This article first appeared in The Edge Malaysia Weekly, on October 26 - November 1, 2015.

TDM Bhd has received verbal clearance from the Securities Commission Malaysia (SC) that it will remain on the shariah-compliant list that will be reviewed by the regulator’s Shariah Advisory Council (SAC) next month, say executives familiar with the matter. 

TDM, which is controlled by the Terengganu government, came under scrutiny after its interest income for its financial year 2014 (FY2014) exceeded the shariah accepted level of 5% of revenue. This raised concerns that it may not be shariah compliant and thus fall off the radar screen of institutional funds like Lembaga Tabung Haji that invest only in shariah-compliant stocks.  

The SC’s rules state that if a stock’s market price exceeds or equals a shareholder’s initial investment cost, such investors must dispose of those shares within a month of knowing about the reclassification. However, sources say TDM (fundamental:1.05; valuation:1.40) should be “safe” in the coming review. 

TDM is involved in plantations and healthcare services.

In FY2014 ended Dec 31, TDM’s interest income from a conventional non-Islamic instrument totalled RM22.3 million or 5.8% of revenue — marginally higher than the 5% threshold. Revenue grew 4.2% year on year to RM386.2 million.

However, the ratio continued to climb in the first half of FY2015. Interest income totalled RM14.6 million or 8.6% of revenue, which dropped 9.8% to RM169.7 million.

TDM’s management was not available for comment at press time.

The state’s investment vehicle Terengganu Inc Sdn Bhd is the single largest shareholder of TDM with 62.2% equity interest, followed by Perbadanan Memajukan Ikstisad Negeri Terengganu (13.3%) and Kumpulan Wang Persaraan (Diperbadankan) (8.48%), according to the latest filings with Bursa Malaysia.

The fixed-income securities first surfaced in TDM’s income statement for FY2013. Interest income was only 2% of revenue at the time, when the company described the securities as an unsecured Indonesian rupiah notes programme. According to the 2013 annual report, the fixed-income securities with an annual interest rate of 12% and 12-year maturity period were linked to securities issued by Oversea-Chinese Banking Corp Ltd.

As at end-2014, the value of TDM’s investment in the securities totalled RM274.3 million.

Earlier reports indicated that TDM would be working to convert some of those funds into Islamic products by the time the SAC sat for the biannual screening next month. In fact, says the head of a local corporate finance advisory firm, converting a fixed-income security into an Islamic product is not particularly difficult.

“In TDM’s case, a likely instrument for them to use would be a musharakah or mudharabah. Either of them would be typical for a plantation company that’s financing land development,” he explains.

While TDM’s annual reports do not explicitly indicate the purpose of the funding, analysts covering the company say the money is being used to manage its Indonesian plantations. In any case, says an analyst, meeting the SAC’s interest income threshold will become easier for TDM once its revenue starts to grow.

PublicInvest Research forecasts TDM’s revenue to hit RM448.9 million in FY2017 while RHB Research puts the figure at RM501 million.

“We understand that management is also explaining the essence of this product [the fixed-income securities] to the SAC to obtain some form of documentation to verify that it is for a shariah-approved purpose, that is the operation of an oil palm estate,” RHB Research analyst Hoe Lee Leng says in a June report. 

This would be the first layer of shariah-compliant requirements whereby the underlying business activity has to be shariah approved. Non-shariah-approved activities, like gambling, tobacco and liquor, among others, cannot exceed 5% of group revenue or profit before tax. This area is theoretically not an issue for TDM.

The head of the corporate finance advisory firm points out that leverage is another crucial factor to look at to ensure companies like TDM are not at risk of financial distress.

As at June 30, TDM’s net debt stood at RM534.2 million while its gearing ratio was 50.35%.

According to the SC’s latest list, issued at the end of May, two balance sheet ratios — cash/total assets and debt/total assets — must be less than 33%.

Based on its June 30 numbers, TDM’s cash/total assets ratio, at 5.6%, was well below the SAC’s requirement.

The cash/total assets ratio indicates the proportion of a company’s assets that is held in cash or marketable securities. Typically, creditors like a high ratio because that gives them a level of security when it comes to repayments.

TDM’s debt/total assets ratio is 28.9% — still below the SAC’s threshold. 

TDM’s share price has been trending downwards this year due partly to the weak crude palm oil prices, which is eating into its plantation earnings. The stock slipped 36% from January to hit a low of 53 sen on Aug 24. But it has recovered since and closed at 71 sen last Thursday, giving the company a market capitalisation of RM1.05 billion.

According to Bloomberg data, the consensus 12-month target price for TDM is 69 sen.

Note: 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. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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