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Broker's take: Exotix Capital initiates coverage on Wilmar with 'sell'

EXOTIX Capital has initiated coverage on agribusiness group Wilmar International with a "sell" call, saying the stock is currently trading at an "unwarranted" 36 per cent premium to the sector average "in light of its faltering returns and poor earnings growth".

Head of consumer research Nirgunan Tiruchelvam said the market is not factoring in risks as Wilmar shares are trading at about 14 times enterprise value to Ebitda (earnings before interest, tax, depreciation and amortisation) for 2018.

Implying a share downside of 27 per cent and expected total return of -24 per cent based on a discounted cash flow-derived valuation, Exotix considers 10 times price/earnings as the appropriate valuation multiple, and recommends a target price of S$2.29.

Wilmar shares were trading at S$3.17 as at 11.20am, up one Singapore cent or 0.3 per cent.

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Wilmar performed poorly in the investment bank's stress test on vulnerability to interest rate hikes and depreciation, and Exotix noted that a bear market in palm oil and soybean, both of which are facing excess supply, could be a bearish catalyst for the stock.

As the largest palm oil processor in the world, Wilmar is in danger of inventory writedowns as palm oil prices have fallen by a magnitude within a six-month period not seen since 2008, Mr Tiruchelvam said. Wilmar recorded a 23 per cent drop in pre-tax earnings in the fourth quarter of that year.

Other players including Mewah, Indofood Agri and China Agri have reported poor processing margins for palm oil and soybean oil, due to a capacity glut. For Wilmar, pre-tax processing margins in its palm and laurics business fell to US$10.75 per metric tonne in FY2016, versus US$33.40 per metric tonne in FY2012.

In addition, Wilmar's earnings could be affected if the US dollar to Chinese yuan carry trade narrows. In FY2017, Wilmar had net interest expenses of US$187 million on a net debt of US$20.5 billion. A narrowing of the carry trade to an interest rate spread of 2 per cent from 4.4 per cent in FY2014 could reduce FY2019 net income for Wilmar by 20 per cent, and a narrowing to 1 per cent could reduce earnings by a third, said Mr Tiruchelvam.

Finally, Wilmar's capex spending of US$6.5 billion, mainly in the tropical oils segment, has not yielded good returns, said Mr Tiruchelvam, noting that its capex per tonne for processing assets has been well above the industry average of US$160 per tonne. Its weighted average cost of capital has exceeded its return on invested capital (ROIC) for the past three years, and ROIC may falter in FY2018-2019 due to the excess processing supply, he said.