank Enerdata. This suggests that the mining slump in Australia, a big drag on industrial’s results, will not last forever.
The main takeaway is both plantation and industrial can hold their own within the highly volatile sectors they operate, still turning out profit during down cycles where both are apparently in now. This implies solid fundamentals ahead of a coming upcycle, though when is anyone’s guess.
Other sectors are less worrying. While the motors division has hit a bump on its road to spin-off listing, things are looking up from here onwards. The stock clearance sales preceding the implementation of goods and services tax in Malaysia, its biggest market, slashed profits but the market will slowly pick up going forward, said the group.
Meanwhile, its property division remains among the bigger names in the local Malaysian market. The sector is also slowing down somewhat in recent times due to tighter lending policies for homebuyers, among others.
That said, its products have some diversity which bodes well — a case in point was how sales of industrial properties propped up earnings in 3Q15. With a massive cheap potential land bank from its plantation big brother, the division is on solid ground.
The value investor should consider the point that Sime Darby has long been shackled by a conglomerate discount. This is probably why the counter has seen its market capitalisation value falling over the years, going from RM59.5 billion post-merger in 2007 to just over RM53 billion as at May 26’s closing bell. That is roughly a 10% dip.
Poor sentiment from the sector turbulence facing plantation and industrial does not help. However, the downtrend in turn may present opportunities for investors to take a position ahead of the potential division spin-offs as stated by Mohd Bakke, which would be a major boost to share price performance.
A successful motors listing followed by a property listing would dissipate the conglomerate discount somewhat. Mohd Bakke had said the endgame is to have several listed subsidiaries under the parent group and this would boost the entire value of the Sime Darby group by about a third, according to a KINIBIZ analysis in 2014.
Investors should take note, however, that the conglomerate discount would probably disappear for the listed subsidiaries but remain to some extent with the parent entity’s shares. The dynamics of this depends on the eventual structure of the group.
Overall, Sime Darby is not the sexiest growth counter out there. But it should be considered by long-term investors seeking staying power and stable dividends amid tell-tale signs that the current high-valuation environment may wake up and smell the coffee someday soon.
The long-term decline of its value is a cause for concern, but a breakup of the group would be a good catalyst upwards for its share price. Now that the group has confirmed it wants to do this, investors may start paying more attention to the counter.
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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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