OREANDA-NEWS. Fitch Ratings has downgraded the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of Sime Darby Berhad (Sime Darby) to 'BBB+' from 'A'. The Malaysia-based conglomerate's senior unsecured rating and the rating on the USD1.50bn sukuk issue have also been downgraded to 'BBB+' from 'A'. The Outlook is Negative.

Sime Darby's subordinated sukuk is eligible for 50% equity credit under Fitch's "Treatment of Hybrids in Nonfinancial Corporate and REIT Credit Analysis" criteria.

The downgrade reflect the extended period of high leverage, with the company taking longer than initially anticipated to deleverage due to the challenging environment for the industrial business and still-low, though recovering, crude palm oil (CPO) prices. To reduce debt, Sime Darby planned to list its motor business and take other capital management initiatives in the financial year to 30 June 2015 (FY15), but these did not materialise. The Negative Outlook reflects ongoing challenges across all of Sime Darby's businesses, which could derail it debt reduction plans.

KEY RATING DRIVERS

Financial Leverage Remains High: Sime Darby's consolidated FFO-adjusted net leverage rose to 5.30x in the six months ended 31 December 2015 and 4.06x in the end of FY15 from 1.68x at end-FY14. This puts the financial leverage above the 1.75x level at which Fitch would consider negative rating action. The increase was due to the MYR6.0bn debt-funded acquisition of New Britain Palm Oil Limited (NBPOL) in FY15, as well as low CPO prices and poor performance of the industrial business (mainly the heavy equipment business), which squeezed EBITDA margin.

EBITDA Margin Under Pressure: Low CPO and coal prices and slower economic activity in Australia and China drove consolidated EBITDA margin down to 8.2% in 1HFY16 from 12.1% in FY14 and 10.6% in FY15. Fitch expects Sime Darby's EBITDA margin to improve, albeit gradually, to around 10% in the next 12 to 18 months due to rising CPO prices and a renewed focus on mid-market housing.

Deleveraging Initiatives: Fitch expects FFO-adjusted net leverage to decline in the medium term to about 3.0x following the company's recent MYR2.20bn perpetual sukuk issue, the proceeds of which Sime Darby plans to use to repay debt. The company also proposes to divest non-core real estate assets to reduce debt.

Weaker earnings prompted Sime Darby to cut its dividend per share by 31% to 25 sens in FY15 from 36 sens in FY14. This, coupled with the dividend reinvestment plan that a significant number of shareholders have opted for, resulted in a 37% reduction in cash dividends paid to MYR973.9m in FY15.

Improving CPO Outlook: The ongoing El Nino weather pattern and low rainfall in some parts of Indonesia have supported CPO prices. The average monthly CPO price improved to USD639 a metric tonne (MT) in February 2016 from USD538/MT in September 2015, which was the lowest since January 2015. In Malaysia, monthly CPO output reached 1.04 million MT in February 2016, which was the lowest since January 2013. CPO stocks declined to 2.17 million MT in February 2016, representing 41 days of production in the last 12 months, from a peak of 2.91 million MT in November 2015, or 53 days.

Sime Darby's plantation EBITDA margin narrowed to 14% in 1HFY16 from 22% and 17% in FY14 and FY15 respectively, due to the earlier decline in CPO prices.

Equity Credit For Sukuk: Sime Darby issued MYR2.2bn of perpetual subordinated sukuk securities under its MYR3.0bn perpetual subordinated sukuk programme in March 2016. These securities rank senior only to Sime Darby's ordinary shares. Coupon payments are cumulative and deferrable at the discretion of management and include a step-up margin of 1% 10years from the issue date, which is also the first call date.

The maximum equity credit is restricted to 50% as any coupons deferred are cumulative. Fitch considers the issue's effective maturity to be in 30 years' time, given that intent-based replacement language drops away at that point. In accordance to Fitch's criteria, the 50% equity credit will apply for up to 25 years from the issue date and nil thereafter.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Sime Darby include:
- The average CPO selling price will gradually improve to about USD650/MT (MYR2,600) in FY17
- Consolidated EBITDA margin of 9%-9.5% in FY16 and FY17 and improve to around 10% in FY18
- Annual capex of MYR2.75bn-3.00bn in FY17 and FY18
- Proceeds from the sale of non-core real estate properties will be used to repay debt

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to revision of Outlook to Stable include:
- Sime Darby's consolidated free cash flow (cash flow from operations less capex less dividends) to move towards a neutral to positive position after the New Britain Palm Oil Limited acquisition and in a low commodity price environment, which will allow the company to deleverage
- A sustained improvement in consolidated operating EBITDA margin to 12.5% stemming from improved margins in the plantation and industrial businesses, and
- Consolidated FFO adjusted net leverage moderating to less than 3.0x on a sustained basis

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Consolidated FFO-adjusted net leverage is sustained at over 3.0x, and
- Sime Darby continues generating negative free cash flows

LIQUIDITY

Comfortable Liquidity: Cash of MYR3.0bn as of 31 December 2015 (30 June 2015: MYR3.64 bn) is equivalent to 15.3% of reported outstanding debt of MYR19.58bn. The debt maturity profile is well spread out, and committed unutilised banking facilities are also substantial, which enhances financial flexibility.

Low Structural Subordination: As of 30 June 2015, the holding company's outstanding debt, financial guarantees extended to subsidiaries and cash stood at MYR1.91bn, MYR3.03bn and MYR204.80m respectively. The holding company has 100% stakes in most operating subsidiaries and cross default clauses, which minimises the structural subordination that holding company debt is exposed to.

FULL LIST OF RATING ACTIONS

Long-Term Foreign-Currency IDR downgraded to 'BBB+' from 'A'; Outlook Negative
Long-Term Local-Currency IDR downgraded to' BBB+' from 'A'; Outlook Negative
Senior unsecured rating downgraded to ' BBB+' from 'A'
Rating on Sime Darby's USD1.50bn sukuk issue downgraded to ' BBB+' from 'A'