OREANDA-NEWS. Fitch Ratings has revised the Outlook on Malaysia-based conglomerate Sime Darby Berhad (Sime Darby) to Stable from Negative. At the same time the agency has affirmed the Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDR) at 'BBB+'. Sime Darby's senior unsecured rating and the rating on its sukuk issue have also been affirmed at 'BBB+'.

The revision of the Outlook to Stable follows the Sime Darby's announcement of a successful share placement, proceeds from which will help the company lower its leverage. In addition, the outlook for its principal oil palm plantation business has improved significantly following a recovery in crude palm oil (CPO) prices this year. Higher cash flows from the plantation business will also support deleveraging at Sime Darby, in our view.

KEY RATING DRIVERS

Share Placement Aids Deleveraging: Sime Darby said on 5 October 2016 that it raised MYR2.4bn (USD569m) cash by placing out 316.35 million shares, which account for 4.7% of its expanded capital base. We estimate the share placement will help the company lower its FFO-adjusted net leverage to 3.0x in the financial year ending 30 June 2017 (FY17), compared with 4.0x in FY16 as per unaudited summary financial statements.

The company proposes to use around 50% of the placement proceeds to repay debt, and the rest of the proceeds to fund capex and working capital. Permodalan Nasional Berhad (PNB) will continue to be Sime Darby's largest shareholder with a stake of approximately 53% after the share placement. Fitch does not expect the share placement to change the company's cash dividend payout of around 40% of net income in the medium term.

Improving EBITDA Margin: CPO prices increased 30% to USD736/tonne in August 2016 from USD565/tonne in January 2016 due to reduced inventory levels in Malaysia and steady demand. Fitch expects CPO prices to remain at the current levels or even increase, which would drive an improvement in Sime Darby's operating EBITDA margin to around 11.5% in FY17-18 (FY16: 10.8%). Improvement in Sime Darby's margins would facilitate deleveraging to below 3.0x by FY18.

Sime Darby's plantation business, mainly oil palm cultivation and processing, is a key driver cash flows and earnings, and accounted for 27% of its consolidated FY16 revenue and 45% of EBITDA. Low CPO prices and the muted performance of Sime Darby's industrial business resulted in a relatively weak consolidated EBITDA margin in FY16. Fitch expects the plantation business to continue to be the dominant cash flow contributor and key driver of its rating over the medium term, so we have amended the rating sensitivities to capture weakness in the profitability of its plantation business.

Further Deleveraging from Divestments: Sime Darby realised MYR1.2bn in cash by selling non-strategic subsidiaries, JVs, associates and assets in FY16, including the sale of two Singapore-based property subsidiaries for around MYR600m. Sime Darby plans to raise around MYR1bn through the sale of non-strategic assets in FY17, such as its stake in property developer Eastern & Oriental Bhd for over MYR300m.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Average CPO selling price of USD650/tonne (MYR2,800) in FY17, improving further to USD675/tonne by FY19

- Consolidated operating EBITDA margin of around 12% over FY17-19

- Average EBITDA per mature hectare for plantation business of MYR7,000 over FY17-19

- Annual capex of MYR2.7bn on average over FY17-19

- Proceeds from asset sales (net of acquisitions) of MYR300m in FY17; none thereafter.

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

-FFO-adjusted net leverage exceeding 3.0x on a sustained basis

-EBITDA per mature hectare for plantation business falling below MYR6,000 (FY16: MYR4,300)

-No material weakening of profitability across its other businesses

Positive: Future developments that may, individually or collectively, lead to positive rating action, include:

-FFO-adjusted net leverage falling to less than 2.0x on a sustained basis

-Improvement in FCF generation with margin of 5% or above on a sustained basis (FY16: -1%)