• Oilseeds and grains performance could recover even with the prolonged African swine fever outbreak.
• Yihai Kerry Arawana Holdings (YKA)’s IPO valuation will determine Wilmar’s share price re-rating prospects ahead.
• Maintain BUY with slightly lower Target Price of S$4.25.

Staying Profitable in the Current Environment

• WILMAR INTERNATIONAL LIMITED (SGX:F34)’s profit before tax (PBT) tumbled to US$193.7m (-54% y-o-y, -41% q-o-q) followed by core net profit of US$177m (-50% y-o-y, - 29% q-o-q), below our and consensus estimates.
• Overall 2Q19 performance was driven by the weaker-than-expected oilseeds and grains, and sugar division performance, while tropical oil division was relatively stable q-o-q.
• We revised down our 2019 earnings forecasts by 10% to account for 2Q19 weakness and expect performance to recover in 2H19, driven by better oilseeds and grains earnings performance.

Where We Differ: Wilmar Is Still Bigger Than What We Know Today

• As more information is revealed on its China operations, the more we are convinced that Wilmar is bigger than what the market perceives today. As the market leader in each segment, we believe Wilmar’s presence has become difficult to be replicated by its competitors in each region, and this provides a solid footing to further grow its market share and earnings ahead.
• Also, Wilmar is heading towards a steadier earnings profile business model via the higher contribution from the consumer branded products.

What's New - Aiming for Recovery in 2H19

2Q19: Below expectation – African swine fever hit oilseeds & grains division

• Wilmar’s profit before tax (PBT) tumbled to US$193.7m (-54% y-o-y, -41% q-o-q) followed by core net profit of US$177m (-50% y-o-y, -29% q-o-q) below our and consensus’ estimates.
• Overall 2Q19 performance was driven by the weaker-than-expected oilseeds and grains manufacturing, and sugar division performance, while tropical oil division was relatively stable q-o-q.

Tropical Oils division: Steady q-o-q, low palm oil prices helped margin performance

• Tropical Oil division’s top line dropped by only 1% q-o-q to US$3.8bn (-12% y-o-y). The top-line trend was tracking the palm oil price performance which affects the derivatives product pricing. However, the lower palm oil price environment also helped Wilmar to maximise its profitability which was seen in its PBT of US$177m (+15% y-o-y, -4% q-o-q), accounting for 91% of 2Q19 PBT amid the weaker-than-expected performance in other segments.

Oilseeds & Grains: Still affected by the African swine fever

• The division PBT reached only US$59m (-80% y-o-y, -35% q-o-q) due to the absence of high volume and crush margin experienced last year, and also the African swine fever outbreak, which delayed the recovery of this segment.

Sugar: Back in the red on Shree Renuka Sugars consolidation

• Sugar swung back to negative territory with a loss before tax of US$69.4m (2Q18: US$-46.2m, 1Q19: US$1.7m), due to the consolidation of Shree Renuka Sugars Limited which became a subsidiary in June 2018. However, the Australian and Indonesian units performed well.

Joint ventures and associates

• “Others” segment’s pretax profit shrunk to US$6.9m (2Q18: US$26.3m losses) due to positive contribution from Shipping and Fertilizers business, sending the 1H19 PBT for this segment to US$42.6m (1H19: US$9.8m).
• Meanwhile, JV and associates contribution reached US$22m (-56% y-o-y, +5% q-o-q), due to still weak China associates.

Balance sheet: Gearing ratio maintained in 2Q19.

• Ending cash & cash equivalents were higher at US$4.2bn (1Q19: US$4.1bn) while 1H19 net debts were relatively stable at US$12.4bn (4Q18: US$13.5bn). This translates into reported net gearing ratio of 0.77x (FY18: 0.84x). Including liquid working capital, net gearing ratio would have been 0.35x (FY18: 0.34x).

Outlook: Key Interesting Point From Today’s Briefing

• During Wilmar's 2Q19 results briefing, management shared regarding the company’s prospects and addressed investors’ concerns on the company/share price. The most important point in our view, is that the management believes Wilmar’s crushing business and other business would perform better in 2H19.

Capital expenditure to bring lucrative long-term returns

• Wilmar’s capital investments, mainly in Asia and Africa, will bring more revenue and profit to the company. Wilmar sees food as being the biggest industry and best play in the region, with exposure to 4.5 billion people, and vast economic growth.
• Moreover, the increasing consumer branded goods such as Oleochemical, rice and flour will help to smoothen earnings volatility going forward vs. the current exposure to commodities price volatility, such as palm oil.
• African swine fever impact on China’s soybean meal demand may take several years to eradicate, although China’s lower hog production will be partially offset by strong growth in the poultry sector.
• Meanwhile, the US-China trade war has not impacted Chinese domestic consumption of food and in fact, the demand for better quality food continues to grow.

Earnings Revision

Still expecting performance to recover in 2H19, despite our lower 2019 earnings forecast

• Our earnings revision is premised on expectations for earnings performance recovery in 2H19, premised on stable performance of tropical oil segment as we expect palm oil price to stay at US$500 per MT in 2H19, and only recover to US$543 per MT in 2020., followed management capability to execute better earnings performance in both Sugar and Oilseeds & Grains division, reflected by profitability recovery for expectation, and higher contribution in 2H of the year.
• All in, we cut our FY19 earnings forecast by 9% to US$1,049m (- 19.8% y-o-y) before bouncing back to US$1,207m (+15.1% y-o-y).
• Our earnings forecasts are below the consensus at this moment as we have cut the figures after 2Q19 briefing although management is relatively upbeat on Wilmar’s 2H19 performance recovery.

Assume neutral impact on lower commodity price assumptions

• We believe Wilmar’s business model is set to place a profitability cushion amid current low commodity prices. The company’s strong tropical oils business division should be able to sustain its profitability this year. The contribution would mainly be from its refining/consumer branded cooking oil segment, as palm oil price has limited room to recover due to stagnated soybean price following the correction in 2Q19.
• Meanwhile, we expect the soy crushing business margin in China to still be affected by the current African swine fever epidemic which hinders volume expansion, although the pressure on margins would be partially offset by lower input cost.

Where We Are Right Now

Market is looking for positive profitability performance and upcoming listing of China operations

• Wilmar’s share price has performed well year-to-date as the market is gradually convinced that Wilmar’s performance is able to withstand headwinds arising from the trade war.
• The market also expects the China A-share listing to help Wilmar’s valuation, which is still largely in line with its commodity peers. A higher valuation multiple can be justified with a higher contribution from its consumer branded products division. We estimate that more than 20% of its profit before tax was already derived from the consumer branded products in 2018.

Rating and Target Price

Lower Target Price of S$4.25, mainly due to lower earnings forecast

• We lowered our target price to S$4.25 per share, which arose from our lower 2020 earnings forecast, but partially mitigated by slightly higher multiple assumption for tropical oil division in our sum of the parts (SOTP) valuation. In anticipation of the China operations’ listing, we switched our valuation methodology to SOTP, which we believe better reflects the business.
• We employ a different PE multiple for each business division in our valuation for Wilmar. The key changes from previous assumption are: slightly higher multiple of 12.5x PE for tropical oil seeds and grains’ 2020 estimated earnings from 11x previously, given its good earnings performance year to date. Tropical oil division performance year to date has detached itself from dependency on palm oil price rally to perform well, given its exposure to palm oil downstream products such as oleochemicals.
• We maintained our multiple of 18x assumption for oilseeds and grains manufacturing business, considering its size in China and emerging branded consumer product division. Consumer branded goods currently account for approximately 40-50% of YKA’s earnings. Meanwhile, we still apply a 11x PE multiple for its sugar business, granting its volatility trend in the past.
• Besides its quarterly earnings, the key factor for share price performance is Wilmar’s capability to list YKA at a valuation multiple above Wilmar’s current multiple. Hence, the IPO will only lift Wilmar’s share price if it lists YKA at 18x plus. This is possible given that the ChiNext market average P/E multiple is 40.4x.

Source: DBS Research - 15 Aug 2019