Sime Darby - FY09 earnings to be hit by low CPO price

We expect Sime Darby’s (Sime) 4QFY09 and FY09 results to meet our expectations. Any surprise would be on the downside, coming from potential provisioning/losses at its projects in Qatar.

Lower contribution from plantation division. Sime’s plantation division is its largest division, contributing about 60% of the Group’s pre-tax profit. This division is expected to deliver better qoq results in 4QFY09, due to higher production and average selling price (ASP) of crude palm oil (CPO). However, we believe Sime’s 4QFY09 CPO ASP will be below the industry’s average as it had already locked-in sales for its 4Q production earlier, in late-1Q09. 4QFY09 earnings will be lower yoy due to a 28% yoy decline in CPO ASP. For FY09, contribution from this division will be lower due to the following factors:

a) Lower CPO ASP. Based on Malaysian Palm Oil Board’s (MPOB) spot prices, the ASP for FY09 was 23% lower than FY08.

b) Higher fertiliser cost. Operating profit margin will be affected by record high fertiliser costs in 2QFY09 and 3QFY09.

c) Only marginal increase in production. Total production was up only marginally by 4%, driven mainly by its Indonesian estates. However, it was lower-than-expected due to the bad weather in Kalimantan in 3QFY09.

Contribution from manufacturing division to improve in 4QFY09. The manufacturing division’s operating profit margin would be hit by high cost, but is likely to turn in a small profit or break-even, with the bulk of the high-priced inventories brought forward being recognised in 3QFY09. This division is contributing about 20% of Sime’s total operating profit.

Property sales pick-up in 4QFY09 to cushion weaker sales 1Q-3QFY09. The property division is likely to perform better in 4QFY09 due to sales pickup since Mar 09. However, for FY09, operating profit contribution will be at least 15-20% yoy lower due to the lacklustre 1HFY09. For FY09, Sime has sold about RM1b worth of properties from its existing stocks through three major selling campaigns (Parad of Home) since 1 Jun 08. Of these, 60% was locked-in at end-3QFY09 and 4QFY09. Thus, 4QFY09 performance is likely to be better qoq but flat yoy.

Momentum slows at heavy equipment division. We are still expecting lower qoq contribution from this divison due to margin squeeze, although this may be somewhat mitigated by the strengthening of the Australian dollar in 4QFY09 vs 3QFY09. Also, as commodity prices moved up in 2Q09, the risk of order cancellations is now lower. For full-year FY09, this division likely to be helped by the good results in 1QFY09.

Sime is still expensive after we raise its fair price to RM7.60, pegged to 20x FY10 PE. The strong support from government-linked funds have been the driving force behind the rise in Sime’s share price. At the current price of RM8.37, the stock trades at 23x FY10 PE, which is higher than its historical average of 20x. Even pegging it to 20x FY10 PE, Sime’s target price of RM7.60 is still well below its current trading price of RM8.31. Maintain SELL.