Sime Darby Bhd
(Aug 30, RM8.35)
Maintain neutral at RM8.10 (Aug 27) with higher revised target price of RM8.62: The meeting we arranged for a small group of fund managers with Sime Darby’s new group CEO Datuk Mohd Bakke Salleh left us feeling slightly more positive as we like the new strategy put forth by him. But it is still early days and turning around a conglomerate of this size is not an easy task.
Investors should not expect instant results if previous attempts are anything to go by. Sime Darby is looking to unwind some past decisions and may have successfully ring-fenced the problematic issues. But these legacy issues will linger and may dampen sentiment. We maintain our view that the changes will take time to trickle through to earnings and could crimp near-term earnings by putting a stop to easy land sale gains.
Investors will need to be convinced on the execution of strategy which may take time due to the group’s poor track record. Thus, we retain our neutral call despite raising our sum-of-parts (SOP)-based target price by 5.5% to RM8.62 after halving our SOP discount to 5% in view of our more positive view on the group. Our earnings forecasts are unchanged.
We will review our rating when a new and more stable management is in place and when there is progress in the execution of its strategy and a clearer view of the group’s portfolio when it completes the review in 1Q2011.Key takeaways from the meeting include Sime Darby’s plans to pursue organic growth rather than an acquisition-driven one and the scope to recover provisions. The conglomerate also plans to review some joint ventures to maximise the return on existing assets and is keen on strategic alliances in downstream plantations and non-engineering, procurement and construction (EPC) contracts.
More management changes could be on the cards. We believe these are reasonable plans in these circumstances but are unlikely to excite investors in the short term.
There are four key thrusts in Sime Darby’s plan. These include the turnaround of its energy and utilities unit, potential maximisation of all its core businesses, instituting a high performance culture and a review of the company’s portfolio mix.
Overall, we are positive on the group’s plan, which aims to put Sime Darby back on the right path of going back to basics, to where its original expertise lies, by maximising the existing value of its core businesses, building a strong management team for succession planning and reassessing the existing businesses.
The group has set a two-year time frame for the turnaround of its oil and gas business. Its key priorities are to resolve outstanding issues and enhance project management and execution capabilities. For a start, the group has identified and ring-fenced the outstanding issues and liabilities of the various projects.
Some of the outstanding project issues to resolve include the need to continue pursuing outstanding variable orders for Qatar Petroleum, ensure a timely handover of Maersk Oil Qatar Project by Sept 10 — besides the need to minimise cost overruns — and complete oil and gas projects in India on a timely basis.
In the latest quarterly results, the group provided RM777 million for its oil and gas division, which is the latest assessment of the probable cost to complete the various projects based on today’s prices. The other immediate issues to resolve are to improve the bidding process for the oil and gas division and strengthen governance.
The next step would be to rebuild core capabilities by strengthening leadership by recruiting key technical personnel and focusing on operational excellence. It will be working with cost consultants to ensure price competitiveness for future projects and to ensure the right talent and processes when it comes to project management.
The group is also close to finalising a joint venture with a reputable, recognised engineering design house to improve its competitiveness. The last part of the plan is to win new projects but priority will be given to projects within the group’s core competencies, mainly EPC contracts. For non-EPC contracts, it will be selective in its participation in international projects with reputable partners.
The new CEO’s key priority is to enhance the business performance of the group, which is a slight departure from the previous management’s enthusiasm for mergers and acquisitions. His plan to inculcate a culture of thrift and cost-consciousness is also new and is positive as it will help boost efficiency in its existing businesses to ensure that the group will be fit to compete as well as help restore shareholders’ value. This includes ensuring that all its businesses are “best in class”, emphasising efficiency rather than size.
There are also plans to build strategic alliances to improve competitive advantage. The new CEO, for instance, does not see the need for Sime Darby to own 100% of all of its downstream assets and is open to joint ventures and strategic alliances in some businesses.
The conglomerate’s plan to institute a high performance culture addresses the issue of ensuring the right culture is implemented in Sime Darby to allow the group to compete effectively. This involves strengthening the leadership pipeline, performance and rewards practice as well as capability development.
This has in the past been talked about as part of the group’s strategy, but we believe that the point is the extent to which these measures have been put into practice and communicated within the group.
Under the previous management’s plan, a review of the group’s business portfolio is slated for 2011. This is also part of the new CEO’s plan. His view is that the businesses should be looked at on their own merits and there should be no rush to dispose of any business just because it is not part of the core businesses of the group.
The more important consideration is the prospects of the business. Should a disposal be deemed necessary, getting a good price would be part of the plans to maximise value in the group. — CIMB Research, Aug 30
This article appeared in The Edge Financial Daily, September 1, 2010.
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