Friday 29 Mar 2024
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KUALA LUMPUR (Mar 30): Fitch Ratings has today revised its outlook on Sime Darby Bhd's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) to negative from stable.

According to the firm, the IDRs and the company's senior unsecured rating are affirmed at 'A'.

Fitch has also affirmed the rating on the company's US$1.50 billion sukuk issue at 'A'.

In a statement today, Fitch said the revision in the outlook to negative followed a sharp increase in Sime Darby (fundamental: 1.0; valuation: 0.9)'s fund from operation (FFO)-adjusted net leverage to about 2.50 times in the first half of its financial year ending June 30, 2015 (FY15) compared to FY14’s 1.52 times.

It said it was well above the 1.75 times level at which Fitch would consider negative rating action.

While Fitch expected the increase in leverage after the debt-funded acquisition of New Britain Palm Oil Ltd (NBPOL), the agency now estimated that the deleveraging process would take longer than initially expected.

This is due to the weaker than expected performance of Sime Darby's industrial equipment business and higher net debt to fund the property development business.

"Given the weak commodity environment, Sime Darby's industrial equipment business will continue to face challenges over the short to medium term," Fitch said.

Fitch said Sime Darby’s industrial division’s earnings before interest and tax (EBIT) declined by 46% to RM316.2 million in the first half (1HFY15) due to the continuing weakness in the Australian mining sector.

This has resulted in lower equipment deliveries and lower margin from product support sales, it said.

"Profit in its Malaysia and Singapore operations also fell due to lower equipment and engine sales due to the slowdown in the construction, mining and shipyard sectors, while in China and Hong Kong, profit improved due to better margins from equipment deliveries," Fitch added.

Commodity prices continued to fall to near marginal production cost, resulting in intense pressure on the product support business, it pointed out.

Fitch said Sime Darby proposed to engage in capital management initiatives that could include the listing of its motor division by end financial year 2016 (FY16), which, if successful, would result in financial leverage declining towards Fitch's negative trigger of 1.75 times.

"Also, a significant proportion of Sime Darby's shareholders have opted for its dividend reinvestment plan (DRP), which reduced cash dividends paid by 23% to RM1.57 billion in FY14.

"Of the RM1.80 billion final dividend declared for FY14, only RM505 million (28% of dividends declared) was paid in cash," it noted.

While Fitch expects Sime Darby to maintain its dividend payout ratio at about 50%, the cash payout is likely to decline due to the success of the DRP, which would help to reduce leverage.

Apart from that, Fitch pointed out that Sime Darby debt-funded the acquisition of a 98.84% stake in the Papua New Guinea-based oil palm company NBPOL for RM5.70 billion.

NBPOL has a land bank of 135,000 ha, 12 oil mills and two refineries — one in Papua New Guinea and the other in Liverpool, UK.

"This acquisition has resulted in an increase in Sime Darby's land bank by 16% and improved Sime Darby's capabilities to deliver oil palm products to Europe," it said.

Fitch also said robust crude palm oil (CPO) output in Malaysia and Indonesia driven by improved productivity, a bumper soybean crop that has narrowed the differential between soybean oil and CPO prices, and a low crude oil price (to which CPO is closely correlated as CPO is a bio-diesel input) has resulted in sustained low CPO prices.

"As Sime Darby is an integrated low-cost CPO operator, its downstream division benefits from declining input costs. But this is not adequate to offset the price decline," it said.

Fitch believed that the company will tide over this period of low prices, but margins — in US dollar and per metric ton terms — would remain depressed in the next 12 to 18 months.

However, it said Sime Darby's failure to successfully complete capital management initiatives to reduce its financial leverage to below 1.75 times by end-FY16, a downgrade in Malaysia's Country Ceiling of 'A' and an increase in the role of the Malaysian sovereign or related entities in Sime Darby's decision making process might lead to negative rating action.

(Notes: The Edge Research's fundamental score reflects a company's profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations.)

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