PETALING JAYA: Analysts are mixed on their views about the severity of Sime Darby Bhd's cost overruns of RM964mil.

While some say the impact won't be severe mainly because it was hit at its periphery energy and utilities (E&U) business, some feel that the issue of confidence will weigh strongly.

It is, however, worth noting that the cost overrun of RM964mil is equivalent to just 1.9% of Sime's market capitalisation of about RM52bil. On Friday, Sime shed 40 sen to RM8.25 on volume of 40.97 million shares.

To recap, Sime established a Board Work Group (BWG) in October 2009 to review the operations of its E&U division.

The BWG reviewed the Qatar Petroleum project, the Maersk Oil Qatar project, construction of vessels for use in the Maersk Oil Qatar project and the Bakun Hydro-electric dam project.

The BWG recognised provisions totalling RM964mil in Sime's results for the second half of 2010 and, more importantly, it made several key personnel changes to correct deficiencies with regard to management and internal controls.

RHB Research has downgraded its recommendation to underperform as it believes that investor sentiment and confidence in management will be severely damaged. “For a large-cap index-linked stock, this is very important, especially for foreign funds, which now holds about 14.7% of Sime Darby.”

It expects the provisions to erode Sime's earnings by 39.4% in FY10.

“Although the management expects these provisions to be the worst-case scenario and one-off, we believe this could affect confidence in the management. We believe this provision will also raise questions about Sime's other divisions,” RHB Research said.

MIDF Research, however, applauded the Sime management's decision to take the bull by the horns and do a thorough cleaning of its E&U books.

“On a positive note, this aggressive kitchen-sinking exercise will provide Sime Darby and its E&U business with a fresh beginning,” said MIDF Research, which is revising downward its financial year (FY) 2010 earnings forecast by 33% to RM1.56bil.

MIDF also said it would not be surprised if Sime were to announce some write-backs later on particularly from the Bakun project.

MIDF maintains it neutral recommendation on Sime with a target price of RM8.70.

Putting the write-offs aside, KAF Research expects the positive earnings momentum to continue, driven mainly by growth in plantations which accounts for almost 70% of profits due to higher crude palm oil (CPO) prices and production, as well as improvements in the g roup's other cyclical businesses in tandem with the global recovery.

“We cut our FY10 earnings by 33% to reflect the provisions for cost overruns and 3% for FY11, but left FY12 relatively unchanged. Our target price is reduced from RM10.80 to RM10.40,” KAF Research said.

KAF maintains its buy call. The research house said the stock was trading at an attractive 14.6 times FY11 price/earnings ratio and 2.2 times price-to-book while offering a yield of more than 4%.

ECM Libra Research analyst Bernard Ching is not positive. Looking at Sime's other divisions for guidance, Ching said the plantations segment had not been performing quite well this year.

“While the rest of the industry had a good fourth quarter for the calendar year to 2010, Sime did not. Also, our sector outlook is only lukewarm with an average crude palm oil price of RM2,400; hence, there is little catalyst there.

“On the industrial segment, performance is also expected to be weaker year-on-year due to a pullback in government spending in Australia this year,” Ching said.

He said other segments should have flattish performance and even if positive, it would not be able to significantly raise group earnings as a whole.

Ching has downgrade Sime to a sell, with a lower sum of parts target price to RM7.75 from RM8.30 before.