IOI Corp Bhd
(Nov 18, RM4.60)
Maintain neutral with revised target price of RM4.70: IOI’s revenue for the first quarter of financial year 2015 ending June (1QFY15) fell by 6.8% year-on-year (y-o-y) to RM3.02 billion. This translates into lower 1Q earnings of RM176.7 million. The sharp 41.5% y-o-y decline in earnings was mainly attributable to the cessation of profit contribution from the property business following the demerger exercise in 1QFY14.

Excluding the effect of the demerger exercise and translation difference on foreign currency-denominated borrowings for both 1QFY15 and 1QFY14, the underlying profit for 1QFY15 was 24% lower than in 1QFY14. The drop in profit was due to lower contribution from the resource-based manufacturing (RBM) segment.

Despite the uninspiring group performance, the plantation business was still robust. Higher fresh fruit bunch production (10% y-o-y), coupled with better palm kernel (PK) prices, lifted the plantation segment’s profit by 12% y-o-y in 1QFY15.

However, profit from the RBM segment fell 50.2% y-o-y to RM108.8 million in 1Q. The lower profit was attributable to tighter profit margins as well as a drop in sales volume from the oleo chemicals and refinery sub-segments.

We expect profit margins from the refinery sub-segment to remain depressed due to stiff competition arising from the aggressive expansion of refining capacity in Indonesia. In addition, the oleo chemical segment is expected to experience a challenging market following the emergence of new capacities for fatty acids and soap noodles locally and abroad. Moving forward, this situation is expected to apply downward pressure on IOI’s growth.

Given this backdrop, we are adjusting our earnings forecast downwards for FY15 by 26% to RM1.5 billion and for FY16 by 17% to RM1.7 billion by removing contributions from the property business.

The demerger of the property-related business from IOI Corp has unlocked its value as a pure plantation company. With the streamlining of IOI Corp’s business as a pure plantation company, we are of the view that the sum-of-parts (SOP) valuation methodology is no longer appropriate in valuing the company.

We believe that ascribing a price-earnings ratio (PER) to the company’s earnings per share (EPS) would better reflect the fair value of the company. Therefore, we are changing our valuation method from SOP to PER.

With better control and focus in growing its upstream and downstream plantation business, we believe IOI Corp is entitled to a higher valuation. Hence, we are revising our target price from RM4.20 to RM4.70 per share. We derive our target price by pegging IOI’s 2015 EPS to a PER of 20 times, mirroring Kuala Lumpur Kepong Bhd’s PER. KLK is also involved mainly in the upstream and downstream plantation businesses.

There is not much upside potential for this stock in the next 12 months, therefore, we maintain “neutral”. — MIDF Research, Nov 18

This article first appeared in The Edge Financial Daily, on November 19, 2014.