This article first appeared in The Edge Financial Daily, on July 26, 2016.

Sime Darby Bhd
(July 25, RM7.68)
Maintain hold with a lower fair value (FV) of RM7.55: We maintain “hold” on Sime Darby Bhd with a lower FV of RM7.55 versus RM7.77 previously. We have reduced Sime Darby’s financial year 2017 forecast (FY17F) net profit by 14.2% to account for weaker fresh fruit bunch (FFB) production and property and industrial earnings. We have tweaked the group’s FY16F earnings downwards by 4.7%, and applied a price-earnings ratio (PER) on FY17F property earnings to arrive at its  revalued net asset value (RNAV). Previously, the FV was derived after applying a 20% discount to RNAV, which was supported by market value of its property land bank.

After stripping out RNAV of the non-plantation divisions from Sime Darby’s market capitalisation of RM46.6 billion (based on a share price of RM7.50), the implied FY17F PER of the group’s plantation earnings is 25 times. This is slightly higher than Kuala Lumpur Kepong Bhd’s (KLK) nine months of FY17F PER of 23.7 times and IOI Corp Bhd’s FY16/FY17F PER of 23.8 times.

However, from an asset point of view, the implied market valuation of Sime Darby’s planted areas is low at RM36,274 per ha. In contrast, the implied market valuation of KLK’s planted land bank is RM103,453 per ha. The implied market valuation of IOI’s planted land is RM133,015 per ha. Interestingly, the implied market value of Sime Darby’s planted land bank is softer than the equity value (EV) per ha of RM84,000 for the acquisition of New Britain Palm Oil Ltd.

We think the market is ascribing a low EV per ha to Sime Darby’s land bank as its FFB yields and oil extraction rates may not be as high as its peers. Sime Darby’s FFB yield was 20.39 tonnes per ha in FY15, versus KLK’s 21.96 tonnes per ha and IOI’s 24 tonnes per ha. Sime Darby’s oil extraction rate was 21.7% in FY15, against KLK’s 22.3% and IOI’s 21.5%.

It also appears that the property development potential of Sime Darby’s land bank in Malaysia is not as appreciated as its peers. We estimate that about 36% of Sime Darby’s plantation land bank in Malaysia is located in Selangor and Johor, compared with 24.6% for KLK and 15.1% for IOI.

Operationally, we expect Sime Darby’s FFB production to inch up by 0.1% in FY17F. Improvement in motor earnings in FY17F is envisaged, to be supported by the launch of the BMW 5 Series model, while share of profits in joint ventures is anticipated to climb by more than fivefold, underpinned by recognition of sales of the Battersea project.

To reduce borrowings, Sime Darby is anticipated to dispose of more than 10 industrial properties in Australia in FY17F. The net book value of these properties is RM1.03 billion in total. — AmInvestment Bank Research, July 25