KUALA LUMPUR (Oct 31): Moody's Investors Service has downgraded the issuer rating for Sime Darby Bhd, which is in the midst of a demerger, to Baa3 from Baa1, with a stable rating outlook.

“The downgrade for Sime Darby reflects a significant reduction in its scale and cash flow, and in particular, a weakening in its business profile, because it can no longer benefit from the diversification afforded by its plantation and property businesses, which are more profitable than the rest of its operations,” Moody's vice president and senior analyst Jacintha Poh said in a statement today.

Moody’s said the rating action concludes its review of Sime Darby’s rating for downgrade, which was initiated on Feb 3 this year, after the group announced a plan to create three standalone businesses. Under the move, the group will retain its motors, industrial, logistics and other businesses, while listing its plantation and property divisions on Bursa Malaysia.

On Oct 27, Sime Darby obtained approval from Securities Commission Malaysia to list the standalone entities, i.e. Sime Darby Plantation Bhd and Sime Darby Property Bhd. The group expects the demerger to be completed by end-2017, pending approval from Bursa Malaysia and Sime Darby's shareholders at an extraordinary general meeting.

Nevertheless, Moody's believes Sime Darby's Baa3 rating will be supported by its strong global positioning within its motors and industrial businesses, where it has a long operating track record and enjoys a broad presence across Asia Pacific.

Moody’s also said Sime Darby has the second largest Bayerische Motoren Werke Aktiengesellschaft (BMW) dealership globally and the third largest Caterpillar Inc dealership globally.

“Looking ahead, we expect Sime Darby will maintain market leadership positions for its motors and industrial businesses, supporting stable leverage and interest coverage ratios within its Baa3-rating threshold,” Poh said.

Over the next 12-18 months, Moody's expects Sime Darby's adjusted debt-to-earnings before interest, tax, depreciation and amortisation (debt/EBITDA) to register around two times, with adjusted earnings before interest and tax-to-interest expense (EBIT/interest expense) at around six times.

Moody's also expects Sime Darby to keep a heavy reliance on short-term funding, though refinancing risk is partially mitigated by Sime Darby's superior access to funding, given its ownership by government-linked shareholders.

As at Sept 30, Sime Darby was 6% directly owned by Permodalan Nasional Berhad (PNB), 43% by Skim Amanah Saham Bumiputera, 7% by other PNB-managed funds, and 11% by the Employees Provident Fund.

Meanwhile, the stable rating outlook reflects Moody's expectation that Sime Darby's motors business will remain stable while its industrial business will improve on the back of stronger coal prices.

Moody's also expects Sime Darby to continue to demonstrate a disciplined financial policy, including low debt levels.

However, the rating agency said Sime Darby's rating is unlikely to be upgraded over the next 12-18 months given its small scale and inherent cyclicality in its operations. But a track record of maintaining stable cash flow and strong credit metrics with reduced reliance on short-term funding will lead to positive momentum for the rating, it added.

Having said that, Moody’s warned that the rating could be downgraded if Sime Darby’s business conditions worsen, resulting in earnings decline; increase in reliance on short-term funding with limited access to funding; or aggressive expansion plans, which result in an over-extension of its management or financial resources.

Credit metrics that could lead to negative rating actions are adjusted debt/EBITDA above 3.5 times, and EBIT/interest expense below five times on a sustained basis.

Sime Darby shares slid 7 sen or 0.76% to RM9.20 today, giving it a market capitalisation of RM62.57 billion.