02/01/2018 (The Edge Markets MY) - Sime Darby Plantation Bhd (Dec 29, RM6)

Initiate market perform with a target price (TP) of RM5.50: Sime Darby Plantation Bhd is the largest plantation company (by planted area), and ranks in the top three globally in terms of milling capacity, fresh fruit bunch (FFB) production and refining capacity. It is a premier palm oil player producing about 4% of global palm oil production.

Of its total production, 98% is certified sustainable palm oil (CSPO), affording it a pricing premium which we estimate at about US$20 (RM81) per tonne or more depending on the oil grade. As a fully integrated planter with both upstream plantations and downstream manufacturing, earnings are less affected by crude palm oil (CPO) price movements as lower CPO prices lead to lower downstream feedstock cost.

In the aftermath of the severe drought from 2015 to 2016, production was flat from the financial year ending June 30, 2016 (FY16) to FY17, leading to slow earnings recovery and high production cost per tonne. Going forward, we expect yield to improve in line with the industry of about 8%, for a higher FY18 to FY19 FFB production of 4% to 7%.

Given sector-wide production recovery, we expect Sime Darby Plantation’s CPO prices to soften by 10% to 6% to RM2,569 per tonne to RM2,417 per tonne but believe that better economies of scale and lower tax expense should lead to core net profit (CNP) increasing by 7% to 6% to RM1.4 billion in FY18 and RM1.49 billion in FY19.

With its “Mission 25:25” aim of 25 tonnes/hectare (ha) FFB production and 25% oil extraction rate (OER) target by 2025, we think that the long-term productivity outlook should be positive, implying a compound annual growth rate (CAGR) of 6% per year based on our CPO production estimates.

Our projections indicate the targets should be achievable, with an estimated FFB yield of 24.6 tonnes/ha and OER of 24.8% by 2025 through the use of high-yield planting material and technological improvements.

Its strong FY18 to FY19 free cash flows of RM1.7 billion to RM1.65 billion should easily support its management’s minimum dividend policy of 50%. Based on the historical payout ratio (ex-FY17 which saw a large one-off land transaction boosting net profits), of 66%, we anticipate the FY18 to FY19 payout ratio at 65% for dividend per share of 13 sen to 14 sen per share, which translates into a decent dividend yield of 2.4% to 2.6% (versus the sector average of 2.6%).

Our forward price-earnings ratio of 26 times represents a 5% premium to its integrated peers’ (IOI Corp Bhd and  Kuala Lumpur Kepong Bhd) average valuation of 25 times. We believe the premium is justified given Sime Darby Plantation’s market leadership position, majority CSPO production, FFB recovery track and productivity push.

However, its high net gearing of 0.56 times may preclude mergers and acquisitions, while previous production setbacks have pushed up unit production cost. Given that its current valuations appear competitive against its closest peers, we initiate our coverage of Sime Darby Plantation with a “market perform” call. Our TP of RM5.50 implies a total return of 2.8% (share price upside: 0.4%; dividend yield: 2.4%). — Kenanga Research, Dec 29