CB Industrial Product Holding Bhd
(May 6, RM1.10)
Downgrade to hold from buy with a lower target price (TP) of RM1.15 from RM1.36. In its financial year 2018 (FY18) annual report, auditors Crowe Malaysia PLT issued a qualified audit opinion on CB Industrial Product Holding Bhd (CBIP), mainly due to concerns arising from its associates (30%-owned Bahtera Bahagia Sdn Bhd and 30%-owned Kumpulan Kris Jati Sdn Bhd)  and its 50%-owned joint venture (JV) Pride Palm Oil Mill Sdn Bhd.

 
Crowe Malaysia stated that the audited financial statements and auditors’ reports of the two associates and JV are not available. As such, CBIP’s audited financial statements have been consolidated using the unaudited management accounts of the two associates and JV for FY18 ended Dec 31, 2018. As the auditors were unable to perform appropriate audit procedures to obtain sufficient and appropriate audit evidence deemed necessary for the two associates and JV, they could not determine whether any adjustments were necessary with regard to CIBP’s FY18 financial statements as at Dec 31, 2018.

The qualified audit opinion was a negative surprise to us. The two associates and JV are involved in the cultivation of oil palm, production of crude palm oil and palm kernel.

In FY18, CBIP’s investment value in both associates and the JV amounted to RM104.6 million and RM22.9 million respectively, while its share of losses from them amounted to RM4.9 million.

We believe that this development is unlikely to have a significant impact on the group’s core operations and our core earnings estimates, as we only conservatively assumed RM2 million per annum (revised from RM4 million per annum) contributions from its JV and associates for financial years 2019 to 2021 (FY19-21).

Nonetheless, we are concerned that the qualified audit opinion could heighten the impairment risks on CBIP’s investment value in these entities with a maximum exposure of RM128 million. This could dampen investor sentiment on the stock.

In another development, the group announced that it has acquired a 70% stake in Gulf Lubes Sdn Bhd for a total consideration of RM45.3 million. Gulf Lubes is principally involved in the palm-based biodiesel business. It has two biodiesel processing plants with production capacity totalling 350,000 tonnes per annum and a refinery plant with annual production capacity of 250,000 tonnes per annum. We understand both plants have been idle since 2009. We have not factored in any potential contributions from this venture yet.

We revise our FY19-21 earnings estimates on CBIP by 3% to 4% mainly to conservatively trim the estimated combined contribution of the JV and the two associates from RM4 million to RM2 million per annum. We believe the qualified audit opinion could: i) heighten impairment risks on the group’s investment value of its JV and associates; and ii) dampen investor sentiment on the stock.

We believe that CBIP offers limited upside, at least until these issues are resolved. In view of this latest negative development, we lower our TP to RM1.15, after imposing a 10% discount on our valuation, which implies target price earnings multiple of 10 times (previously 11 times), about -1 standard deviation of its historical mean. — AllianceDBS Research, May 6