It has been 18 months since the Synergy Drive mega merger of Sime Darby Bhd, Kumpulan Guthrie Bhd and Golden Hope Bhd to form the biggest publicly traded plantation company in the world, with a landbank of 633,607ha and operations spanning 20 countries and employing more than 100,000 people worldwide.

The merged entity was relisted as Sime Darby on Nov 30, 2007, with a market capitalisation of over RM50 billion, making it the largest company on Bursa Malaysia.

There is no shortage of superlatives when it comes to profiling Sime Darby, but has the company lived up to expectations?

Its share price peaked at RM13.20 on Jan 11, 2008, before falling to RM4.94 in intra-day trade on Dec 2 on the back of declining crude palm oil (CPO) prices and concerns over rising customer defaults — a widespread problem among plantation companies at the time.

Fast forward six months: CPO prices have got off their lows, pulling along with the prices of plantation companies. Sime Darby has underperformed both the Kuala Lumpur Composite Index (KLCI) and the KL Plantation Index since its listing. While the KL Plantation Index is 63.2% off its one-year low, Sime Darby has been lagging behind, rising only 32%.

Why are investors avoiding Sime Darby despite the CPO rally? Some say its valuation looks rich while others worry about the performance of its non-plantation businesses in the light of the global economic slowdown. Institutional funds, benchmarked against the KLCI, invest in it mainly for the stock’s weighting on the KLCI and not necessarily for the company’s fundamentals — at least not now.

Out of 27 analysts covering the stock, seven have recommended a “buy” on it, 15 a “sell” and the rest a “neutral”.

“People don’t understand Sime Darby — is it under plantations? Is it trading? Frankly, Sime Darby is Sime Darby. We have the opportunity to leverage the strength of the plantation [business], but we also have other core businesses for balance. Sime Darby is in a unique position where we can counter balance. You cannot just put me in the plantation mould. We are very pleased all our other businesses are performing,” says Datuk Seri Ahmad Zubir Murshid, Sime Darby’s president and group chief executive in a recent interview.

To be fair, given the diversity of Sime Darby’s businesses, earnings are less sensitive to upswings in CPO prices compared to a pure planter.

For Sime Darby’s FY2008 ended June 30, when the company benefited from high CPO prices in early 2008 (average realised CPO price of RM2,885), its plantation business contributed 40% of revenue and 71% of profit. But in FY2007, when realised CPO prices averaged RM1,745, the segment contributed 29% of revenue and 45% of profit.

For FY2009, analysts are projecting net profit of RM1.8 billion to RM2.8 billion, according to Bloomberg data. Sime Darby itself is projecting net profit of RM1.9 billion under its financial Key Performance Index, which had been revised downwards from RM3.7 billion.

Ahmad Zubir says the company is on track to achieve its net profit target as well as reaping merger synergies of RM400 million to RM500 million over three years following the merger — a projection it had made during the listing of Sime Darby. The company announced last year that it was close to halfway and ahead of schedule in achieving the target when it realised RM210 million in merger synergies in the plantation and property businesses in FY2008.

“We’re on track; this year, we’ll reach another milestone. Next year [FY2010], we’ll reach RM400 million,” he says.

Be that as it may, investors are saying the synergies are nowhere to be seen. Sime Darby in turn is asking investors to judge them in about two years.

“Give us another 2 to 2½ years. Whatever you do today — plant and apply good fertilisers — you will see the results two to three years down the road. What we’ve been doing in the last one year, we’ll see the fruits two years from now. We’re just now harvesting the low-hanging fruit, the easy ones,” says Ahmad Zubir.

Datuk Azhar Abdul Hamid, managing director of Sime Darby Plantation Sdn Bhd, and Zubir explain that the company has been taking the best practices of the three plantation companies and standardising them across all Sime Darby estates and mills.

“If we are going to manage the same way as we did in the last 10 years, then nothing’s going to change. In the plantations, for example, standardisation is the order of the day. It’s no longer personality-driven … all these takes time but I’m glad to say it’s moving. We’re taking a lot of history and trying to change and go forward, giving a new face to the business,” says Azhar.

Both recognise the need to improve Sime Darby’s plantation statistics, which have been weighed down by weak yields from its Indonesian plantations. For example, in FY2008 the average FFB yield per mature hectare for its Indonesian estates at 18.7 tonnes pales in comparison with the Malaysian estates’ 23.6 tonnes, resulting in group FFB yield of 21.8 tonnes. Although the 23.6 tonnes is higher than the Malaysian 2007/2008 average of 19.6 tonnes, it is behind IOI Corp’s 28.4 tonnes.

While saying there is room for improvement in its Indonesian estates, Azhar and Ahmad Zubir remind investors that given Sime Darby’s sprawling estates, extending from Acheh to Sulawesi and Perlis to Kalimantan, it is not comparable to the top planters in Malaysia whose operations are less extensive. Also, Ahmad Zubir points out, Sime Darby’s palms have yet to reach their potential as 80% of them are young, thus making comparisons with leaders in the industry less accurate.

“But we’re not complaining. We’re saying we have the potential to improve,” says Ahmad Zubir.
In fact, the Indonesian operations have emerged as a best performer among Sime Darby’s estates in the last one year. The average FFB yield has improved from 13 to 15 tonnes per hectare to 18 to 19 tonnes/ha over the last year, while the average for Malaysian estates improved by only two tonnes.

The company has gone into rehabilitation mode to standardise its operations by upgrading the infrastructure, putting in place estate best practices and rebuilding the communities in the estates. A critical factor was the poor condition of Sime Darby’s estate roads, which caused transport problems. Thus, it had to invest heavily in improving the roads. The company also wants to bring down manure costs by looking at other options, such as composting.

According to Azhar, Sime Darby’s average cost of production per tonne of CPO, without the kernel factor, comes up to RM1,250. He stresses that the cost of palm product is slightly above RM1,000 per tonne.

Net buyer of CPO by 2011
Sime Darby’s weak downstream operations have become the group’s Achilles’ heel. Its mammoth upstream plantation is not matched by downstream capacity, causing it to be held at ransom by refineries. With annual refining capacity of only one million tonnes, the group sells 70% of its oil and processes the rest itself. Losses widened to RM78 million in 2QFY2009 in its downstream operations from RM28 million in 1QFY2009.

“We’re going through third parties — this is our biggest problem because we have too much oil, but we don’t have enough refineries to process it. Secondly, downstream depends on the price of oil — if the prices are high, you don’t make that much but if the prices are low, you make margins downstream but then again, we don’t have enough refineries,” Ahmad Zubir explains.

An industry player notes that size should not matter because it all boils down to how the company manages the downstream operations, given transparency in CPO prices. Nevertheless, to deal with this problem, Sime Darby will be increasing its refining capacity to 2.5 million  tonnes over the next two years and subsequently to four million tonnes. It is constructing refining facilities in North Port, Port Klang, as well as in Kalimantan, China and Eastern Europe.

Aside from that, Sime Darby is restrategising by looking at the plantation business as an entire value chain and apportioning the margins upwards by managing the overall integrated margin.

“By end-2011, we’ll be a net buyer of CPO,” says Azhar.

But while waiting for the refining capacity to come up, Sime Darby will have to put up with the tolling arrangement with local refiners.

“That’s why our story line is three years, not just improving the trees, but the downstream too,” says Ahmad Zubir.

But time may not be a luxury Sime Darby can afford, in the face of rising pressure from major shareholder Permodalan Nasional Bhd and its unit trust scheme Amanah Saham Bumiputera to maintain dividend payout. With Malayan Banking Bhd — PNB’s other major investment — going through a difficult year, with the meltdown in global financial markets and bleeding from acquisitions overseas, the word in the market is that screws would be tightened on Sime Darby to provide bumper dividends.

The merger of Sime Darby itself was a point of contention for PNB as the exercise was driven by CIMB Merchant Bankers, with Sime Darby playing a dominant role. Furthermore, Sime Darby was undervalued, which resulted in PNB owning 48% of the merged entity — less than it would have had if Sime Darby had been given a higher value.

Before the merger, PNB had a bigger say in  the running of Kumpulan Guthrie and Golden Hope than Sime Darby. With the merger, both now come under Sime Darby and effectively Ahamd Zubir and his team.
Effectively, the influence of PNB chairman Tun Ahmad Sarji Abdul Hamid on the plantation businesses within the PNB group waned. It was more telling when Tun Musa Hitam was appointed chairman of Sime Darby.

Also, the merger had the full blessing of then prime minister Tun Abdullah Ahmad Badawi, who was a strong advocate of reforms in government-linked companies (GLCs). Now, we have a new prime minister in Datuk Seri Najib Razak. He has so far left the GLCs to their own devices, which is not a surprise considering the volatile political climate. But whether he supports the reforms of GLCs in their present form is left to be seen.

Sime Darby was in a net cash position of RM1.6 billion as at end FY2008. Its dividend policy is to pay not less than 50% of its earnings. Last year, it paid out a gross dividend of 50.9 sen per share. In the current year of operations, according to consensus, Sime Darby is expected to pay a gross dividend of 24 sen per share.

This is lower than last year’s payout, which leaves some in the industry guessing if shareholders, such as PNB, would press management for a higher dividend.

And if Sime Darby does come under pressure, will management be able to stand up to it? Or can it convince PNB to be patient and wait another 18 to 24 months for the harvest of the “difficult” fruits from the mega merger?

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