This article first appeared in The Edge Malaysia Weekly on December 13, 2021 - December 19, 2021

AFTER a stellar financial performance in the first nine months of its financial year ending Dec 31, 2021 (9MFY2021), thanks to higher crude palm oil (CPO) prices, Sime Darby Plantation Bhd (SDP) is looking to ensure consistent, stable income growth in FY2022 and beyond.

The group reported a 73% year-on-year increase in net profit to RM1.79 billion in 9MFY2021 on the back of a 39% increase in revenue to RM13.14 billion. This was attributed to a solid performance from its upstream sector, which was supported by a 43% y-o-y increase in realised CPO prices during the period to RM3,545 per tonne, while palm kernel prices surged 66% in the same period to RM2,299 per tonne.

CPO prices reached record highs in 2021, primarily driven by the continued tightness in global vegetable oil supplies and inventories. SDP, in its latest quarterly financial report, says that prices are expected to remain elevated at least until the end of the year before a possible downward adjustment in the second quarter of 2022 (2Q2022), when supplies are anticipated to improve.

Things were not so rosy, however, for its downstream sector in 3QFY2021, when it saw a decline in profitability. Its downstream segment, Sime Darby Oils, faced a challenging quarter as profit before interest and tax declined to RM7 million from RM71 million in the previous year, mainly attributable to lower profits generated by its Asia-Pacific operations.

In an email response to questions from The Edge, SDP says its downstream segment in 3QFY2021 was impacted by an unrealised loss on commodity hedges due to rising CPO market prices.

“Moving forward, the group will continue to practise forward hedges for its Malaysia CPO production when prices are favourable to reduce the impact of palm oil price volatility and ensure consistent, stable income growth for its operations,” it says.

MaybankIB Research, in a Nov 19 note on SDP, said that the group had committed to forward sales of CPO at lower average selling prices in FY2021.

On why the group did so when CPO prices are currently higher, SDP says forward sales, or hedging, is a tool it uses to manage price risks.

“Our price strategy committee oversees this function, which determines how much volume is hedged and at what price. It should be noted that hedging is only applied to our Malaysian operations, mainly from peninsular Malaysia, whereas our production in Indonesia and Papua New Guinea are largely based on spot pricing,” the group says.

SDP adds that it has also secured most of its fertiliser requirements for next year, which is expected to increase its production costs by 10% to 15%.

In a Nov 19 note on Sime Darby Plantation, UOB KayHian said SDP’s management has highlighted that it is still facing challenges in sourcing for nitrogen — one of the major components of fertiliser — which it mainly sources from China.

“Management commented that total manuring cost is about 28%–30% of total cost to customer before the recent price hike. The higher fertiliser cost is likely to lead to a 10%–15% increase in cost for 2022,” the brokerage said.

SDP’s balance sheet as at Sept 30, 2021 showed that its total borrowings amounted to RM7.09 billion, which made up 41% of its equity, while its cash balance stood at RM1.52 billion.

On efforts to reduce its gearing levels, SDP says it is continuing to look at active portfolio management, whereby sub-optimal lands are assessed to be disposed of or redeployed.

“The group has been reducing its debt levels over the years and has set a gross gearing target of 30% by FY2023, which as of 30 September 2021 stood at about 41%,” it says.

Last year, SDP embarked on a divestments and deleveraging exercise that included the disposal of its entire shareholding in Sime Darby Plantation Liberia Inc to Mano Palm Oil Industries Ltd; approximately 843 ha of land in Malaysia; its 52% stake in Singaporean subsidiary Verdant Bioscience Pte Ltd; its entire 95% shareholding in Indonesian unit PT Indo Sukses Lestari Makmur (which has a rubber plantation development in Indonesia); and its 94.5% stake in another Indonesian subsidiary PT Tamiyang Sumber Rezeki.

This year, the group and PTTGC International Ltd exited their joint venture (JV) in the Asia-Pacific business of Emery Oleochemicals (M) Sdn Bhd (EOM) and Emery Specialty Chemicals Sdn Bhd (ESC), selling their collective 100% stake for RM38 million to Edenor Technology Sdn Bhd, a JV incorporated by Mega First Corp Bhd and 9M Technologies Sdn Bhd.

On how Cukai Makmur — the one-off prosperity tax announced in Budget 2022 to be imposed on companies with a chargeable income of above RM100 million in year of assessment 2022 — would impact the group, SDP says the tax is not applicable to group-wide profits.

“The one-off prosperity tax is applicable to Malaysian companies with profits above RM100 million and not the group-wide profits. Thus, it is not expected to significantly impact the group,” SDP says.

As for the increase in threshold value of the windfall profit levy that was also announced in Budget 2022, SDP expects higher CPO prices to mitigate the impact of the increases.

“The change in the windfall tax structure involves raising the threshold by RM500 per tonne to RM3,000 per tonne (Peninsular Malaysia) and RM3,500 per tonne (East Malaysia), as well as the standardisation of windfall tax rate for East Malaysia from 1.5% to 3%, similar to the rate currently imposed in peninsular Malaysia.

“In general, the group expects the higher CPO price threshold to help mitigate the windfall tax rate for East Malaysia,” SDP says.

PublicInvest Research, however, in a Nov 19 note, said while the SDP management views the impact from Cukai Makmur as small as there are only two subsidiaries that will be subject to the one-off taxation, the research house reckoned that the impact from the taxation on foreign-sourced income is quite material, as it makes up more than 55% of the group’s bottomline.

In December last year, the US Customs and Border Protection (CBP) detained palm oil and products containing palm oil produced by SDP based on information that reasonably indicated the presence of all 11 of the International Labour Organization’s (ILO) forced labour indicators in SDP’s production process.

On the group’s progress so far to lift the ban, SDP says it appointed ethical trade consultancy Impactt Ltd in March to conduct a comprehensive third-party evaluation of labour practices across its Malaysian operations, mapped against the ILO’s 11 indicators of forced labour.

“While the assessment was initially targeted to be completed by June, unfortunately, the strict movement and travel restrictions imposed throughout Malaysia to curb the Covid-19 pandemic delayed the exercise. As the restrictions have now been relaxed, we are now targeting to complete the assessment in the first quarter of 2022. The CBP is aware that we are conducting the assessment and that it is ongoing. Once completed, the findings from the evaluation will be submitted to the CBP,” the group explains. As at the end of September, it had over 25,000 workers in its upstream operations in Malaysia, of which more than 16,800 are foreign workers.

“The shortage of workers in our operations as at the end of September is approximately 7,000, which represents about 22% of the total requirement for workers, of over 32,000, for our upstream operations in Malaysia.

“The new [foreign plantation worker] intake will certainly help to address some of the shortfall,” the group says.

It was reported that the government has approved 32,000 foreign plantation workers who have completed their Covid-19 vaccination to be brought into Malaysia in stages starting mid-October. The workers are understood to be employed as harvesters, as locals are not keen on taking up such jobs.

Analysts remain sanguine on the prospects for SDP, with 10 out of 18 analysts covering the stock recommending a “buy” call.

Maybank IB Research, in a Nov 19 note, upgraded its call from “hold” to “buy” after the release of SDP’s latest quarterly financial results, with a target price of RM4.47.

“We raise SDP to ‘buy’ from ‘hold’ given attractive upside to our revised revalued net asset value (RNAV) target price of RM4.47 (previously RM4.58) based on unchanged 0.45 times RNAV peg. Upside catalysts to our FY2022 estimated dividend per share will come from successful disposal of some of its non-strategic assets or estates,” the firm said.

RHB Research also upgraded its call on SDP after its earnings release, from “neutral” to “buy”, with a target price of RM4.35.

“Sime Darby Plantation’s 9MFY2021 earnings beat expectations. Its share price has declined by 9% in the last few weeks, and we see value emerging — with 2022 P/E (price earnings) at 17 times vs peers’ 19 to 22 times. We expect 4QFY2021 numbers to be just as sturdy, although ESG (environmental, social and governance) issues will continue to keep valuations below historical averages,” the brokerage said in a Nov 19 note.

Plantation counters have been impacted over ESG concerns from international investors, reflected by their dwindling foreign shareholdings. For SDP, its foreign shareholdings — as reported on its website — has declined from 12.18% in December 2018 to 9.2% as at Nov 30 this year. Permodalan Nasional Bhd remains its largest shareholder with a 56.44% stake, followed by the Employees Provident Fund with 15.9%. 

Year to date, SDP shares have declined by 25% to RM3.75 last Friday, translating into a market capitalisation of RM25.9 billion. 

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