This article first appeared in The Edge Malaysia Weekly on August 15, 2022 - August 21, 2022
SIME Darby Bhd seems to be in a good place. Following the demerger exercise in November 2017 that left the century-old company focused exclusively on its core trading business and saw its plantation and property businesses spin off into two separate companies — Sime Darby Plantation Bhd and Sime Darby Property Bhd — it has grown its net profit at a compound annual growth rate of 32% in the last three years.
Its net profit jumped by 74% year on year (y-o-y) to RM1.4 billion for the financial year ended June 30, 2021 (FY2021) as consumers from China splurged on luxury cars to make up for the months of lockdown and inability to travel overseas. Revenue rose 20% y-o-y to RM44.5 billion — its highest since the demerger.
But Datuk Jeffri Salim Davidson, executive director and group CEO of Sime Darby, is not resting on his laurels. There are three things that keep him awake at night — and they are not concerns over the war in Ukraine, Covid-19, rising interest rates, inflation and supply chain disruptions.
“What keeps me awake at night? It’s probably the uncertainty of what is happening in the automotive retail space. We have been doing this (motors trading) business for 50 years, but the auto industry has seen huge changes in its business model for the past few years,” he tells The Edge in an interview.
One is the emergence of the agency model, where an increasing number of car manufacturers are bypassing franchise dealers to sell directly to consumers to have better control of variables such as pricing, customer service and profit margins. This shift is being led by Tesla, the world’s biggest electric vehicle (EV) maker, which has forgone the traditional dealer model and sells directly to consumers.
Sime Darby has not been spared. It has grown to become BMW’s third-largest dealership group in the world by volume.
“Today, we buy stock from car companies such as BMW and then sell them to consumers from whom we make profits at a margin. But the future model is that car manufacturers are now saying, ‘We will do the selling. You, the dealer (Sime Darby Auto Bavaria Sdn Bhd), become the service provider; that is, handle delivery and after-sale service of the cars,’” says Jeffri.
This is already happening in South Africa, where the luxury carmaker is taking the agency model approach to the sale of new cars and is moving to adopt this model in Europe. According to news reports, BMW and its subsidiary MINI are in talks with their European dealers about a move as soon as 2024.
“The [new car sale] model is changing. Carmakers are experimenting [with the agency model]. However, we don’t know if it will work or not,” he says, adding that there are still many unknowns.
Jeffri sees the shift to the agency model happening in Malaysia in four to five years. “It doesn’t mean it would be that bad for us, except we are not quite sure how much of the ‘pie’ would be affected. In fact, we are experimenting [on the agency model] with the MINI brand in China.”
Another thing that weighs on him is the industry’s gradual transition from internal combustion engine (ICE) vehicles towards EVs that have been touted as cars of the future. “EVs incur only 40% of ICE maintenance cost due to fewer replacements of parts, which will affect after-sales profits. But, they are also more complicated and customers cannot just walk into any workshop to fix an EV. So, while this may impact after-sales revenue per car, we should get it for a longer period, and we can also make money on the batteries.”
He believes traditional dealers such as Sime Darby have no choice but to pivot to EVs as more and more EVs hit the road. In Malaysia, the shift to battery-powered vehicles comes as the government gives tax reliefs on EVs to support the development of a domestic EV industry. On its part, Sime Darby has been providing training on EVs to its mechanics. “Every year, we reinvest about RM500 million to RM800 million back into the business, facilities, training and expansion,” says Jeffri.
Used car e-commerce marketplaces — such as Carsome and myTukar, with a lot of capital from multiple sources that have been muscling in on the used car market and shifted offline industries online — also keep Jeffri up at night.
“We have quite a sizeable used car business and over the last three to four years, we have almost doubled the sales revenue. However, e-commerce platforms such as Carsome and myTukar have caused some disruption. Their model is focused on revenue while we are focused on profit to ensure a steady business,” he says.
Nevertheless, he believes Sime Darby is in good shape to compete with these technology start-ups. “We provide good service, our cars are good quality and we have warranties. We are still growing our business, but they are more likely to eat into [the share of] mom-and-pop used car dealerships.
“Online used car platforms are currently loss-making and are also moving towards physical, while traditional players are exploring digitalisation. The industry is likely to converge somewhere in the middle,” he reckons.
In fact, Sime Darby has positioned itself to participate in the new mobility ecosystem by investing US$3 million (RM13.4 million) in Socar Mobility Malaysia, a joint venture between South Korea’s SK Inc and car sharing company Socar Inc, and US$5 million in Singapore-based online used car platform Carro. While many of these privately held tech start-ups operate at a loss, they continue to grow in revenue and scale. Investors are betting on them to reach profitability and will exit their investment if the start-ups go public.
“The main reason we are doing it is so that we can get an insider’s perspective of the mobility sector; understand what they are thinking and how they do business. It’s not purely financial returns we are looking at. If we are lucky, they become successful and go for listing on the stock exchange, and then we will cash out and make some money,” he says.
Jeffri is not alone in this journey. “All car dealers in the world are thinking about these problems. I spent time with Emil Frey, one of Europe’s largest car dealers, and Arnold Clark, the UK’s biggest car dealer, and asked them what they are doing, if they are getting out of the game? They said no, and that they believe the biggest guys will survive as car companies aren’t planning to eliminate their franchised dealers.
“We are committed to the motors business and will continue to invest and expand to capitalise on the growing luxury spend in Asia-Pacific. We believe that scale and reputation are necessary to dominate in this segment. At the same time, we will pivot towards used cars, after-sales, omnichannels and build up new profit pools in order to future-ready our portfolio,” he says.
Not spared from global supply chain disruptions
Like its peers, Sime Darby has not been spared the impact of the global supply chain disruption. Rising costs and component shortages are putting a drag on the group’s earnings as they have caused a shortage of new cars and significant delays in delivery. The group’s net profit dropped 32% to RM825 million in the nine months ended March 31, 2022 (9MFY2022) from the year-ago period, while revenue fell 4% to RM31.8 billion. Sime Darby is slated to release its 4QFY2022 results on Aug 17.
However, it is worth noting that the prior year result included a gain of RM272 million from the disposal of its 30% stake in Tesco Malaysia (now Lotus’s), a Singapore goods and services tax refund of RM39 million and a RM33 million reversal of impairment loss for the sale of its 10.89% stake in Eastern & Oriental Bhd.
“Excluding the one-off gains, net profit for 9MFY2022 was down by 5.2% y-o-y. That’s not too bad considering the issues we have had to manage. FY2022 has been a challenging year due to supply chain constraints. Our normal inventory levels of three to four months in motors have been reduced to one to one-and-a-half months, indicating the lack of stock,” says Jeffri.
According to Bloomberg’s consensus among analysts, the group’s net profit is expected to come in lower at RM1.136 billion on revenue of RM43.426 billion for FY2022. This translates into a price-earnings ratio of 13.9 times FY2022’s earnings.
With sustained demand for luxury cars this year, Jeffri expects the motors division to continue to drive the group’s profits in FY2022. Despite inflation and recession worries, he notes that demand for luxury cars has been holding up particularly well in China, as well as Australia, New Zealand, Singapore and Malaysia. And while supply shortages for certain new models remain a risk to profits, this is partially offset by lower discounts on vehicles amid low inventory and high demand.
Meanwhile, the two big industries that the industrial division serves are construction and mining. Jeffri notes that the industrial division’s earnings in 9MFY2022 were affected by a significant contraction in the sale of excavators in China.
“China is the world’s largest construction market and we hold about a quarter of China’s excavator market share. This year, the volume of sales has halved as the Chinese government pulls back on infrastructure spending, and contractors are scared to start work because of Covid-19 uncertainties. Therefore, our revenue has dropped off. China has been the weakest spot for us in the industrial business,” he says.
Industrial contribution for 9MFY2022 from Australia, largely from the mining industry, also came in below expectations. “We had expected a far better year from the after-sales service last year amid high prices of metallurgical coal, which is a crucial component for steelmaking. However, that didn’t happen as many coal mines deferred equipment maintenance as they prioritise maximising production,” Jeffri says, noting that the after-sales business has higher margins compared with new sales. “For example, we make about 6%-7% margins when we sell the equipment, but we get a margin of 25% on parts and 50% on labour.”
The group expects its after-sales business to bounce back at some point on the back of pent-up demand as the supply chain readjusts.
Sime Darby is also experiencing short-term challenges impacting margins due to labour and higher overhead costs, as a result of the Covid-19 pandemic. “We have thousands of mechanics fixing our trucks. Many of them had Covid-19 and couldn’t come to work and we still have to pay them. In the meantime, we also have to pay someone overtime to carry out their jobs or we have to get a temp in as we have commitments to our customers. So, our cost has also gone up this year because of Covid-19-related absences,” he says.
The group also experiences labour shortages in some markets like Australia due to the mining boom, which has led to mining companies seeking workers from other sectors. “As a result, we had to pull some of our staff out of New Zealand and so, our operations there face a bit of a shortage,” says Jeffri.
Managing in economic uncertainties
When asked about the outlook for FY2023, Jeffri admits it is difficult to predict. “Things are pretty gloomy. If the economic pundits are to be believed, the worst is not over; the world is headed towards a recession amid rising interest rates and inflation. Covid-19 is still hanging around and the supply chain hasn’t sorted itself out.
“So far, demand for luxury cars is still strong throughout Australia and New Zealand, likewise with Malaysia. But we expect sales in Malaysia to drop off in March 2023 when the sales and service tax (SST) exemption for new vehicle orders ends. Demand for trucks in New Zealand is also strong but we have supply shortages.
“There is a worldwide shortage of parts. It will take another six months for carmakers to overcome the supply challenges in the market,” he says. “Thus, the outlook is mixed. It is a very difficult year to budget as we are not quite sure where it is going.
“For FY2022, we spent about RM700 million on capital expenditure (capex), mainly in the motors business. In FY2023, we think it will be under RM1 billion, and again mainly in the motors division, primarily for showroom maintenance, upgrading and expansion.”
Sime Darby’s policy is to distribute a dividend of not lower than 50% of net profit. It has been distributing more than 50% of net profit for the last three financial years following the demerger. For FY2021, it declared a dividend of 15 sen per share, amounting to RM1.02 billion, which is equivalent to 72% of its net profit for the year. This is a 50% increase from the total dividend payout in FY2020 of RM680 million.
Last month, Sime Darby had entered into share sale agreements to dispose of its entire 37% stake in Weifang Ports in China for RMB1.92 billion (RM1.27 billion) cash. It said that the proceeds will be utilised for future investment opportunities, capex and/or repayment of short-term borrowings.
Asked if the group has plans to distribute a special dividend to its shareholders upon the completion of the proposed divestment, Jeffri says: “All options remain open at this stage on the use of the proceeds. We still want to invest. But part of the proceeds could also be used for dividend payments to shareholders.”
In a July 5 note, Hong Leong Investment Bank Research analyst Daniel Wong said while there are ongoing global risks in the near term, Sime Darby would still be able to ride through the choppy waves and present sustainable earnings into FY2023. He has forecast a dividend per share of 12 sen for FY2022, FY2023 and FY2024, translating into a dividend yield of 5.19% based on Thursday’s closing price of RM2.31.
Sime Darby’s major shareholders — Permodalan Nasional Bhd owns a 46.6% stake, the Employees Provident Fund 9.7% and Kumpulan Wang Persaraan (Diperbadankan) 7.6% — should be happy with the prospects of stable dividends.
In terms of share price performance too, Sime Darby has held up, outperforming the FBM KLCI by about 6.5% year to date.
Analysts are still bullish on Sime Darby, with 12 of the 16 analysts who follow the stock rating it as a “buy”, while four have a “hold” call. There are no “sell” ratings. Their consensus target price of RM2.59 translates into an upside of 12.12% from the closing price of RM2.31.
“Investors are very clear. They like the fact that we have broken up, and are solely focused on the trading business. Over the last three to four years, we have also proven that we have consistently generated profits and the funds to continue to invest and buy companies,” says Jeffri.
Right region, right time
Today, Sime Darby takes pride in being a leading trading company in Asia-Pacific, where about 87% of its revenue comes from outside Malaysia. Based on 3QFY2022 revenue, China is the largest region, contributing 39% of revenue, followed by Australasia at 36%, Malaysia 13% and Singapore, Thailand and Indonesia the remaining 12%.
“We are in the right part of the world — Asia-Pacific. The region is seen as young, growing, urbanising and getting richer, where there is growing affinity for luxury consumer goods such as BMW. We are fortunate to have exposure in 19 countries in Asia-Pacific. While China-US issues are going to put a drag on the region’s growth, these are but blips and over the long run, things will smoothen out and China will be the engine to drive Asia-Pacific growth. You can see Asia’s share of global gross domestic product is still growing,” he says.
Sime Darby has a cash reserve of RM1.85 billion while borrowings totalled RM2.54 billion, leading to a net debt position of RM689 million as at end-March 2022. With a low gearing of 0.27 times, Jeffri says the group has ample debt headroom for strategic expansion as well as merger and acquisition (M&A) opportunities.
“We are certainly looking into more M&As. Since the demerger, we have invested about RM1.5 billion in acquisitions to expand our two core businesses of industrial and motors. We don’t want to force a target, but continue to invest in our China businesses and broaden our presence there,” he says, adding that the group is looking to expand its car retail business in Indonesia and India.
“However, these are high-risk, high-return places. It’s early days yet. We probably need local partners to steer through all the complexities in the local markets,” he adds.
Why the change of heart on healthcare unit
For years, healthcare was Sime Darby Bhd’s third business pillar, providing a recurring income profile.
Through Ramsay Sime Darby Health Care Sdn Bhd (RSDH), a 50:50 joint venture with Australia’s Ramsay Health Care Ltd, Sime Darby’s portfolio of three hospitals in Malaysia combines with Ramsay’s three hospitals in Indonesia. Last year, the portfolio expanded to include Manipal Hospitals Klang, now known as Bukit Tinggi Medical Centre.
There were even plans to spin off the healthcare unit, whose share of profit after tax to Sime Darby fell by 62% year on year to RM15 million in the financial year ended June 30, 2021 (FY2021) from RM39 million in FY2020. Since then, however, things appear to have changed.
Sime Darby executive director and group CEO Datuk Jeffri Salim Davidson says the matter of whether to keep the healthcare operations as part of its businesses or not has been deliberated for years at the board level.
“We always have this debate. We are a trading company. We sell cars and tractors. And then we have hospitals. It doesn’t make sense,” he concedes in an interview with The Edge.
“While it is a good, growing business, it is not part of the group’s core businesses. The question then is, why don’t we make it a core?” he muses, acknowledging that providing diverse services and products, however, makes it a conglomerate again — something Sime Darby had made a decision to move away from with the demerger of its trading, plantation and property businesses in 2017.
Then came the interest from hospital group IHH Healthcare Bhd in March this year to acquire 100% of RSDH for RM5.67 billion, which Jeffri describes as a “nice offer”.
“We are currently in negotiations with IHH following the offer made for our 50% stake in RSDH. I can’t talk about the deal publicly yet because it’s still under the due diligence process,” he adds.
In recent years, Sime Darby has been progressively divesting its non-core assets as part of its five-year value creation plan to streamline its portfolio and redeploy capital to put a sharper focus on its core industrial and automotive businesses.
“We have stayed on track with our strategy and in FY2021, we successfully sold our interest in Tesco Malaysia (now Lotus’s) and Jining Ports in December 2020 and our 10.89% equity interest in Eastern & Oriental Bhd for RM93.5 million in April last year. The divestment of our interest in Tesco Malaysia had bagged us a sizeable gain of RM270 million.
“In October last year, we announced the sale of 760 acres of our plantation land in Malaysia Vision Valley in Labu, Negeri Sembilan to Sime Darby Property Bhd for RM280 million. That leaves us with about 8,000 acres, which we are not in a hurry to sell. We are looking to optimise the value we can get out of the land,” says Jeffri. Sime Darby currently leases the land to Sime Darby Plantation Bhd.
Last month, Sime Darby also announced the sale of its Weifang Port companies to China’s SPG Bohaiwan Port Group Co Ltd for RMB1.92 billion (RM1.27 billion), marking its full exit from the non-core logistics business. In addition, the group will receive RMB541 million (RM357 million) as repayment of shareholder loans.
But critics say the returns from its investments in Weifang Port, for which it will record a gain of only RM35 million from the exercise, came in below expectation and could have been better invested elsewhere. Sime Darby’s cost of investment in Weifang Port since 2005 is reportedly at RMB1.5 billion while the sale is at RMB1.92 billion.
It is only fair to point out that the investment was made before Jeffri took the helm at Sime Darby in 2017.
“At the turn of the decade, Sime Darby developed a ‘China growth strategy’ to tap into the fast-growing economy of China. Significant investments were made in growing our motors and industrial footprint in China, as well as developing the ports business in Shandong province which we entered in 2005. I would say from that perspective, this strategy has been largely successful with China now accounting for almost 40% of the group’s revenue,” he says.
“Following the demerger of Sime Darby and the group’s focus on our trading businesses of motors and industrial, the ports business (which comes under the logistics division) is no longer considered a core,” he adds.
He concurs that the disposal price is slightly below the net book value of the Weifang Port companies of RMB2.5 billion, including shareholder loans as at March 31, 2022.
“However, we view it as a good outcome as we are exiting a non-core asset while recouping our investment cost. Also, Weifang Port’s earnings have been declining over the years and its outlook is challenging. Significant capital expenditure is also foreseen to sustain its operations.
“This way, we can recoup our capital and re-channel financial resources towards motors and industrial, which have been identified to be the drivers of growth for Sime Darby,” he explains.
For FY2021, the logistics division reported a loss before interest and tax of RM64 million, but managed to turn around with a profit of RM20 million for 9MFY2022.
Revving up hunt for investment opportunities in mobility space
Disruption has taken many forms within the local automotive industry in recent years, including the emergence of technology start-ups and as consumer interest shifts to hybrid and electric vehicles (EVs) in an effort to go green. But legacy auto players such as Sime Darby Bhd are not taking these challenges lying down.
According to its executive director and group CEO Datuk Jeffri Salim Davidson, the group has had a mobility unit since 2019 to explore new trends and opportunities for growth in the auto industry as part of its strategy to future-proof its motors business, particularly in shared mobility and in the electrification of the industry.
“Recognising that the motors business is on the cusp of disruption, we set aside some funds for investment purposes to keep abreast of trends in the mobility space, and pinpoint some business benefits that are synergistic to our existing business,” he tells The Edge in an interview.
Sime Darby’s maiden investment in the mobility space was in South Korea’s car sharing company Socar Mobility Malaysia, where it invested US$3 million (RM13.4 million) in the start-up’s Series B fundraising exercise in September last year. Less than two months later, it invested US$5 million in Singapore-based online used car platform Carro through the latter’s Series C extension fundraising exercise.
“We have developed an ‘Engine 1’ strategy, which is our traditional bricks-and-mortar car dealership business. But what we also know is that our business is changing. So we have set up a separate unit called ‘Engine 2’, which serves to facilitate our mobility ambitions, to look at different things that are happening that may give us opportunities.
“For example, we have teamed up with Tenaga Nasional Bhd and PLUS Expressways Bhd to set up EV charging stations along highways across Peninsular Malaysia, and we are also the distributor of charging equipment in Malaysia and Singapore. While their contribution is still small, we are kept very busy,” says Jeffri.
“Porsche and Shell Malaysia are also doing something similar. That is why we are investing in Socar and Carro, even in GLy New Mobility Fund, a private equity fund that gives us access to all these mobility start-ups.
“Will these [investments] make huge money? We don’t know. It depends on how much we invest and what we learn from them. But we are on the lookout for more investment and collaborative opportunities with other strategic partners in the mobility and EV space,” he reveals.
“This is part of our aim to be part of the entire auto ecosystem. The objective is not to generate immediate returns but to grow our presence and capabilities, especially in new and emerging areas in the motors business,” he says, adding that it is not purely financial returns the group is looking at.
“It is to look ahead and be on the pulse of these new developments and how we can fit in on a synergistic and strategic angle. These investments will enable us to gain from the experience of knowledge sharing and know-how to strengthen our motors business, in line with our mobility strategy and as part of our push to develop alternative ownership models.
“We are conscious that there will be a gestation period for investments of this nature and are not expecting immediate returns,” he says.
Meanwhile, Jeffri says Sime Darby is leveraging its wide portfolio of world-class principals, such as BMW, Porsche, Jaguar and Hyundai which are rolling out their EV line-ups, to tap on the growing EV market.
“Also, we are seeking new EV original equipment manufacturers to carry their products, given our wide distribution channel. Our high-value assembly capabilities at our Inokom plant in Kulim, Kedah are a differentiator for us as our value proposition can include being an EV assembly hub for the region,” he adds.
Last year, Sime Darby managed to convince Porsche AG to choose Malaysia for its first assembly facility outside of Europe, with Jeffri hailing the move as a coup for the group.
Currently, about 3% of new and used vehicles sold by Sime Darby are EVs, with 52% of that being in China and mostly comprising BMW models, says Jeffri. “We are seeing strong demand for EVs. In Malaysia, all the brands that offer EVs have been fully booked.”
Under Budget 2022, the Malaysian government has decided to fully exempt EVs from import duties, excise and sales tax to support the local EV industry as they are energy efficient and help reduce air pollution.
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