This article first appeared in The Edge Financial Daily on November 23, 2018

Sime Darby Bhd
(Nov 22, RM2.46)
Upgrade to hold with a higher target price (TP) of RM2.50: Sime Darby Bhd reported 57% year-on-year (y-o-y) core net profit growth in the first quarter ended Sept 30, 2018 (1QFY19) to RM192 million, after excluding RM78 million one-off gains from the disposal of Weifang Water and RM35 million impairment on equity stake in E&O.

The group attributed the stronger earnings mainly to higher industrial equipment and parts demand to support the mining activities in Australia and construction activities in China.

Its industrial division posted 118% y-o-y core profit before interest and tax (PBIT) growth in 1QFY19, driven by margin expansion on the back of higher equipment deliveries to the mining sector in Australia.

Average industrial core PBIT margin expanded 2.8 percentage points (ppts) y-o-y to 5.6% in 1QFY19.

The group expects to keep industrial margins at current levels in view of its healthy order book replenishment, which stood at RM2.6 billion as at the end of September 2018 (versus RM2.4 billion in September 2017).

Its motor division recorded an 8% y-o-y revenue growth in 1QFY19 due to higher sales volume in China (+13%) and Malaysia (+35%).

The group benefited from the zero-rated goods and services tax period in June to August.

In spite of higher sales performance, core PBIT for the motor division fell 23% y-o-y during the quarter due to margin pressure on the back of competitive discounting, especially in North Asia and Southeast Asia.

Nevertheless, we expect stronger motor earnings delivery in the second half of FY19 forecast  (2HFY19F), driven by new model launches such as the new BMW 3 series.

Sime Darby announced recently that it is acquiring industrial equipment provider Heavy Maintenance Group (HMG) for A$58m (RM176.3 million).

We are positive on Sime Darby’s strategy to expand its presence in Australia. HMG is involved in the manufacture, refurbishment and surface finishing of hydraulic cylinders used in heavy industries.

Overall, we expect Sime Darby will continue to benefit from the expansion in coal mining activities in Australia.

As we roll over our valuation to end-FY19F, our sum-of-parts-based TP rises from RM2.44 to RM2.50.

We upgrade Sime Darby to “hold” in view of the pullback in its share price, down 12% since February, and robust growth prospects in the industrial segment (we project three-year industrial earnings compound annual growth rate of 23%).

Stronger earnings from the industrial segment and earnings-accretive acquisition are potential rerating catalysts, while weaker-than-expected auto sales and profit margin are potential derating catalysts for the stock. — CGSCIMB Research, Nov 21