Tuesday, November 27, 2007

Synergy Drive: Some Caveats

The Malaysian markets will be in for a major fillip on Friday owing to the requotation of sorts via Synergy Drive. Conservative estimates see the KLCI jumping 30-35 points based on the requotation, thus we are looking at 1,400-1,420 as the new base judging by today's market performance.

While many foreign houses and international funds played Sime Darby prior to its suspension. Many opted to cash out rather than hold for the extended suspension period to get Synergy Drive's shares. SD is expected to account for 9% of the recalculated KLCI capitalisation. Regional and index funds will have to have SD in their portfolio, no two ways about it.

There is a prediction that some investors will sell other plantation counters to switch to SD. That is unlikely to hold true as SD is not a pure plantation exposure. While SD will be the biggest in terms of plantation earnings, it is not a pure play - and that could be the thing which could trip up SD.

For FY07, plantations will contribute 45% of SD's operating profit. The figure rises to 52% for FY08. Its a significant figure but it still looks more like a conglomerate to me, and probably to most professional investors.
Those bullish on SD have cited its involvement in the Bakun dam and undersea hydroelectric cable and power transmission to the peninsular as the near term catalyst.

The fact that its not pure plantation may actually result in a lower valuation over the longer term. I would expect the initial couple of weeks to see robust uptrend in SD's share price on just foreign institutions and more importantly, local government investment institutions. However, following the euphoria, SD's price could be repriced at a discount to pure plantations valuations. The discount could come to 20%. The discount is largely due to the fact that SD has its fingers in many pies as well - motor, oil & gas, utilities, heavy equipment and property. That's a conglomerate in my books.

No doubt that SD has a few factors going for it:
a) world's largest plantation group with over 500,000ha - that has to mean something
b) more than 75% of its palm oil are young (below 15 years)
c) seemingly stronger & more professional management
d) finally a Malaysian counter that can provide ample liquidity to "big investors" - over 6bn shares in share capital and a decent free float

e) a premium rating should be accorded for the above factors cited

The often cited synergies and cost savings in plantations still needed to be delivered. Valuation wise, the simplest would be a sum-of-the-parts valuation based on the business PER for the respective businesses. After scouring some of the latest research reports, on the low side we have Kim Eng/Yuanta with a RM9.60 valuation and an exuberant OSK target price of RM13.65.

At the end of it all, we have to ask ourselves if Synergy Drive is indeed a better animal than Sime Darby. Well, plantations make up 21% of Sime Darby's operating profit in FY07 compared to 45% for Synergy Drive. Heavy equipment made up 44% of Sime Darby's operating profit in FY07 but only contributes 18% to Synergy Drive. Going forward, palm oil and other soft commodities have a much better outlook on a 3-5 year view.

For foreign funds, palm oil is increasingly being seen as the only unique and worthwhile exposure worth looking at when investing in Malaysia - that's something a lot of people don't want to hear.
If you are touting banks, airlines or utilities: to a regional investor he/she have the option of investing in similar industries in HK, Japan or Singapore - where the stocks may be bigger and more liquid.

All big Malaysian companies must compare themselves to regional or even global peers in their industry in order to be noticed. Getting bigger like SD is one thing, performing like IOI Corp is another.

If you are a fund manager, god help you if you do not have some Synergy Drive in your books at a decent price. For retail investors, don't chase, just wait a week or two, there should be at least one or two new covered warrants on Synergy Drive, that's a better trade.

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