Sime Darby Bhd reported better than expected results in the first quarter of its 2020 financial year ended Sept 30, 2019 with a net profit of RM246 mil, an increase of 9.3% quarter-on-quarter (qoq).

This was attributed to a strong contribution from the group’s industrial division, with analysts calling the improved growth “remarkable.’’

“We have reported a good set of results, with our industrial division recording wins in most markets, riding on the mining and construction waves to enjoy increased sales in China and the Australasia region.

“Our order book for the industrial division is solid at RM2.5 bil as at Sept 30, 2019. Our motor division too saw significant improvements, particularly in the China market, this quarter due to higher margins from vehicle sales,” says Sime Darby’s group CEO Datuk Jeffri Salim Davidson.

Sime Darby stands as a strong industrial and auto player, with luxury auto brands such as BMW, Jaguar and Porsche under its umbrella. It also has long-standing partnerships with Caterpillar Inc (CAT) and other brands, which see Sime Darby distributing industrial vehicles and machinery in 18 countries.

Other than that, Sime Darby features a healthcare segment, made up of six hospitals and a day surgery centre, which had a flat contribution of RM15 mil to the group’s 1QFY20 results.

Finally, there is the logistics segment, which provided a weaker contribution year-on-year (yoy), as its RM6 mil profit before interest and tax came in 46% lower than in 1QFY19.

Affin Hwang Research analyst Brian Yeoh notes that the drop in contribution was due to the 1QFY20 loss before interest and tax from joint ventures of RM6 mil.

“Excluding the disposed Weifang Sime Darby Water Management Co Ltd and joint venture losses, the ports (parked under the logistics division) recorded a core profit before interest and tax (PBIT) of RM15 mil, an increase of 88% yoy, from higher bulk cargo throughput at Weifang Port. This amounted to a 4% increase yoy to 7.3 mil metric tonnes,” he adds.

Portfolio rationalisation

Sime Darby is looking towards divesting its non-core businesses in a portfolio rationalisation exercise over five years. What this means is that the industry and auto arms will continue to be its primary focus while it looks to grow its fledgling healthcare segment.

Its non-core assets include the logistics arm, which operates a sea port and three river ports in the Shandong region of China. Its other businesses under the logistics division – a water treatment plant, along with its management firm – have already been sold.

Other non-core assets include its 30% stake in Tesco Malaysia, as well as the 3,561.23ha of land in the Malaysia Vision Valley in Negeri Sembilan owned by the group.

Interestingly, the four ports still sit pretty in Sime Darby’s books. This raises the question as to whether the group is still looking to divest the ports or hold on to them given their encouraging performance.

Jeffri Salim Davidson

Earlier, Sime Darby met a stumbling block in the form of a nationwide port consolidation initiative being put in place by the Chinese government. This has led to the group putting its port divestment plans on hold.

“The ongoing nationwide port consolidation exercise has changed the dynamics of the ports business in China and created significant downside risks to obtaining a strong valuation,” says Jeffri in the group’s 2019 annual report.

“In view of this, we made a strategic decision to delay the divestment of our ports until the port consolidation exercise is completed, at which time divestment is expected to be more beneficial to the group,” he adds.

Referring to a previous report, Yeoh from Affin Hwang notes that the floor price for the ports is estimated at RM2.3 bil, which is equivalent to the total of Sime Darby Logistics’ invested capital in FY18.

Hong Kong blues

Sime Darby has large business interests in Hong Kong, with all of its core competencies having a foothold there. Not only does Sime Darby Industrial deal in CAT vehicles there, Hong Kong (together with China) is also a market for the group’s luxury car brands under Sime Darby Motors.

Even the healthcare segment, which the group is looking to grow, has a day surgery centre in Hong Kong, which was opened in November 2018.

The group’s CEO has also gone on record at the group’s recent annual general meeting, stating that Sime Darby will not be pulling out of Hong Kong.

“Hong Kong is a mature market with 56 years presence in the country. It has an affluent society with a large market share of the luxury segment,” says Jeffri, adding that the group’s businesses there make up 5.9% of Sime Darby’s revenue.

“We need to hunker down and wait for things to settle down. We have to ensure that our staff are safe,” he notes, adding that the group employs about 1,200 staff in Hong Kong.

AmInvestment Bank analyst Jeremie Yap notes that he had expected sales by the motor division to be sluggish due to the Hong Kong protests.

“Nevertheless, the region’s sales volume held up well at 10,800 units, an increase of 8% yoy,” he adds.

Trade tensions

In the recently-ended quarter, China was identified as a key driver for Sime Darby’s beyond-expectations results, as the trade superpower contributed strongly to the group’s industrial and auto divisions.

TA Securities analyst Angeline Chin notes that, for the auto segment, the “higher contribution was mainly driven by improving margins and higher revenue in China, which has helped to offset lower sales in Malaysia as a result of the absence of the zero-rated Goods and Services Tax (GST).”

Chin adds that “the strong performance (from the industrial segment) was underpinned by higher equipment deliveries to the mining and construction sectors in Australia and China.”

However, she cautions that the ongoing US-China trade tension could impact the group’s earnings moving forward.

“Despite growing demand from Australasia, Malaysia and Southeast Asia, management sees a more cautious investment approach due to the trade tension, which is also expected to weigh on consumer spending,” she adds.

Valuation

Affin Hwang and AmInvest are maintaining hold calls on Sime Darby, with a target price of RM2.23 and a fair value of RM2.64 to adjust for the strong 1QFY20 results. TA Securities also upgraded the group to a hold call, along with a target price of RM2.43.

Moving forward, analysts lean towards concern over the group’s long-term prospects, with Yap from AmInvest hoping that “the group will continue its efforts to monetise other non-core assets, such as Lockton Insurance, the 30% stake in Tesco Malaysia and its 11.6% stake in Eastern & Oriental Bhd.”

Affin Hwang’s Yeoh shares the sentiment, noting that “while we raise our FY20 earnings per share forecast by 12% on the strong 1QFY20 results, Sime Darby’s long-term prospects look shaky in view of its susceptibility to an economic slowdown.”

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