Sime Darby Bhd - 2010

MARC has affirmed its AAAID/MARC-1ID and MARC-1ID ratings on conglomerate Sime Darby Berhad’s (Sime Darby) RM4.5 billion Islamic Medium Term Note Programme (IMTN Programme) and RM500 million Islamic Commercial Papers/Islamic Medium Term Notes Programme (ICP/IMTN Programme) with a combined limit of RM4.5 billion, and RM150 million Underwritten Murabahah Commercial Papers (MCP) Facility respectively. The outlook on the ratings is revised to negative from stable. The negative outlook reflects the uncertainties related to ongoing, unconcluded negotiations with clients in respect of problem projects at the energy and utilities division as well as execution risk on other existing projects. If the energy and utilities division returns to profitability within the next six to 18 months, MARC could revise the outlook to stable. The rating action concludes the review of Sime Darby's ratings initiated end of August 2010 following the announcement of its second consecutive quarterly after-tax loss. MARC's review had focused on the implications of the recent adverse performance of Sime Darby's energy and utilities division and risks posed to its consolidated credit profile.

In MARC's view, while Sime Darby continues to exhibit a diverse business mix and earnings streams, its troubled energy and utilities division continues to be a principal source of recurring risk to the group's consolidated financial profile. The corresponding support burden carried by Sime Darby and the recent volatility of its results runs counter to its historical stability of earnings through cycles that has been central to its ratings all this while. Moreover, recent developments at Sime Darby have exposed weaknesses in management oversight and enterprise risk management.

MARC has affirmed the ratings this time, nevertheless, on the expectation that Sime Darby will successfully transition back to a credit profile that is consistent with its current ratings in the next two quarters. In the three months ended June 30, 2010, Sime Darby made further provisions of RM777.3 million at its energy and utilities division for foreseeable losses and impairment in respect of six identified problem projects. The additional provisions provide a cushion against future losses from the six projects. Realised losses on the six projects may vary from current estimates eventually given that the group is still actively negotiating with clients on claims. The rating agency also notes that Sime Darby has announced the initiation of mitigation measures for project risks among its remediation initiatives.

Since July this year, there have been notable executive changes at Sime Darby, including the appointment of a new CEO and a new head for the energy and utilities division. Each business segment will have its own Board of Directors by early next year to enhance board oversight and corporate governance. While MARC believes that it will take time for the group to rebuild public confidence in its governance structure and processes, it is of the view that the franchises of Sime Darby's plantation, property, industrial, motor and healthcare businesses have not been harmed by the recent events. These businesses have continued to generate recurring earnings streams which was enough to lift Sime Darby's consolidated performance to a full-year profit of RM854.8 million as of June 30, 2010 (FY2010) (FY2009: RM2,340.8 million).

Sime Darby’s liquidity position remains satisfactory at holding company level and includes unencumbered cash and bank balances of RM321.5 million (FY2009: RM300.5 million) and RM2.7 billion of availability under its rated debt facilities. This should be sufficient to support its short-term borrowings of RM1.8 billion (FY2009: RM1.9 billion) as at June 30, 2010. On a consolidated basis, Sime Darby’s liquidity position looks stronger and remains a positive rating factor. The group’s consolidated cash and cash equivalents amounted to RM4.5 billion (FY2009: RM3.3 billion) against its short-term borrowings of RM3.3 billion (FY2009: RM3.6 billion).

Management's success in confronting its challenges at its energy and utilities division over the next year and in restoring its earnings performance will likely determine the course of Sime Darby's future rating outlooks.

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