Wilmar has derived much of its earnings from trading gains. While it has been fortunate, its run of success cannot last forever. At 9x FY09F earnings, Wilmar seems overvalued to us for the risks that it presents. We downgrade to Sell and cut our target price to S$2.14.

Wilmar’s merchandising & refining business forms the core of its earnings, representing 55% of its operating profit in 3Q08. An inspection of the last five quarters shows that the reported net profit of Wilmar International has been at least 50% higher than the prevailing soybean processing and palm oil processing margins. Merchandising & refining earnings were boosted by trading gains, due, we believe, to Wilmar being the world’s largest palm oil processor and China’s largest soybean processor. These gains are volatile and are not derived from the core agriculture supply chain business.

Wilmar’s disclosure standards do not meet those of agriculture supply chain majors like Bunge and ADM. The details of its operating performance are limited. For instance, it does not detail the components of broad categories in the palm and laurics division. It also does not distinguish between operating earnings and trading earnings.

At 9x FY09F PE, Wilmar seems overpriced for the risks we believe it presents. Even its major shareholder ADM (whose stake in Wilmar International is held by Wilmar Holdings), an industry leader with better growth prospects on Bloomberg estimates, is trading at 7x FY09 earnings on Bloomberg estimates. We have adjusted our DCF valuation by reducing our medium-term operating margin expectation to 4% to strip out trading gains from the company’s core earnings. Other valuation metrics such as ROE versus P/B and PEG ratios support our view that Wilmar is in line for a correction.