This article first appeared in The Edge Malaysia Weekly, on February 29 - March 6, 2016.

THE mood was somber in the ballroom of Sime Darby Bhd’s convention centre in Mont’Kiara, where the diversified group released its half-year financial earnings. As president and group CEO Tan Sri Mohd Bakke Salleh took his seat at the briefing, he hardly smiled.

“While profit before tax (PBT) fell 22% year on year [to RM463.5 million for the second quarter ended Dec 31], turnover actually increased by 10% y-o-y [to RM11.83 billion]. This should tell you a lot about the environment we are operating in today,” Bakke told the press last Wednesday.

Sime Darby, which has grown enormously in size in the past decade, is likely to remain profitable in the current financial year ending June 30 (FY2016). But the cyclical downturn may hit it hard, despite its well diversified core businesses — plantations, industrial, automotive and property — with no reprieve in sight.

A few quarters of weak earnings due to poor macroeconomic conditions aren’t just short-term problems for Sime Darby. The quarterly numbers might have exposed the group’s vulnerability to the fluctuation of commodity prices.

Some quarters wonder what Sime Darby would look like if it hadn’t gone on the acquisition trail. Furthermore, the conglomerate usually surprises the investing fraternity with the premium prices it is willing to pay for acquisitions.

Young fund managers might not see Sime Darby as an exciting name or a must-have blue-chip that would enable their investment portfolios to outperform their peers’.

“From a debt perspective [Sime Darby’s sukuk, for example], GLCs [government-linked companies] like Sime Darby are great because they are good paymasters. From an equities perspective, however, the appeal is harder to see. The group isn’t good at realising the value of its assets,” says one fund manager.

“If you want exposure to plantations, there are other plantation companies that don’t have Sime Darby’s issues. If you want exposure to property development, there are better developers out there that can give you more value. To top it off, Sime Darby doesn’t look very cheap because its share price is well supported by its shareholders,” he says.

For the six-months ended Dec 31, net profit fell 36% y-o-y to RM601.7 million, coming in below analysts’ expectations. Revenue grew 5.4% y-o-y to RM22 billion.

The timing and acquisition price of New Britain Palm Oil Ltd (NBPOL) last year are debatable. Some fund managers see it underscoring the conglomerate’s struggle to create value.

That said, the RM6.07 billion NBPOL acquisition did help to lift Sime Darby’s revenue by adding 80,000ha of palm oil plantations in Papua New Guinea that are deemed to be prime assets. However, the plantation arm, which makes up 40% of PBT, still performed poorly overall due to low crude palm oil prices, poor weather and an export levy imposed by Indonesia.

Even with a contribution of 749,000 tonnes of fresh fruit bunch production (FFB) from NBPOL, PBT for the plantation segment fell 17.7% y-o-y to RM460.4 million. Note that NBPOL’s contribution made up about 14% of the group’s total FFB production of 5.4 million tonnes during the period.

“The severe drought has reduced the contribution from NBPOL, but overall, the synergy from the acquisition is positive. It is good for the company’s long-term sustainability,” says Kenaga Research analyst, Voon Yee Ping.

Notably, the PBT includes RM101.5 million from the midstream and downstream operations for the period, compared with a loss of RM1 million in the previous year. In addition, exchange gains for the settlement of intercompany balances of RM50.7 million were recognised during the period.

Stripping out these items, the group’s upstream plantation business actually saw a contraction of 44.8% in PBT to RM308.2 million.

The group’s diversified nature hasn’t helped it to diversify earnings risks. With commodity prices at rock-bottom levels, prospects for Sime Darby’s Australia-based industrial segment continue to deteriorate. The slowdown in the property market isn’t doing Sime Darby any favours either, and to top it off, automotive sales are expected contract for the first time in four years (see table above).

Weak earnings are putting pressure on the group to deleverage its balance sheet or risk a ratings downgrade. Last year, rating agency Moody’s Investors Service had already revised the outlook on Sime Darby’s A3 rating to negative because “the A3 rating is not sustainable at four times leverage [debt/earnings before interest, taxes, depreciation and amortisation (Ebitda)],” it wrote.

Moody’s revision came after the NBPOL acquisition, which has increased Sime Darby’s gearing to 61%.

“The outlook is negative and could crystallise into a downgrade if substantial debt reduction fails to materialise in the next six months, such that adjusted debt/Ebitda remains above 2.5 times,” Moody’s writes.

Bakke is finding ways to address the ballooning debts. He hopes to monetise RM1.8 billion in assets at end-March and launch up to RM3 billion in perpetual sukuk by the middle of the year, in order to reduce the group’s gearing to 54%.

Operationally, however, Sime Darby is pretty much in line with its peers of a similar size (see table 2). For the six-month period, Sime Darby’s annualised FFB yield was slightly above 21 tonnes per hectare, well above the national average of 18 to 19 tonnes per hectare.

Still, Bakke admits that there is room for improvement.

“Our yield is about one tonne less than some of our peers. That one tonne is a lot when you add it up. This is something that we are addressing through replanting,” says Bakke.

While replanting will take many years to bear fruit, Bakke has more pressing concerns. Some analysts do not think the current monetisation plan to pare down borrowings will be sufficient.

“The RM1.8 billion asset monetisation is a start, but Sime will need to do more. Management has mentioned previously that it will look to monetise non-core businesses, as well as some of its property development landbank. Tesco and the group’s hospitality business could be some non-core assets to monetise,” says one analyst.

However, monetising assets to reduce its gearing isn’t exactly a draw for investors. Permodalan Nasional Bhd controls 48.7% of Sime Darby while the Employees Provident Fund holds 12.7%.

Likewise, Kenanga’s Voon points out that Sime Darby will continue to be an important stock for funds to have their portfolios due to the sheer size of the group’s assets. “Sime Darby has the largest plantation landbank among Malaysian planters and is the largest CPO producer following the acquisition of NBPOL,” she says.

But Sime Darby cannot ride on its size forever. At some point, it will have to achieve its own tagline, “Developing Sustainable Futures”.

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