We reiterate our Sell recommendation on Wilmar, implying a 44% downside on the back of its poor Q2 results. Wilmar's model has serious weaknesses including chronic poor returns and potential exposure to the unwinding of the carry trade. These have been amplified by the trade war, the depreciation of the yuan and the African Swine Flu outbreak. The company's planned US$10bn IPO of its Chinese business may not even materialise as the trade war worsens.
Q2 results derailed by African Swine Flu. Wilmar's net profits fell 52% to US$151mn and revenue was down by 9%. The results are heading toward our below-consensus net profit forecasts. The main source of the disappointing results was a drop in margins from the impact of the African Swine Flu outbreak on soybean meal demand, which was greater than previously expected. The results were also affected by lower palm oil and sugar prices.
Wilmar has applied to list its Chinese operations on the Shenzen Stock Exchange in a possible US$10bn listing. Wilmar is the largest player in the branded vegetable oil space in China. The IPO plan comes at a time when investors are questioning the viability of consumer growth in China. Just last month, the US$10bn Budweiser APAC IPO was dropped due to valuation and growth concerns.
Carry trade may be affected by the recent yuan depreciation. Wilmar has US$18bn in net debt, making it one of the most indebted companies in the region. In FY 18, Wilmar had net interest expenses of US$384mn on net debt of US$18bn, which is a net interest expense rate of 2%. Our analysis suggests that Wilmar's net interest expense is so low due to its use of the carry trade. It is conceivable that a narrowing of the US$-RMB carry trade to an interest rate spread of 2% (from 4.4% in FY 18) could reduce Wilmar’s FY 19 net income by 20%. A narrowing to 1% could shave off over a third of its earnings.
Poor returns from US$4.9bn capex spending. The core of Wilmar’s FY 14-18 capex of US$4.9bn was the tropical oils segment, which includes palm oil and soybean processing. Wilmar’s capex per tonne for processing assets has been much higher than the industry average of US$160/t. The ROIC has been below its WACC in the last five years, and may falter in FY 19-21 due to excess processing supply.
Processing margins are depressed by excess capacity. Heavy expansion in palm oil and soybean oil refining capacity have affected refining margins. Wilmar is planning to use the IPO proceeds for refining capacity in China. The company's own pre-tax processing margins in the palm & laurics business has weakened in FY 13-18. Meanwhile, demand for animal feed has collapsed in China due to the African Swine Flu virus.
Reiterate Sell: Our DCF-derived valuation suggests a downside of 44%. At c16x EV/EBITDA 2019f, Wilmar is trading at a 42% premium to the sector average. This is unwarranted in light of its faltering returns and exposure to the carry trade.
Wilmar International: ROIC vs WACC