We recently attended an analyst engagement session with Felda Global Ventures (FGV)’s Group President and CEO, Dato’ Zakaria Arshad and senior management to discuss FGV’s new business transition plan. We came away neutral as clear improvement may only be seen in the long-term while short-term risks from negative FFB growth and on-going Eagle High acquisition talks limit upside. Maintain UNDERPERFORM call with TP maintained at RM1.21 based on Fwd. PER 20.5x on unchanged FY16E EPS at 5.8 sen.

Sit-down with FGV CEO. We recently attended an analyst engagement session with FGV’s newly appointed Group President and CEO, Dato’ Zakaria Arshad and members of senior management to discuss FGV’s new business transition plan. We came away from the event feeling lukewarm, as we think that clear performance improvement can only be seen in the long-term. Meanwhile, short-term earnings growth could be limited by negative FFB growth due to lagged drought impact and large-scale replanting efforts.

Focus on operations. Management outlined its key focus areas, which we understand is mainly geared towards operational improvement and reducing complexity in FGV’s reporting and business segments. Notable points include lesser M&A focus, active review of previous M&A projects, cost reduction, lowering plant inefficiencies, and improving plantation yields. However, management noted that although the Zhong Ling acquisition is off the table, talks on the Eagle High acquisition remain active, which we think could prolong negative sentiment among the investment community.

Three-year RSPO re-certification plan intact. Recall that FGV and Felda Group withdrew the RSPO P&C certificates of 58 complexes from 3rd May 2016. Management elaborated that the main reason for its withdrawal was to retrain the smallholder community to better align with RSPO requirements. We understand that FGV’s plan to re-certify its facilities within three years remains in place, with a target of 15 complexes to be recertified in FY16. Management also mentioned that the recertifying process could cost c.RM35m over the three years, inclusive of training costs. Post-management clarification, we maintain our earnings forecast – while FGV could partly recover its RSPO premiums as its facilities are re-certified, this is offset by the additional cost of re-certification. Furthermore, business impact remains unclear as management said that discussion is on-going with its buyers on whether they would continue buying from FGV after its withdrawal.

Review on tolling system. We gather that FGV is considering a review of its downstream tolling system. Recall that the tolling system was implemented in early- 2015 during a segmental reshuffling exercise which separated the upstream, downstream and trading segments. We understand that the initial switch to tolling was meant to improve synergies in refining operations. However, management mentioned that the system could have resulted in additional intercompany transaction costs, hence triggering the review. While a reversal may result in some adjustment to segmental performance, we think impact to group revenue and earnings should be minimal.

Maintain UNDERPERFORM with TP at RM1.21 with no change to our earnings forecasts. Our TP of RM1.21 is based on an unchanged 20.5x Fwd. PER applied to FY16E EPS of 5.8 sen. We maintain our Fwd. PER of 20.5x based on -2.0SD valuation. While we think the new transition plan could lead to long-term improvement in FGV’s bottom-line, short-term risks such as negative FFB growth and negative sentiment on the Eagle High deal could limit share price upside. Nevertheless, potential re-rating catalysts for FGV would include: (i) stronger-thanexpected yield improvement from its major replanting program, (ii) resolution of the Eagle High acquisition, (iii) rapid re-certification of FGV’s mills and complexes, and (iv) consistent margin improvement post-transition program.

Source: Kenanga Research - 17 May 2016