This article first appeared in The Edge Financial Daily on January 15, 2018

Ta Ann Holdings Bhd
(Jan 12, RM3.55)
Maintain market perform with an unchanged target price (TP) of RM3.60: Ta Ann Holdings Bhd has proposed to acquire a 30.4% stake in Sarawak Plantation Bhd for RM163.9 million or RM2 per share. We are neutral on the deal, given minimal incremental earnings, though the sizeable stake could lead to a full takeover. No change to financial year ending Dec 31, 2017 (FY17) to FY18 core net profit (CNP). We maintain “market perform” for now with an unchanged TP of RM3.60 pending further guidance on long-term goal for the acquisition. 

Ta Ann has entered into a conditional agreement to acquire 85 million shares in Sarawak Plantation representing a 30.4% stake, for a cash consideration of RM169.9 million, or RM2 per share. This represents an 11.1% premium to the previous closing price of Sarawak Plantation. We gather that Sarawak Plantation owns a land bank of 48,100ha of oil palm plantation of which 1,900 ha is under the Sarawak Native Customary Rights (NCR) scheme. The total planted area was 34,800ha as at end-2016, with a calculated average tree age of 11.3 years. The company also owns and operates two palm oil mills with total operating capacity of 150 tonnes/hour. The acquisition, pending shareholders’ approval in an upcoming extraordinary general meeting (EGM), is expected to be completed by the first quarter of 2018 (1Q18). Note that both companies share the same chairman, classifying the deal as a related party transaction (RPT). 

We are overall “neutral” on the proposed acquisition, as our estimated incremental associate profit before tax (PBT) of RM12.7 million is offset by an increased interest charge of RM6.8 million, assuming a 80:20 debt:equity ratio. This implies a net CNP increase of 2%. Our earnings estimate is premised on Sarawak Plantation maintaining its current yield levels, though we calculate that if Sarawak Plantation achieves its three-year high yields, Ta Ann should see a higher incremental PBT of RM16.2 million, implying net CNP increase of 4%. In terms of valuation, we note an 11.1% premium to the previous closing price of Sarawak Plantation and calculated a forward price-earnings ratio (PER) of 16.9 times based our earnings projections. We think this is fair compared with our small-cap planters’ average forward PER of 17.5 times. We expect the transaction to further stretch FY18 net gearing to 0.46 times from 0.34 times, which approaches our maximum comfort levels of 0.5 times.

We gather that the rationale for the associate stake is to increase Ta Ann’s plantation exposure, notably to new areas in Niah and Mukah and potentially collaborate for new areas. Management did not rule out an eventual takeover, which is possible considering the acquiring target’s light balance sheet and potential for Ta Ann to raise equity funding further to compete the acquisition. We observe that this scenario has similarities with property developer Hua Yang’s acquisition of a 31% associate stake in Magna. Despite decent land bank potential, the operational slowdown in Magna requires Hua Yang to engineer a turnaround. Shorter-term investors could not stomach the impact arising from severe earnings reduction from funding the low return on investment (ROI) from the Magna stake and this has negatively impacted Hua Yang’s share price. While Ta Ann’s acquisition is earnings-neutral after  onsidering the funding cost and Sarawak Plantation earnings, we note that net gearing is approaching critical levels which limits growth or may lead to potential cash calls for further acquisitions. This may result in similar weakness seen as in Hua Yang’s case. 

We reiterate “market perform” with an unchanged TP of RM3.60 pending further guidance on their long-term plans for the Sarawak Plantation stake. As noted, we would be negatively biased on a full takeover, and observe limited incremental gains on the associate stake despite increased net gearing. Our valuation is based on an unchanged forward PER of 13 times applied to FY18 earnings per share (EPS) of 27.8 sen. Our forward PER of 13 times is based on the mean valuation as the Sarawak Plantation contribution on higher production would be offset by weak timber-segment earnings due to higher royalties, softer volume and a declining US dollar-ringgit exchange rate. — Kenanga Research, Jan 12