It has been over two years since PPB Group Bhd hived off its palm oil-related businesses, leaving it with a 18% stake in the world’s largest palm oil trader, Wilmar International Ltd, and a few staple food businesses that include sugar and flour.

The Wilmar stake is precious to PPB as about 78% of its net profit for 1HFY2009 ended June 30, came from this investment. The contribution has even surpassed analysts’ yearly expectations.

To investors, holding a share in the Kuok-owned PPB is a luxury as the counter acts as a good proxy to Wilmar, and what is more, it is cheaper too.

However, given the performance of the two counters of late, some investment houses call a preference over Wilmar’s shares to PPB’s because of the former’s better upside.

HwangDBS Vickers Research, for example, has a “buy” call on Wilmar at a target price of S$7.25 (RM17.40) per share but a “hold” call on PPB.

“We prefer direct exposure to Wilmar as we expect better upside in Wilmar compared to PPB,” says HwangDBS in a report on Aug 24.

HwangDBS’ target price for Wilmar is based on discounted cash flow valuation while its RM15.30 target price for PPB is based on sum-of-parts valuation. In its Aug 24 report, there was 19% and 4% upside left to HwangDBS’ target prices for Wilmar and PPB respectively.

Note that Wilmar’s shares have gained 132.62% YTD while PPB’s, 64.09%. For sure, Wilmar’s plan to float its shares in Hong Kong, which is estimated to raise some US$4 billion (RM14 billion), has given its shares a boost.

HwangDBS’ recommendation is understandable because unlike PPB’s investment in Wilmar, its core divisions’ prospects appear unclear given the fluctuation of raw material prices, ocean freight charter rates and weakening consumer consumption.

PPB’s sugar division is the largest revenue and profit earner, accounting for 60.15% or RM82 million of operating profit. Total operating profit for the first six months was RM131.78 million. The segment contributes 38%, or RM613 million, to the company’s revenue in 1H2009.

The sugar division is the only business that saw growth in operating profits in 1H2009 while the rest posted double-digit declines. The livestock farming division recorded losses.

In terms of profit contribution, PPB’s core division accounted for about 20% of its net profit, which is tiny compared to the contribution from Wilmar.

However, some analysts say this should not be the reason for investors to overlook the value of PPB’s core business.

“There are a few ways of looking at this. While some prefer direct exposure to Wilmar, you can’t discount the fact that PPB offers a cheaper entry into the Wilmar group. There is a lot of value within the PPB business itself,” says an analyst.

Based on PPB’s closing share price of RM15.80 last Thursday, PPB’s market capitalisation stood at some RM18.73 billion.

Stripping out the value of a 18% stake in Wilmar of RM17.88 billion, the market pegs a value of RM849 million on PPB’s other businesses.

However, an analyst says this undervalues PPB’s core activities, as he believes the businesses should be valued at not less than RM2.4 billion, almost triple the pegged value of RM849 million.

He says the RM2.4 billion is based on the enterprise value and cash position of the respective divisions. When including PPB’s other investments, such as Malaysian Bulk Carriers Bhd, the analyst says the figure will jump to RM2.8 billion.

“The market has hugely discounted PPB’s core activities. As the company is in the business of producing staple food, it is hard to explain why the market gives the stock a very low valuation. Even at a time when Wilmar’s value nearly exceeded PPB’s market capitalisation, the business was valued at zero. This does not make sense, does it?” he adds.

The analyst’s argument is fair enough. Furthermore, PPB’s 50% share of the sugar and 40% of the flour market here should warrant a commendable valuation, at least on its sugar and flour businesses.
The analyst values PPB at RM17.80.

PPB Group managing director Tan Gee Sooi assures that the group’s diversified businesses will remain relevant, and this should appeal to investors.

“By owning a PPB share, I will own a share in Wilmar, plus other business that are generating income,” he tells The Edge.

At present, Tan says PPB is expanding its core businesses despite the economic slowdown.

He adds that another RM150 million will be spent on flourmill expansions this year, besides the RM77 million spent on a flour and feed milling facility in Indonesia earlier this year. It is understood that the mill in Cilegon is its first in Indonesia, with a production capacity of 1,000 tonnes per day. PPB expects the mill to start contributing in the next four months. Given Indonesia’s promising outlook, PPB has plans to set up a second mill there.

The company has also spent RM28.7 million to upgrade its sugar refinery. A notable development is that PPB has, for the first time, received government subsidy of 60 sen per kg to produce the price-controlled item. The local retail price for coarse sugar is RM1.45 per kg and RM1.55 per kg for refined sugar.

Furthermore, PPB has a long-term contract with the government to supply 70% of its requirement for raw sugar at 17.5 US cents per lb, 27% lower than the market price. Note that margins at its sugar division have improved in 1H2009 compared with 1H2008.

Although fluctuations in prices of raw material and ocean freight rates lingers, analysts say prices will eventually come back to the previous levels and the company’s diversified business will prosper again.

PPB has hinted that it will eventually increase its stake in Wilmar and did not rule out participating in Wilmar’s recently proposed Chinese IPO.

Regardless, investors should not overlook the value of the core businesses within PPB’s stable.

This article appeared in The Edge Malaysia, Issue 772, Sep 14-20, 2009.