Sime Darby Plantation’s high costs, debts lead to Fitch downgrade

The rating firm lowers SDP’s long-term issuer default rating to ‘BBB’ from ‘BBB+’ with a stable outlook


FITCH Ratings Inc has downgraded Sime Darby Plantation Bhd’s (SDP) debt ratings as the planter faces problems lowering its debt level, while its operational costs remain high against industry averages.

The rating firm downgraded SDP’s long-term issuer default rating to ‘BBB’ from ‘BBB+’ with a stable outlook.

The credit rating agency also downgraded SDP’s senior unsecured rating, the rating on its US$1.5 billion (RM6.3 billion) sukuk programme and the outstanding issuance under the programme to ‘BBB’ from ‘BBB+’.

Fitch said the downgrade reflects its view that SDP’s leverage, measured by funds from operations adjusted net leverage, is likely to stay elevated above three times in the next year or two, and is not consistent with a ‘BBB+’ rating.

“SDP’s inability to reduce leverage is driven by its high production costs and is exacerbated by persistently weak crude palm oil (CPO) and palm kernel (PK) prices,” Fitch noted in a statement yesterday.

It added that SDP’s high production-cost structure accentuates the risk to its earnings in light of commodity cyclicality and the cost-benefit from accelerated replanting in Indonesia will take time.

SDP posted a net profit of RM27 million for the second quarter ended June 30, 2019, largely contributed by the registered losses in the upstream segment, namely its operations abroad, due to the weak CPO prices.

For the six months, SDP posted a net profit of RM101 million on the back of RM5.88 billion in revenue.

The plantation giant closed 2.11% or 10 sen higher yesterday to RM4.83 with a capitalisation of RM33.25 billion.

Fitch said SDP’s high production-cost structure, high capital expenditure (capex) commitments and persistently weak CPO and PK prices will keep its leverage elevated for at least the next 12-18 months.

The potential delay in asset sales, operational disruptions due to factors like the weather pose additional risk to the company’s ability to deleverage.

“There is limited flexibility in SDP’s ability to scale down capex; the spending is related to the company’s replanting programme, which is instrumental in maintaining plantation productivity, particularly in Indonesia,” the credit rating agency said.

On high production costs, Fitch believes SDP’s upstream cash costs are among the highest in the industry.

“Its upstream cash cost stood at around RM1,600 per tonne at end-June 2019, versus the RM1,200 to RM 1,600 per tonne range reported by peers. We believe SDP’s high cash-cost structure is driven by structurally high production costs in Malaysia and Papua New Guinea (PNG) and high proportion of old trees in Indonesia, which drag overall plantation productivity,” it said.

SDP is looking to improve its man per land ratio and has accelerated its replanting programme, most aggressively in Indonesia since 2016, to address its high production costs.

Lower labour cost and other initiatives to improve efficiencies, such as precise fertiliser application, saw a 9% year-on-year (YoY) decline in Malaysian production costs as of end-June 2019, but this did not fully offset continued high production costs in Indonesia and PNG, Fitch said.

SDP’s upstream-focused operation leads to greater earnings volatility compared to peers with more downstream activities.

Around 60% of SDP sales contribution comes from CPO and simple refined products.

Fitch said SDP’s high level of operating integration across the value chain benefits the company in a high-price environment, as this allows it to retain optimum profit margins.

“However, this exposes SDP to greater earnings volatility when prices are low, as overall margins decline in tandem with prices. This is in contrast to peers with downstream capacity that is higher than their CPO output, as downstream production earnings tend to be more stable, despite lower margins,” Fitch explained.

SDP wants to sell land and stakes to reduce debt, and targets to sell RM1 billion worth of assets in 2019, but has only managed to sell around RM100 million worth so far.

SDP sold around RM1.1 billion of landbank and investments to Sime Darby Properties Bhd last year, but Fitch believes disposals now may take longer given current market conditions and estimated SDP sales may dispose of around RM700 million worth of property this year.

SDP has significant debt maturities in the next 12 months, totalling RM5.7 billion as of end-June 2019 including RM3.7 billion is term loans facilities that mature by June 2020.

SDP is now the world’s largest palm-oil producer with more than 600,000ha of planted area and annual downstream capacity of 3.8 million tonnes.