Kretam stake buy cancellation a positive for Hap Seng Plantations

This article first appeared in The Edge Financial Daily, on June 20, 2018.
Kretam stake buy cancellation a positive for Hap Seng Plantations
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Hap Seng Plantations Holdings Bhd
(June 19, RM2.21)
Upgrade to market perform with a higher target price (TP) of RM2.15:
Hap Seng Plantations Holdings Bhd announced that it had terminated its share sale agreement to acquire 55% of Kretam Holdings Bhd from Datuk Lim Nyuk Sang @ Freddie Lim and Santaprise Sdn Bhd after finalising its due diligence process and finding the results “unsatisfactory and unacceptable”. Recall that the deal was valued at RM1.18 billion or 92 sen per Kretam share. As of June 14, Kretam’s closing share price was 69.5 sen, or 24% below Hap Seng Plantations’ offer price.

 
We are positive on the cancellation as we had noted that the incremental earnings contribution from the deal of about RM45 million per year would not have offset the additional interest cost of RM50 million to RM100 million per year, leading to at least two years’ earnings dilution until Hap Seng Plantations turned around Kretam’s operations. Note also the proposed offer price valued Kretam at a massive forward price-earnings ratio of 77 times (versus the small-cap average of about 18 times), and would have pushed Hap Seng Plantations’ net gearing to 0.5 times to one times from its current net cash position.

While the deal may have led to long-term synergies in terms of expansion into scarce Sabah land bank and the entry of Hap Seng Plantations into downstream processing, we think that the cancellation is sensible given the hefty valuation premium and immediate material earnings risk (up to 30%).

Without the Kretam deal, we expect an improvement in Hap Seng Plantations’ current outlook. As production trends turn positive towards the second half of 2018, we think Hap Seng Plantations’ earnings should begin picking up on lower unit costs. However, we do not expect outsize earnings for the sector given that palm oil prices are likely to remain capped on rising production, more so should soybean oil prices be suppressed by Chinese tariffs on US soy. However, the conclusion of this deal should ease investors’ concern about near-term earnings headwinds, which should lead to better stability for Hap Seng Plantations’ share price.

We maintain our financial year ending Dec 31, 2018 estimated (FY18E) to FY19E core net profit at RM93 million to RM103 million as the status quo is maintained on the conclusion of this exercise.

We upgrade our call to “market perform” (from “underperform”) with a higher TP of RM2.15 (from RM2) based on unchanged average FY18F to FY19E earnings per share of 12.3 sen applied to a higher forward price-earnings ratio of 17.4 times (from 16.1 times) as we return our valuation basis to +0.5 standard deviation (from a mean valuation basis) upon the cancellation of this earnings-dilutive deal. Despite Hap Seng Plantations’ average fresh fruit bunch growth prospect of 6% versus the sector average of 8%, we think it commands an above-average valuation given its operation quality and healthy balance sheet position with net cash of RM65.5 million (8.2 sen per share) in the latest quarter, supporting its dividend yield of 3.5% (versus the sector average of 2.7%).

Risks to our call include: i) lower-than-expected crude palm oil prices; ii) higher-than-expected cost of production; and iii) changes in government policy (such as the minimum wage hike). — Kenanga Research, June 18