Analysts say conglomerate’s 2016 financial year will be challenging.

“It’s a potpourri of bad news.” – Tan Sri Mohd Bakke Salleh

THE advantage a conglomerate has is its diversity. But when nearly all major divisions in a conglomerate are flashing red, the signals they send are worrisome.

These are no ordinary times for Sime Darby Bhd. During a briefing on Wednesday to announce its full-year results, the company gave an outlook that was laced with uncertainty.

“It’s a potpourri of bad news,” says president and group chief executive Tan Sri Mohd Bakke Salleh.

Sime’s strength has always been its assortment of businesses. From plantations to heavy equipment, motor and to property, the idea was that should one segment underperform, then the slack will be picked up by other.

The same with the various economies in the region. Sime is exposed to South-East Asia, China, Hong Kong and Australia. The matrix of different business segment in multiple geographies has smoothen shocks on its financial performance.

But this time, things are different. Economies in which it operates are slowing and the price of commodities such as crude palm oil (CPO) and coal, which influences demand for heavy equipment it sells, is down.

The signs are not good.

As a result, most of the divisions last year showed a decline in profitability. The quantum was significant enough for Sime to miss the yearly guidance it hands out in the second quarter of each year.

Net profit fell 31% to RM2.3bil last year and that saw it miss it net profit key performance indicator of RM2.5bil for its 2015 financial year. The return on average shareholders’ fund was 7.8% versus its target of 8.5%.

Much of the blame is directed to the slump in commodities and economies in the region.

“The group continues to be adversely impacted by bearish commodity prices and volatile market conditions in the period under review. CPO and coal prices have been on a downward trend and the challenging business environment has resulted in subdued demand in most of our business activities, thus culminating in a weaker set of earnings,” say Bakke.

The slump in the price of CPO particularly hurt Sime. It realised an average selling price of RM2,193 per tonne which was lower than the expected price of RM2,350 a tonne.

With the price of CPO well below RM2,000 a tonne, the influential plantation sector for the group isn’t expected to provide much relief. In fact, the volatile and low price of CPO made it hard for Bakke to give his estimate for where he thinks the future price of the vegetable oil will be in the coming months.

The same with the mining industry. In Australia, Sime has a 64% share of industry net sales for mining equipment. The slump in coal prices has hurt its business there, along with other countries such as Malaysia, China and Singapore where it has a substantial slice of the heavy equipment market.

Dealing with weaknesses

Sime’s financial weakness for its 2015 financial year was expected. The group which posted a net profit of RM3.35bil during its 2014 financial year had forecast profits for 2015 to be much lower but the RM2.3bil it earned was the lowest since its 2010 financial year when it reported a net profit of RM726mil after its oil and gas units dragged down earnings.

The conglomerate will only divulge its 2016 financial forecasts in the second quarter but the noise in the market is making predictions difficult, especially with returns on commodities at a multi-year low.

Bakke says that weakness in the economies of China and Malaysia will affect the financial performance of Sime. Volatility is also making it laborious to forecast what the price of CPO will be, with Bakke saying he expects a range of between RM1,900 and RM2,000 a tonne up to the end of September. He admits there is little clarity beyond that in terms of price movement.

With palm oil, a big driver of earnings, Bakke says Sime will concentrate on what it can. The group says that means exploring more innovative approaches for its operations, processes and technologies while pursuing strategies that will maintain its leadership position in the long-term.

“With CPO, we will focus on things that are controllable,” he says.

Hong Leong Investment Bank in a note, after the results were announced, says the outlook for Sime is challenging for its 2016 financial year.

It says that is mainly due to tough environment for the motor segment (arising from tough sales environment for luxury marques in China, high household debt and slow wage growth in Australia, and the weak ringgit against the US dollar), depressed CPO prices, as well as the prolonged low coal price environment (which will in turn have an impact on heavy equipment demand at the industrial segment).

Among its largest profit centres, Sime’s industrial division had the biggest fall in earnings in 2015 compared with a year earlier as pre-tax profit fell 49% to RM521.2mil from RM1.01bil.

“The outlook for the group’s industrial division remains challenging. This division continues to be impacted by lower equipment deliveries and declining profit margin for its product support business as coal producers in Australia are negatively impacted by the low coal prices.

“This is reflected in the lower order book of RM1.9bil as at end-June 15, from RM2.4bil as at end-March 15. The good news is that this division is starting to benefit from the cost reduction initiatives that it had implemented earlier,” says CIMB in a note.

The industrial division is undergoing a business transformation project where 80% of its targets are met. The benefits of that programme was seen in the last month of its 2015 financial year.

The other big segment that will see weakness is Sime’s motor division. That segment say a 25% decline in pre-tax profit in 2015 and general economic weakness in China, Hong Kong and Malaysia has hurt earnings.

The outlook for that segment is not pretty as Sime expects conditions to be more difficult than moderate, except for Vietnam where sales have soared.

Sime Darby sells foreign marques such as BMW and Porsche, and the weak ringgit against the dollar has been hurt sales.

While 56% of the group’s revenue is generated outside Malaysia, AmResearch in a report says that on a transactional basis, the ringgit weakness could negatively impact purchases in the auto division, but translational, it would be positive on foreign assets valuation. On a net basis, management believes that the currency weakness would not have a negative impact.