IOICORP - SELL RM3.40

Negative Signal From Rights Issue


IOI is proposing to issue a renounceable rights issue of 420.989m shares at RM2.90 each at a ratio of 1 rights share for every 15 existing held. The issue price of RM2.90 is a 38.3% discount to its theoretical 5 day VWAP ex-rights price of RM4.70. We view IOI Corp’s proposed rights issue negatively, interpreting it as a signal of more subdued outlook going forward given its past tendency of issuing debt to fund its expansion and allowing degearing to be taken care of by its cash flow and bond conversion. Maintain Sell on negative sector outlook and lofty valuation of 20x forward earnings.

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Capex needs. Proceeds will amount to RM1.221bn, which will be used for capex and repay borrowings. We believe part of the proceeds will go to the building of new 300k tonnes refinery capacity in Rotterdam and additional 100k specialty fats capacity at Pasir Gudang, Johor. On top of that, IOI is also developing 60k hectares of land in Kalimantan into oil palm plantation, the work of which has already begun.

Financial impact. The rights issue will help to lower net gearing from 42.5% to 26.3% which is a good thing while EPS dilution for FY10 is minimal at an estimated 6.5%. Signals tough times ahead? In the past decade, IOI always issued debt for expansion purposes, which also helped raise its gearing level for a more optimal capital structure. Anytime it issues new debt, its gearing rises to uncomfortably high levels but was quickly brought down due to its strong cash generation and strong stock price performance, which resulted in conversion of its convertible bonds into shares.

So, the raising of rights issue makes us suspect that IOI's management may be concerned that its future cashflow generation may be weaker than before. Without the rights issue, its gearing will linger at the current levels much longer than desired. While the previous debt raising exercise was a bullish signal, the rights issue is a negative signal sent out by management.