This article first appeared in The Edge Financial Daily on February 21, 2018

Sime Darby Plantation Bhd
(Feb 20, RM5.55)
Maintain hold with a target price of RM5.72: Sime Darby Plantation Bhd’s near-term upside will likely be capped by uncertainties over the European Union’s potential move to ban palm-based biofuels by 2021 and its pricey valuations. However, we remain positive on its longer-term prospects, underpinned by its accelerated replanting efforts (which will translate into a higher oil yield over the longer term) and efforts to improve profitability of the downstream division.

Accelerated replanting started paying off, witnessed by a profit before interest and tax (PBIT) contribution of RM48 million in financial year 2017 (FY17). To achieve its “mission 25:25” (an average age of 10 years, with fresh fruit bunch [FFB] yield of 25 tonnes per hectare and an oil extraction rate of 25%) by 2025, Sime Darby Plantation is embarking on accelerated replanting (with a replanting rate of 5% to 7%) with high-yielding planting materials.

Sime Darby Plantation is also working towards lower production cost, via further mechanisation, which will in turn lower labour and overhead costs, and increase palm productivity.

Sime Darby Plantation has plans to further increase its PBIT margin and PBIT contribution from the downstream division (to 20% by FY25 from 5.2% in FY17), and such a target would be achieved by: Shifting into high-margin specialty products (which carry superior margins relative to other generic products); deriving full value from certified sustainable palm oil through collaboration with smallholders; and working towards fully segregated and traceable refineries.

Risks: Lower-than-expected FFB production; a sharp decline in prices of edible oils (including palm oil); acute labour shortage; imposition of import tariffs/duties by major palm oil consuming countries; and volatile raw material prices, which will in turn hurt profitability of the downstream segment.

Our forecasts are maintained for now, pending release of the second half of FY18 results tomorrow.

While we like Sime Darby Plantation for its established market presence and track record in the oil palm plantation industry, sound management team, and low enterprise value/hectare (relative to its large-cap peers), we believe the near-term upside is capped by higher price-earnings ratio (PER) valuations (FY18 to FY20 PER of 25 to 29 times, higher than its large-cap peers of 22 to 24 times).

We value the upstream plantation business at 28 times FY19 earnings and the downstream plantation business at two times price-to-book ratio. — Hong Leong Investment Bank Research, Feb 20