Fitch Downgrades Sime Darby to 'BB+'; Off Rating Watch Negative

(The following statement was released by the rating agency) SINGAPORE/JAKARTA, November 22 (Fitch) Fitch Ratings has downgraded Malaysia-based Sime Darby Berhad's (Sime Darby) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) to 'BB+' from 'BBB+'. The Outlook on the ratings is Stable. The agency has also downgraded Sime Darby's senior unsecured rating to 'BB+' from 'BBB+'. Simultaneously, the ratings have all been removed from Rating Watch Negative (RWN), which was in place since 2 March 2017. The resolution of the RWN on Sime Darby's ratings and their downgrade follows shareholder and regulatory approval for the demerger of its plantation and property businesses. These businesses, especially Sime Darby Plantation Berhad (SDP, BBB+/Stable), were a key driver of Sime Darby's cash flows and earnings, contributing around 70% of consolidated EBITDA in the financial year ending June 2016 (FY16). Sime Darby is now significantly smaller in scale with lower business diversity. In addition, its remaining businesses, mainly motors and industrial equipment dealerships, do not benefit from robust market positions similar to that of SDP, which is the world's largest producer of certified-sustainable palm oil. They also have materially lower profit margins and are more prone to economic cycle volatility in our view than the plantation business. While Sime Darby's business profile has weakened significantly, its leverage profile - following restructuring within the group - remains largely unchanged in our estimate. KEY RATING DRIVERS Moderate Diversification Benefit for Motors: Sime Darby's motors division (66% of FY17 revenue) is the second-largest BMW dealer globally and currently represents 29 brands, ranging from luxury to mass-market brands as well as trucking names. However, luxury and super-luxury cars comprise more than 75% of total sales by value. The division is present in 10 countries in Asia-Pacific. However, China (including HK and Macau) and Malaysia dominate earnings, accounting for more than 70% of FY17 EBIT. While Sime Darby enjoys some geographical diversification, we believe the benefits are partly offset by a lack of meaningful share in any market and concentration in luxury brand sales. Apart from the retail and distribution of cars, Sime Darby is also involved in car assembly at its Inokom plant in Malaysia. The assembly operations have higher margins than the retail and distribution operations. The number of vehicles assembled by Sime Darby increased by 19% in FY17, and the company is seeking to expand its assembly operations by increasing the number of models and volume of cars built, as well as adding the assembly of engines. Volatile Industrial Equipment Business: Sime Darby's industrial division (33% of FY17 revenue) is one of the world's largest dealers of machinery made by Caterpillar Inc. (A/Negative). It offers a variety of services from sales of new machines, engines or used equipment to rental and a range of product support services. The industrial division is mainly exposed to the mining sector in Australia - profit after direct expenses in Australia formed around 60% of total profit in FY17 - and its earnings have declined over FY14-17, mainly due to cooling demand for coking coal. Coking coal prices have increased since 2H16 and Sime Darby's order book jumped 23% in FY17. These factors bode well for industrial sales and EBITDA, and we have assumed sustained growth over the next three years. However, we believe the division does not materially enhance Sime Darby's credit profile because of its volatility. Other Businesses Small: Sime Darby's remaining operations (around 1% of FY17 revenue) are dominated by logistics, which comprises of port and water operations in Shandong Province, China. Sime Darby Logistics operates the largest multi-purpose port in the Yellow River Delta. Sime Darby also has a joint venture with Australia's Ramsay Health Care Ltd to manage hospitals in Malaysia and Indonesia. In addition, Sime Darby has a 30% stake in Tesco Stores (Malaysia), which has over 60 hypermarkets and convenience stores. We view favourably Sime Darby's intent to gradually rationalise its exposure to these other businesses. This may also result in cash inflows from asset sales. Gradual Deleveraging: We estimate Sime Darby's FFO-adjusted net leverage to be around 3x in FY18. In addition to existing bank debt, the leverage estimate takes into account capitalisation of Sime Darby's substantial operating lease expenses. We forecast leverage to decline to below 2.5x by FY20, based on a sustained increase in EBITDA. While motors EBITDA should continue to grow steadily, we expect higher commodity prices to drive a recovery for the industrial division. We also assume lower capex, as Sime Darby narrows its business focus, and a decrease in cash dividend outflow from FY19. These assumptions lead to an estimate for positive FCF from FY19. DERIVATION SUMMARY Sime Darby's ratings can be compared with rated auto dealers in Asia such as China Grand Automotive Services Co., Ltd (China Grand Auto, BB-/Stable) and PT Mitra Pinasthika Mustika Tbk (MPM, BB-/Stable). China Grand Auto is the largest auto dealership in China, with more than 750 outlets in 28 provinces covering more than 50 brands. We view China Grand Auto's operating profile as slightly better than Sime Darby's, given its dominant position in a key market and more brand variety. Sime Darby's benefits from presence in multiple markets are offset by its focus on the luxury segment, while its industrial equipment business does not add much strength to its business profile, in our view. However, China Grand Auto's rating is constrained by its high leverage, which is estimated to remain at more than 2x higher than Sime Darby's over the next three years. MPM is the sole distributor of Honda motorcycles in the East Java, Indonesia, in addition to being a dealer for Nissan and Datsun cars in Indonesia. While its leverage is estimated to be similar to Sime Darby's over the next three years, it is significantly smaller in scale with revenue at less than one-fifth of Sime Darby's. In addition, Sime Darby has better brand and geographical diversification. These factors justify a two-notch rating differential between Sime Darby and MPM. KEY ASSUMPTIONS Fitch's key assumptions within the rating case include - Average revenue growth of 4% annually from FY18 (FY17: 6%) - Operating EBITDA margin to improve to 6% in FY19, from 3% in FY17, and remain stable thereafter - Capex of MYR1.7 billion in FY18, and around MYR800 million on average annually thereafter - Cash dividend outflow at around 50% of net income from FY19 RATING SENSITIVITIES We do not expect a positive rating action in the medium term, as we believe Sime Darby's operating profile is consistent with a 'BB' category rating. Developments That May, Individually or Collectively, Lead to Negative Rating Action -Inability to improve FFO-adjusted net leverage to below 3.0x by FY20 -Negative FCF generation on a sustained basis LIQUIDITY Manageable Liquidity: Sime Darby had MYR3.2 billion of debt, excluding perpetual sukuk, at FYE17, 98% of which was unsecured. Of the total, around MYR1.95 billion was working-capital-related debt and the current portion of long-term loans. By comparison, Sime Darby had cash and cash equivalents of around MYR2.1 billion. We expect the working-capital-related debt to be rolled-over. Sime Darby also has robust banking relationships and proven access to diverse sources of funding, which mitigate residual liquidity risks. Contact: Primary Analyst Akash Gupta Associate Director +65 6796 7242 Fitch Ratings Singapore Pte Ltd One Raffles Quay South Tower #22-11 Singapore 048583 Secondary Analyst Rufina Tam Associate Director +62 21 2988 6813 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Summary of Financial Statement Adjustments: Key adjustments made include: - Use of a 7x multiple to capitalise Sime Darby's operating lease expenses, majority of which are in Australia. - 50% equity credit has been provided to the MYR2.2 billion perpetual sukuk issue that has been transferred to Sime Darby Plantation but was on Sime Darby's balance sheet for FY17. We have included the sukuk under debt, and have treated distribution to holders as interest. - Items deemed as non-operating, such as income from investments, impairments, FX gains/losses and fair value gains and losses, have been excluded from operating EBITDA and CFO. Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) https://www.fitchratings.com/site/re/901296 Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) https://www.fitchratings.com/site/re/899659 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/1032738 Solicitation Status https://www.fitchratings.com/site/pr/1032738#solicitation Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE AVAILABLE AT HTTPS://WWW.FITCHRATINGS.COM/SITE/REGULATORY. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Copyright © 2017 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch’s factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch’s ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed. The information in this report is provided “as is” without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers. For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001