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The merger of the plantation companies under Permodalan Nasional Bhd (PNB) into Sime Darby Bhd — the world’s largest oil palm planter — at end-2007 was timed perfectly.

With the price of crude palm oil (CPO) hitting a record high of RM4,300 per tonne last year, nobody can complain that the amalgamation of the “old” Sime Darby Bhd, Kumpulan Guthrie Bhd and Golden Hope Bhd was not solid. Despite the collapse of global commodity prices in 2H2008, the price of CPO has rebounded to RM2,655 from a low of RM1,400 in October last year.

The buoyant CPO market augurs well for Sime Darby’s plantation revenue, which ballooned to RM6.7 billion in FY2008 ended June 30 from RM3.9 billion in FY2007. This division outshone the group’s other four main businesses of property, automotive, heavy equipment and energy and utilities.

Nonetheless, Sime Darby’s management is well aware of the cyclical nature of the plantation business. Its earnings are dependent on the movement of CPO prices, which is beyond the group’s control.

If CPO price had not recovered to its present level, the conglomerate’s earnings would not have been exceptional because it lacks downstream activities that would enable it to take advantage of softer commodity prices.

In addition, three out of Sime Darby’s four core businesses are sensitive to economic conditions. Property, car and heavy equipment sales tend to do well during an economic boom and vice versa in a slump.

Hence, it is no surprise that Sime Darby’s president-cum-CEO Datuk Seri Ahmad Zubir Murshid plans to expand its non-plantation businesses, with emphasis on those that can provide it with recurring income.
“We want to grow our recurring income,” he tells The Edge in an interview.

Sime Darby’s latest move is to acquire a fabrication yard in Johor from Ramunia Bhd. Upon the completion of the deal, Sime Darby will be the country’s largest licensed fabricator of oil and gas (O&G) equipment.

Ahmad Zubir says the deal will “fit like a glove”. With additional yard capacity, Sime Darby will be able to bid for more and bigger contracts from the oil majors.

“We want to double the size of our O&G business,” Ahmad Zubir adds.

An expanded income stream will stabilise the group’s earnings and protect it against the adverse effects of an economic downturn or a fall in CPO prices.

Sime Darby is well known as a diversified entity but it lacks sizeable businesses with defensive elements like Tanjong plc and the YTL group. Both these companies have defensive assets in power plants that ensure steady cash flow during all weathers of the economy.

The group’s 2QFY2009 results show its non-defensive income base.

“Sime Darby’s 2Q results showed a significant deterioration from its 1Q numbers. This is understandable, given the decline in CPO prices as well as the rapidly worsening economy, against which its well-diversified business offers no defence,” says OSK Research when commenting on its 2QFY2009 earnings in February.

For 2Q2008 ended Dec 31, Sime Darby’s revenue fell 16% q-o-q to RM7.29 billion compared with RM8.7 billion in 1Q. Net profit dropped 68% q-o-q to RM278.5 million from RM866.9 million.

To seek recurring income, one possible way is to be a concessionaire. Towards this end, Sime Darby wants to expand its port management business in China.

“We are trying to focus on China. Our port business there provides us with recurring income,” says Ahmad Zubir when commenting on the group’s port business, which seldom draws the attention of investors.
According to Ahmad Zubir, Sime Darby has been given the opportunity to develop another four ports in mainland China.

The group is currently managing five ports, including three inland ports. They are located in Jining and Weifang in central China’s Shandong province. “Our port in Weifang has doubled its capacity,” says Ahmad Zubir.

The Weifang port provides feeder services for shippers within the city and the industrial hinterland. This multi-purpose wharf handles mainly bulk (both dry and liquid) and general cargoes, with container operations being planned in the future. Last year, the port handled more than 10 million tonnes of cargo.

Besides port management, water supply is another area Sime Darby is exploring in Malaysia and China. Nearer home, it is involved in the project to transfer underground water from Perak to Selangor.

“We are continuing [with efforts to tap underground water]. We have secured a supply of 500 million litres per day (mld) [of underground water] now. We are setting up a water treatment plant,” Ahmad Zubir says. “We want to increase our capacity to 2,000 mld.”

Sime Darby’s plan is to tap the underground water in Batang Padang, Perak, and supply it to the state water department and Selangor when there is a shortage. In December last year, Perak stated that it wanted to have 60% of its water supply sourced from underground and the rest from the surface such as rivers.

In China, Sime Darby’s unit, Weifang Sime Darby Water Co Ltd, has a 50-year concession for the sale of treated water for industrial use in the Hai Hua Development Zone and Hanting Northern District in Shangdong province.

The unit owns a reservoir which can supply 40,000 cubic metres of water per day. It plans to expand its volume to 200,000 cubic metres a day to meet the rising demand for water as more industries move into the economic development zone.

Port management and water business are housed under Sime Darby’s energy and utilities division. Based on the earnings in 1HFY2009, the division only accounts for 3.5% of its EBIT (earnings before interest and taxes).

“Sime Darby’s plantation division is massive. Hence, it is difficult for the other division to contribute significantly to the group’s earnings,” says a research manager who tracks the counter.

She points out that the profit contribution of each division is relatively small, accounting for less than 30% of Sime Darby’s EBIT.

But the relative size of the non-plantation divisions is large individually, with some divisions chalking up EBIT of well over RM100 million. For example, the property division recorded EBIT of RM407 million and heavy equipment RM688 million in FY2008.

“The divisions are big enough to be standalone business entities,” adds the research manager.

When asked whether Sime Darby will spin off any of its business units, Ahmad Zubir says “anything could happen. We could do a reverse takeover. There’s lot of potential out there … it all depends on the situation”.

He adds that the current downturn and plunge in asset prices have presented lots of opportunities.
Macquarie Research, however, argues that Sime Darby’s non-plantation businesses have affected its attractiveness compared to its plantation peers.

“Recent unsuccessful attempts at the acquisition of assets [privatisation of the National Heart Institute or IJN and the land sale in Labu to build a low-cost carrier terminal] have raised our concern about the lack of strategic clarity in these businesses, going forward,” the research outfit says in a note.

But to be fair to Sime Darby management, the proposal to privatise IJN was said to be prompted by “higher-ups”, while its unsuccessful foray into the airport business was merely as a property developer, namely to sell a parcel of land to AirAsia Bhd in return for cash.

Sime Darby’s efforts to diversify may not be appreciated by investors, including analysts. Some would rather see it staying put as a plantation outfit since CPO and its products are basic foodstuff and demand for them is resilient.

“I can always diversify my portfolio by investing in different types of companies. I don’t need companies to do that for me,” says a fund manager.

Nevertheless, strategic shareholders that rely on dividend income may argue differently. A more stable income stream is essential for constant dividend payout, especially when Sime Darby has a major shareholder such as PNB to consider. Whether investors like it or not, Sime Darby does not have a choice but to diversify into businesses with constant cash flow.

 

This article appeared in Corporate page of The Edge Malaysia, Issue 755, May 18-24, 2009

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