TSH Sukuk Ijarah Sdn Bhd - 2009

MARC has affirmed its MARC-1IS /AA-IS ratings on TSH Sukuk Ijarah Sdn Bhd’s (TSH Sukuk) issue of up to RM100 million Sukuk Ijarah Commercial Papers (ICP) and up to RM300 million Sukuk Ijarah Medium Term Notes (IMTN) programmes. Concurrently, it has revised the ratings outlook to developing from stable. TSH Sukuk, a wholly-owned subsidiary of TSH Resources Berhad (“TSH” or “the Group”), is a special purpose vehicle created to facilitate the issuance of the Sukuk ICP and Sukuk IMTN programmes. The affirmed ratings reflect TSH’s ability to weather a recent period of revenue weakness driven by lower CPO prices and dampened export sales of its wood products. MARC believes that the moderation of revenue pressure at TSH’s cocoa manufacturing and wood products businesses, observable since the third quarter of 2009 and the recent uptrend in CPO prices should allow TSH to realise meaningful improvement in its earnings and cash flow in the near term. TSH’s large capital expenditure (capex) programme, which is focused on expanding its planted oil palm land bank and aimed at positioning the Group as a significant CPO producer in the region, should enable TSH to sustain projected annual double-digit growth in fresh fruit bunches (FFB) production in the coming years. Of rating concern, however, is the persisting trend of negative free cash flows (FCF) and an increased tolerance for debt leverage compared to historically conservative levels. The main downside risk to ratings is the sensitivity of the Group’s financial performance and cash flow generation to commodity prices and periods of cyclical weakness. Notwithstanding, MARC believes that TSH has a sufficient level of flexibility within its capex budget to manage its FCF generation in the context of a weaker operating environment and expects the issuance of additional debt to be supported by increases in revenue.

TSH owns a sizable oil palm land bank of just under 80,000 ha, of which 94% or 75,000 ha are located in Indonesia and the remaining is in Sabah. As of June 30, 2009, total planted area accounted for only around 28% or 22,000 ha. The Group’s planting programme will see TSH planting some 4,000 to 5,000 ha annually over the near-to medium term, depending on prevailing economic and financial viability. Its FFB output growth will be supported by maturing acreage in Indonesia. TSH’s plantation maturity profile indicates that prime yielding palms account for the larger part of its planted area in Sabah while immature palms make up the bulk of palm trees in its Indonesian plantations. Although yields at present are  largely  from  the  Sabah  plantations, this would likely  be  surpassed by the Indonesian plantations within the next two years. Average FFB yields (MT/ha) for the planted areas in Indonesia are on an  uptrend and may possibly match Sabah average yields once they enter their prime production age. TSH’s palm and bio-integration segment revenues are augmented by contributions from its complementary palm oil refinery and bio-mass energy generation operations. While the medium-and longer-term prospects of the segment are favourable, the Group’s growing plantation business in Indonesia will also entail higher exposure to an operating and regulatory environment that is less stable and predictable than in Malaysia.

TSH is involved in the manufacture and sale of hardwood flooring through its 65.06% subsidiary, Ekowood International Berhad (Ekowood). Ekowood posted a loss of RM5.5 million for the nine months to September 30, 2009, due largely to lower sales volumes as a result of the global economic downturn. The cocoa manufacturing segment, meanwhile, was affected by lower demand and adverse commodity price fluctuations which caused a significant decline in its operating results. MARC notes quarter-on-quarter improvements in the results of both segments. The performance of the wood product segment, which is export-oriented, remains sensitive to external economic conditions.

Total group revenue in FY2008 increased 29% against FY2007 to reach RM1.1 billion. However, TSH’s operating profit margin declined from 13.6% in FY2007 to 7.2% in FY2008 on the back of higher plantation expenditures and unfavourable commodity price movements, resulting in a 31.8% fall in pre-tax profit. For the cumulative nine-month period ending September 30, 2009, revenue and pre-tax profit declined by 26.3% and 44.5% respectively compared to the previous corresponding period on account of lower average CPO prices and weak demand for its wood products.

TSH’s negative FCF since FY2006 has been driven by its capital investments in its oil palm plantations and bio-integration business. For the latest nine-month period ending September 30, 2009, FCF was negative RM118 million (FY2008: negative RM164 million). In the near term, MARC expects to see a smaller negative FCF on account of incremental cash flow from its newly matured plantation, in addition to increased operating cash flow stemming from higher CPO prices. FCF is projected to remain negative on account of its continued heavy planting commitments. TSH’s D/E ratio rose to 0.70 times (x) as at end September 30, 2009 (end FY2008: 0.64x, end FY2007: 0.36x). TSH’s financial flexibility remains fairly strong, with total unutilised credit lines amounting to RM571.7 million as at June 30, 2009 and undrawn ICP/IMTN facility amounting to RM180 million as at September 30, 2009. TSH has no significant debt maturities in the near term.

The developing outlook reflects some uncertainty in relation to TSH’s ability and commitment to maintain moderate debt leverage and a strong liquidity position, a key driver of which remains the direction of CPO prices. Any further increase in the Group’s financial leverage without an offsetting improvement in its earnings and cash generation capacity will exert pressure on TSH’s credit metrics. An underperformance in earnings and operating cash flow could result in negative pressure on the ratings; however, improved profitability and cash flow generation could lead to a revision of the rating outlook to stable.

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