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This article first appeared in The Edge Malaysia Weekly on October 30, 2017 - November 5, 2017

WHILE Sime Darby Bhd has been enthusiastic about its planned demerger into three pure plays, investors do not seem too excited about the proposed exercise, as evidenced by the subdued movement in the conglomerate’s share price over the past two months.

After the demerger was announced in January, Sime Darby’s share price rose as much as 18% to touch a 3½-year intra-day high of RM9.70 in June before seeing a correction to RM9 at end-August.

Upon the completion of the three-way split, Sime Darby Plantation Bhd will be the second largest plantation player in Malaysia, accounting for 304,867ha or 5.3% of total planted area in Malaysia, after Felda Global Ventures Holdings Bhd.

Although the demerger is drawing near — in late November or early December — there has not been much activity in Sime Darby’s shares.

The counter has been hovering at the RM9 level while trading since early September has remained largely under the 200-day average volume of 8.01 million shares as investors take a wait-and-see stance on the proposed split. Last Thursday, the stock closed at RM9.08, giving the company a market capitalisation of RM61.75 billion.

“I believe Sime Darby Plantation will continue to do well as it is not affected by the shortfall in the other operations. The reason for the lack of interest in Sime Darby’s shares could be concerns about Sime Darby Property and the other businesses that will be left under Sime Darby,” says an analyst. “The property side has recorded a lot of gains on disposal, which if excluded would actually make the operation loss-making.”

In the fourth quarter of the financial year ended June 30, 2017 (4QFY2017), the property division saw a 32% year-on-year drop in operating profit to RM801 million. The decline was attributed to lower gains from the asset monetisation of RM542 million compared with RM671 million a year earlier and lower gains from compulsory land acquisition of RM58 million versus RM145 million in the previous year.

However, an improvement in the operation is possible following the appointment of Permodalan Nasional Bhd group chairman Tan Sri Abdul Wahid Omar as the chairman of Sime Darby Property and former Media Prima Bhd group managing director Datuk Seri Amrin Awaluddin as the property arm’s managing director. But it will most likely take time.

“To be fair, they want to demerge so management can be more focused. So perhaps it could improve after the demerger. But the question is, can they execute it?” the analyst asks.

Public Investment Bank Bhd (PIVB) analyst Chong Hoe Leong has a more positive view of the demerger, forecasting value creation of between RM5 billion and RM6 billion upon the completion of the exercise. This is equivalent to a 9% to 10% improvement from the current structure.

PIVB has an “outperform” call on Sime Darby with a target price of RM9.72.

Chong believes Sime Darby Property has upside potential as it has 16,398 acres of strategically located land bank in the Klang Valley, Negeri Sembilan and Johor with a total estimated gross development value of RM101 billion.

Moreover, he says, the property arm has access to an additional land bank of 11,806 acres through land option agreements. The potential pick-up in the local property market could also lift valuations, he adds.

Value will also come from Sime Darby Plantation’s plan to improve its oil extraction rate and fresh fruit bunch yield. “They are planning to improve the OER to 25% and FFB yield to 25 tonnes per hectare, which will create value after the merger,” says Chong. “They are also doing some aggressive replanting to improve the age profile. The yield improvement will come gradually, though, as they only aim to achieve these targets by 2025.”

As for the lack of investor interest, he says, “Sime Darby is currently trading at around RM9 to RM9.10 and we still have more than a month to go before the demerger. Interest will probably rise when we get closer to the completion date of the exercise. Value creation will only be realised after the demerger, after all.”

Another analyst, however, says Sime Darby’s FFB yield per hectare is lower than that of big-cap plantation players, such as Kuala Lumpur Kepong Bhd (KLK), although the former has a higher price-earnings ratio. “Operationally, their FFB yield per hectare is below KLK’s but their PER is higher. After the demerger, the PER will roll back to average plantation levels. There is no good reason for the premium.”

According to Bloomberg data, Sime Darby was trading at a PER of 33.02 times compared with KLK’s 22.94 times and IOI Corp Bhd’s 38.42 times.

When Sime Darby announced its plan to create three standalone businesses early this year, its chairman, Tan Sri Mohd Bakke Salleh, said the plantation and property divisions were on a sound financial footing and better equipped to be listed as pure plays.

He said the demerger was a crucial step to achieve the original aspirations of the shareholders in 2007, when Sime Darby was created from the merger of Golden Hope Plantations Bhd, Kumpulan Guthrie Bhd and Kumpulan Sime Darby Bhd.

According to analyst reports, Sime Darby revealed more details of the pure plays at a shareholders’ engagement last month. The company had said the plantation arm would focus on growing organically, aiming to improve its FFB yield to 25 tonnes per hectare (from 19 tonnes per hectare now) and OER to 25% (from 21.3% now) by FY2025.

Sime Darby Plantation will also strive to lower production costs in its upstream division by maintaining its aggressive replanting activity, improving its irrigation system and increasing mechanisation in its operations. It aims to increase the pre-tax profit contribution of its downstream division by focusing on differentiated, sustainable and traceable high-value products and building its presence in key markets.

Meanwhile, Sime Darby Property will concentrate on growing its recurring income contribution to 10% of its operating profit by FY2022 by increasing its portfolio of income-generating assets, developing its existing land bank and expanding its overseas property development footprint by leveraging its involvement in Battersea Power Station in London.

Sime Darby will zero in on the motor and industrial businesses.

Upon the demerger, Sime Darby Plantation and Sime Darby Property will have dividend policies of paying out a minimum 50% and 20% of profits respectively.

The final prospectuses and circulars are expected to be released by end-October or early November before the listing of the two units by early December.

 

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