Sime Darby

We have increased our EPS forecast for Sime Darby by 3% for 2008-2009, and our SOP-based price target by 4% to RM11.40. The changes reflect better-than-expected progress in the plantations business, somewhat offset by more conservative estimates for some other divisions. Overall, we remain bullish on CPO and Sime is the world’s largest listed plantation company by hectarage. The stock is also cheap, trading on 12.9x CY08 earnings, a 20% discount to the peer average. Maintain BUY for 20% upside.

We have increased earnings from the plantations business by 4-7% for 2008-2009 due to quick-than-expected improvements to FFB yields, particularly in Indonesia. However, we have cut previously aggressive forecasts for Sime’s property division by 18% this year and 21% in 2009, due to a slowdown in mass residential property and some merger integration issues. We have also cut earnings for the heavy equipment division by 7% for 2008-2009 – again, we were probably too aggressive originally. All up, our earnings increase by 0.2% in 2008 and 3% in 2009-2010. Plantations remain the dominant business, representing 71% of 2008CL earnings.

We remain bullish on CPO prices, forecasting RM3,400/t for 2008-2009. The biofuel drive in the US and Europe is one of the key contributors to the global shortage of edible oil. The current production of corn ethanol requires 3.2bn bushels per day, and more capacity is being added. A marginal supply of edible oil will come from Indonesia and South America. Palm plantation companies are set to benefit from rising prices due to supply shortages, as soy, palm, rapeseed and sunflower oils are perfect substitutes.

Sime Darby is the largest listed plantations company by hectare and the second largest by market cap. It is also one of the cheapest at 12.9x CY08 earnings. We believe risks to earnings are on the upside, due to current CPO prices being above our forecast and still conservative estimates on improvements to the plantations business. The main near-term risk for the stock is any potential hike to Malaysia’s CPO taxes. The taxes are under review now, but we believe any increase is likely to be relatively small and nowhere near as prohibitive as the export taxes imposed in Indonesia.