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Sime Darby has good-to-strong competitive positions in three key businesses: plantation, heavy equipment distribution, and motor distribution. These positions reflect the long track record, large operating scale, and integrated operations of these businesses. Sime Darby's increased appetite for investments, its higher tolerance for debt to fund capital expenditure (capex), and execution risks for some new real estate projects temper the rating strengths.
The rating on Sime Darby is one notch higher than the foreign currency rating on Malaysia (foreign currency A-/Stable/A-2, local currency A/Stable/A-1; axAAA/axA-1+) due to the group's significant overseas assets. These assets contribute about 50% of Sime Darby's earnings, underlining its strong capacity to service foreign currency debt.
The group has strong geographical, product, and business diversity, which provides cash flow stability. Sime Darby's businesses have low correlation with each other, and operate in different industry cycles and across countries.
Sime Darby's financial management is moderate, in our opinion. Consistent financial management offsets the group's increased appetite for debt-funding. However, Sime Darby's leverage has been historically modest, which we believe gives it the flexibility to raise funds at attractive rates.
We view Sime Darby's major shareholder, state-owned fund manager, Permodalan Nasional Bhd. (PNB), as a neutral rating factor. Sime Darby is a key financial investment and major dividend source for PNB. Unlike government-related entities, PNB is directly accountable to unit holders, who comprise a broad swathe of the Malaysian population. We believe state intervention in the group's activities is unlikely.
Sime Darby's portfolio of businesses should remain stable over the next two years. We believe planned capex will help improve the operating efficiency of its plantations and strengthen the market position of the vehicle distribution and port businesses. The redevelopment of Battersea Power Station in the U.K. could involve project execution risks for Sime Darby. Nevertheless, this asset is relatively small in size and the group shares the risk with strong partners.
The large scale, low costs, and prime age of Sime Darby's plantations are a competitive advantage. The market positions of the industrial and motor divisions also benefit from the group's long associations and strong support from industry leaders, such as Caterpillar Inc. (A/Stable/A-1) and BMW AG (A/Stable/A-1).
In our base-case scenario, group revenue could grow by a high single digit over the next two years, given a stable economic outlook for the group's key markets in Asia. A reduced contribution from plantations could be more than offset by: (1) higher property sales in Malaysia; and (2) increased revenue from the industrial and motor segments, particularly in fiscal 2014 (ending June 2014) when we expect China's industrial output and consumption to grow faster.
Nevertheless, we believe the group's profitability will likely weaken over the next 12-24 months, given our expectation of lower crude palm oil prices and reduced demand for mining equipment.
In our base case, we project that Sime Darby's EBITDA margins will slip to about 13%-14% from 15%-16% over the next two years. Our projection may prove optimistic if palm oil prices deteriorate more than we currently expect or if China's economy grows slower than our current expectation of 8% for 2013 and 2014.
Sime Darby has high capex compared with its operating cash flows. The capex for the next three fiscal years should average Malaysian ringgit (MYR) 4.5 billion each year, compared with about MYR2.0 billion for the past five years. We also expect Sime Darby's dividend payout ratio to be high, at 50%.
Sime Darby is likely to largely fund its investments with debt. In our base-case scenario, we expect the group's leverage to peak by 2014, with a ratio of debt to EBITDA of about 2.5x and a ratio of debt to capital of about 35%. The group's free cash flow will be negative until the end of fiscal 2014 and should turn positive in fiscal 2015.
We believe Sime Darby has adequate financial controls and risk management. Following cost overruns for some engineering projects in 2010, the company has strengthened its supervision of the operating companies' finances, contracts, and risk exposure. The group has also reduced its investments to focus on key assets. We expect Sime Darby to continue to divest of non-core assets; it has divested about 40 assets worth MYR3.8 billion since 2005.
We assess Sime Darby's liquidity as "adequate," as defined in our criteria. We expect the group's sources of liquidity to exceed uses by more than 1.2x in fiscal 2013 and fiscal 2014. Our liquidity assessment is based on the following factors and assumptions:
-- Key sources of liquidity include existing cash of about MYR5 billion and annual generation of funds from operations of about MYR5 billion a year until fiscal 2015.
-- Contracted asset sales of MYR1.1 billion (including oil and gas assets) will contribute to cash flows in fiscal 2013.
-- Key uses of liquidity are capex of about MYR5 billion in fiscal 2013 and an average of MYR4.5 billion in fiscals 2014 and 2015.
-- Contractual debt maturities will be about MYR1.5 billion during the second half of fiscal 2013. Debt maturities should be negligible in 2014.
-- Investments in working capital are likely to be about MYR2.0 billion a year in fiscals 2013 and 2014.
-- We expect dividend payouts of about 50% of net profit, or about MYR2.0 billion a year. This is consistent with the group's financial policy.
-- In our base-case scenario, we expect the group to increase its borrowings by about MYR4.5 billion in fiscal 2013 to fund its working capital, capex, and dividends while maintaining MYR5.0 billion in cash.
-- However, the company has the ability to reduce its capital investments if its profitability is weaker than expected and to moderate the increase in leverage.
-- The group has committed credit facilities of about MYR1.7 billion and the flexibility to tap its ringgit MTN program, which will likely be its borrowing sources.
We believe Sime Darby has a good standing in the capital markets and good relationships with lenders. This reflects its long operating track record and consistent financial management.
Sime Darby needs to comply with certain financial covenants in its bank facilities and ringgit MTN program. These covenants are related to borrowings versus shareholder funds. The group has maintained comfortable headroom for all its covenants. As the covenants are not related to profitability or cash flow generation, we expect Sime Darby to have good headroom to comply with the covenants in our base-case scenario.
The stable outlook reflects our expectation that Sime Darby's diversified businesses will generate strong operating cash flows. This should offset likely lower earnings and moderately higher leverage due to large debt-funded capex. The outlook also reflects our expectation that the group will maintain a prudent approach to investments and capex. We expect Sime Darby's debt-to-capital ratio to hover at about 35% in fiscal 2014-2015. This peak gearing is still in line with our assessment of a modest financial risk profile, and compares with about 28% in fiscal 2012.
We may lower the rating by one notch if: (1) crude palm oil prices deteriorate significantly from levels in 2012 and remain below MYR2,000 per metric ton; and (2) the profitability of Sime Darby's mining equipment and motor distribution businesses deteriorates, such that its borrowings will have increased more than we expect due to large capital spending. A debt-to-capital ratio of more than 35% and a debt-to-EBITDA ratio of more than 3x sustained for more than 18 months would indicate that the financial risk profile has deteriorated. We may also downgrade Sime Darby if the group's free cash flows (operating cash flow minus capex) show no sign of returning to positive by the end of fiscal 2014.
The potential upside to the rating is limited for the next 24 months, given our expectation of lower profitability and large debt-funded capex. We could upgrade Sime Darby if the group consistently executes its strategy and investment plan, improves its business diversity, and reduces its leverage (debt-to-EBITDA) below 1.5x for a sustainable period.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Sime Darby Bhd.
Corporate Credit Rating A/Stable/--
ASEAN Regional Scale Rating axAAA/--/--
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