Sime Darby - All engines off

Performance likely to stay subdued on weak plantation production and, more critically, lower margins from other divisions. Potential write-offs for its variation of order (VO) for Qatar project, which should be the VO not approved by client.

Plantation unlikely to turn around soon. Higher production in 4QFY09 is unlikely to compensate for 3QFY09’s shortfall. Thus, for the full year, the plantation division would likely be hit by lower production and lower average selling prices. It is the largest division, contributing about 60% of pre-tax profit.

Uncertainty over Qatar projects. Sime may recognise potential provisionings/losses at its two Qatar projects in 4QFY09. No details have been given. We understand the “variation of order” claims for its Qatar Petroleum project have not been approved, but management expects them to be finalised by Jun 09. Also, there is still risk of potential write-offs for unclaimable amounts, as well as potential cost overruns at its oil & gas fabrication project in Qatar, the Maersk Oil Qatar project.

Momentum slows at heavy equipment division. This division has been growing rapidly and accounted for 30% of 9MFY09 group EBIT. It would likely experience decelerating growth or even earnings contraction, as a wave of cancellations has reduced its order visibility beyond Sep-Oct 09.

We now expect a net profit of RM1,642.3m (EPS: 27.3 sen) for FY09, lower than Sime’s KPI target of RM1.9b. The key adjustment to this was the revision of fresh fruit bunch production in FY09 from a growth of 7.6% to a contraction of 7.9%.

For FY10, net profit is expected to increase 38.4% to RM2,272.8m (EPS: 37.8 sen) on the back of higher crude palm oil price (RM2,200/tonne vs FY09: RM1,900/tonne) and stronger production growth of 7.0% (vs FY09: -7.9%), while growth in other sectors remains subdued.

Maintain SELL. We have switched our valuation method from P/B for the downcycle back to PE for an uptrend. Our fair price has been lowered from RM6.60 to RM5.70 based on 15x FY10F PE, in line with the PE multiple for big-cap peers on an uptrend and in line with Sime’s historical PE multiple.