Kenanga Research upgrades Hap Seng Plantations after Kretam takeover shelved

Scomi Group Bhd surprised investors when it proposed to revise its current issued share capital reduction from RM224.96mil to RM3mil from the earlier RM40mil.

KUALA LUMPUR: Kenanga Investment Bank Research has upgraded Hap Seng Plantations to market perform from underperform with a higher target price (TP) of RM2.15 versus the earlier RM2.

The research house said on Monday it was positive on the plantation company's decision to cancel the proposed purchase of the Kretam stake for RM1.18bil.

Its TP of RM2.15 was based on unchanged average FY18-19E EPS of 12.3 sen applied to a higher forward price-to-earnings ratio (PER) of 17.4 times from 16.1 times as it reverted its valuation basis to +0.5 standard deviation from mean valuation basis upon the cancellation of this earnings dilutive deal. 

“We are positive on the cancellation as we had noted that the incremental earnings contribution from the deal of c.RM45mil a year  would not have offset the additional interest cost of RM50mil to RM100mil a year, leading to at least two years’ earnings dilution until Hap Seng Plantation turned around Kretam's operations. 

“Note also the proposed offer price valued Kretam at a massive forward PER of 77 times (vs. small-cap average of c.18 times), and would have pushed Hap Seng Plantation's net gearing to 0.5 times to one time from its current net cash position. 

“While the deal may have led to long-term synergies in terms of expansion into scarce Sabah landbank and the entry of Hap Seng Plantation into downstream processing, we think that the cancellation is sensible given the hefty valuation premium and immediate material earnings risk (up to 30%),” it said.

To recap, Hap Seng had earlier proposed to acquire 55% of Kretam from Datuk Lim Nyuk Sang @ Freddie Lim and Santaprise Sdn Bhd.  After finalising its due diligence process and finding the results “unsatisfactory and unacceptable”, it decided to shelve the proposed purchase. 

Recall that the deal was valued at RM1.18bil or 92 sen per Kretram share. As of June 14, Kretam's closing share price was 69.5 sen, or 24% below Hap Seng Plantation's offer price.

Kenanga Research said without the Kretam deal, it expects Hap Seng Plantation’s current outlook to be improved. As production trends turn positive towards 2H18, it thinks Hap Seng Plantation's earnings should begin picking up on lower unit costs. 

However,  it does not expect outsize earnings for the sector given that palm oil prices are likely to remain capped on rising production, more so should soybean oil prices be suppressed by Chinese tariffs on US soy. 

Despite  Hap Seng Plantation's average fresh fruit bunches growth prospect (+6% vs. sector average of +8%), the research house thinks the company commands an above-average valuation given its operations quality and healthy balance sheet position with net cast of RM65.5mil (8.2 sen per share) in the latest quarter, supporting its dividend yield of 3.5% (vs. sector average of 2.7%).