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Sime Darby Bhd (MIDF Research) neutral; target price RM8.40

•  Sime  Darby  registered  net  earnings  of RM804.2m in 9M10, a 38%yoy decline due to the hefty provisions incurred by its E&U division.

•  Improved results  from  the Plantation, Property, Motor, Healthcare and Other divisions mitigated the decline  in  Industrial division profit and  the harrowing losses from E&U division.

•  The  E&U  division  underwent  aggressive ‘kitchen-sinking’  exercise  hence we  expect  no more  significant  negative  surprises  going forward.

•  The  mean  PER  of  Sime  Darby  is  18.7x.  Thus based on that empirical measure we arrived at a target price of RM8.40. We thereby reiterate our Neutral  recommendation  on  the  stock  with  a reduced target price of RM8.40 or FY11 PER of 18.7x.

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Sime  Darby’s  net  earnings  of  RM804.2  million  in  9M10  was  38.0%  lower  when  compared  to  RM1,296.1  million recorded  in earlier  year corresponding period.

The shortfall was mainly due  to  the hefty provisions by  its Energy & Utilities (E&U) division despite the better performance from all other divisions except Industrial which reported a lower profit. Please refer to our Equity Beat titled “Sime Darby: Skeletons emerge from the Energy & Utilities’ closet”, dated 15 May 2010, for our commentary on the RM964 million write-offs incurred by the E&U division.

Higher  Plantation  profit  from  better  upstream  and  turnaround  in  downstream  operations.  The  Plantation division  operating  profit  improved  to RM1,705.5 million  in  9M10,  an  increase of 45.0%  as  compared  to RM1,175.9 registered  in  the same period  last year mainly due  to higher FFB production, higher average CPO selling price and improved results from downstream operations. Overall FFB production rose 3.0% in 9M10 to 7.59 million  tones from 7.38 million  tones  in 9M09.

The FFB production  in  Indonesia  jumped 23.0%  to 2.56 million  tonnes due  to  the higher matured hectarage and  improved  yield. However,  the FFB production  in Malaysia declined  by  5.0%  to  5.03 million tonnes due to replanting and unfavourable weather. The average CPO selling price rose 7.1% to RM2,277/mt in 9M10 as compared  to RM2,127/mt during  the previous year corresponding period.  In addition,  the downstream operations reverted back to profitability due to lower feedstock costs.

Higher  Property  profit  from market  recovery  and  gain  on  disposal.  The  economic  upturn  has  helped  in  the recovery  of  property  market  hence  the  improved  performance  of  the  Property  division.  It  reported  revenue  of RM1,196.3 million  for  9M10,  a  33.9%  increase  from  the  corresponding  period  last  year. Moreover,  operating  profit
increased by 69.4%  to RM374.8 million  from RM221.2 million  recorded  the same period  last year. The higher profit was  contributed  by  better  performance  from  the  Bukit  Jelutong  and Nilai  Impian  townships,  as  well  as  a RM37.5 million gain from the disposal of a subsidiary company.

Lower Industrial profit due  lower demand for new equipment. Revenue from the Industrial division  inched up by 0.7%  in 9M10 to RM5,960.3 million from RM5,918.9 million a year earlier. Nevertheless, operating profit declined by 15.3% to RM536.7 million from RM634.0 million in the same period last year.

The lower profit figure was due to lower demand for new equipment in Singapore and Australia. However, this was partially moderated by the higher parts and services sales in Australia, higher equipment sales in China and a RM19.0 million gain from the disposal of a property in Malaysia.

Higher Motor profit driven by strong regional sales. The Motors division performed strongly in 9M10 with a 32.8% increase in revenue to RM7,069.4 million from RM3,321.9 million in the same period last year.

Operating profit (which includes a gain of RM27.7 million  from  the disposal of a property)  increased by 71.3%  in 9M10  to RM232.6 million from RM135.8 million  in the prior year corresponding period. Better top and bottom line numbers were mainly driven by strong regional sales. Operations in New Zealand reported a positive result while losses in Australia narrowed as compared to the previous year.

E&U registered a huge  loss…and  the  final  figure may vary. The E&U division  recorded 50.3%  lower  revenue  to RM1,156.8 million from RM2,325.9 million in 9M09. The division recorded a loss of RM1,019.3 million in 9M10 vis-àvis a profit of RM96.1 million  in  the same earlier period.

The harrowing  loss was  in  relation  to  the delays and cost overruns on four E&U projects.  The projects were the Qatar Petroleum project, the Maersk Oil Qatar (MOQ) project, the  Bakun  hydroelectric  dam  project  and  a  project  on  the  construction  of  vessels  for  use  in  the  MOQ  project.

Negotiations with  the clients of  these projects on  the  claims are ongoing. Furthermore, Sime Darby also appointed independent  technical  consultants  to  review  the estimated  costs  to  completion  for Bakun hydroelectric  dam project and MOQ project hence the estimated loss on these projects may eventually vary.

Healthcare  &  Other  recorded  better  overall  performance.  Healthcare  &  Others  recorded  a  huge  increase  in operating profit to RM80.3 million in 9M10 from a mere RM4.2 million in 9M09 due to better overall performance from insurance,  bedding  and  healthcare  sectors,  together with  a  gain  on  disposal  of  an  associate  amounting  to RM3.8
million.

Outlook.  The  prospect  for  the  mainstay  plantation  business  is  positive  as  the  outlook  relating  to  FFB  output  is favorable due to the yields improvement of its Indonesian estates. We are also positive on the outlook of CPO prices in the medium-term due to the rising trend in general commodity prices. We restate our forecast of CPO prices for the calender  years  of  2010  and  2011, with mean  prices  of RM2,450/mt  and RM2,650/mt  respectively.

 In  addition,  the economic  recovery  has  provided  the momentum  for  the  property, motors  and  healthcare  businesses  which  have shown  improved performance  in 9M10. The market condition  for  the  industrial business however was weaker but  is improving.  The  E&U  division meanwhile  underwent  aggressive  ‘kitchen-sinking’  exercise  thus  we  expect  no more significant negative surprises going  forward despite  the  fact  that  the  final  tally of  the announced write-offs may vary from the earlier estimates.

We maintain our Neutral recommendation with a reduced target price of RM8.40. The mean PER of Sime Darby is 18.7x (see PER Chart below). Hence based on that empirical measure we arrived at a target price of RM8.40. We thereby  reiterate our Neutral  recommendation on  the stock with a  reduced  target price of RM8.40 or FY11 PER of 18.7x.

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FFB Output
Production  dropped  in  3Q10  by  -27.9%qoq and  -4.7%yoy  following  exceptionally  dry weather conditions  in Malaysia &  Indonesia. But  expect  sequential  rise  in  the  coming quarters due to cyclical upturn in yields.

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Revenue & Earnings
Revenue declined QoQ  in 3Q10 due  to  lower plantation  output  and  it  registered  quarterly loss  of  -RM308.6m  due  to  hefty  provisions incurred by E&U division.

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Profit Margin

Margin  turned negative  in 3Q10 due  to hefty provisions.

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P/E Ratio

Mean PER of 18.7x.

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