Keppel Corporation - UOB Kay Hian 2016-04-19: 1Q16 Still Faces Strong O&M Headwinds; Downgrade To HOLD

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KEPPEL CORPORATION LIMITED BN4.SI 

Keppel Corp (KEP SP) 1Q16: Still Faces Strong O&M Headwinds; Downgrade To HOLD 

• 1Q16 net profit of S$210m came in below expectations due to lower-than-expected O&M revenue and investment net profit. 
• O&M operating margin improved 1.6ppt yoy to 13.6% from 12.0% given a 28% yoy decline in overheads. 
• Higher property net profit (+63% yoy) saved the day. 
• Keppel’s share price has rallied 25% in a quarter. 
• In view of a still challenging O&M environment and our revised target price of S$6.40 implying a 6% upside only, downgrade to HOLD. 
• Entry price: S$5.40 and below. 

RESULTS 

 1Q16 net profit below our expectation. 

• Keppel Corp (Keppel) reported a net profit of S$210.6m (-42% yoy) for 1Q16. 
• Despite 1Q being a seasonally weak quarter, earnings were weaker than expected, forming only 16% of our full-year net profit forecast of S$1,277m. 
• The miss was attributed to lower-than-expected O&M revenue and investment net profit, of which the latter was impacted by a loss from associate. Earnings were also dragged down by its infrastructure division. These were partially offset by strong earnings from the property division, which rose 63% yoy for 1Q16. 
• Excluding one-offs - a S$7.8m write-back of impairment from the property division and loss from associate KrisEnergy, normalised earnings would have been about S$246m, down 32% yoy. 

 O&M earnings more than halved. 

• O&M net profit fell 53% from S$202.9m in 1Q15 to S$95.0m in 1Q16, primarily due to lower revenue of S$1.7b (1Q15: S$2.8b). However, operating margin improved 1.6ppt yoy to 13.6% from 12.0% owing to a 28% yoy reduction in overheads during the quarter. 
• Repair volumes remain comparable to 2015’s and are expected to grow 5-10% this year, but margins “remain challenged”. 
• Keppel delivered three jack-up rigs (JUs), a liftboat and a Transformer platform during the quarter. No loss provisions were recorded. 
• Ten new deferments were announced during 1Q16, including: 
  1. Transocean’s five JUs, 
  2. ENSCO’s one JU rig, 
  3. Clearwater’s one JU rig, 
  4. BOT Lease Co’s one JU rig, and 
  5. two semi-sub tender rigs. 
• For c) and d), the deferrals were from 2016 to 2017, while for e), from 2017 to 2019-20. 

 Saved by higher property earnings. 

• Net profit from the property division was up 63% yoy from S$60.5m to S$98.8m due to sales of 940 homes (1Q15: 720 homes). 
• The strong sales were led by positive demand in China, namely Shanghai, Chengdu, Tianjin and Wuxi. While its Central Park City development in Wuxi and V City in Chengdu saw the strongest sales volumes, Shanghai 8 Park Avenue was the strongest contributor to net profit. This was due to the Rmb98,000psm selling price which was 9.3 times higher than the average in other cities. 
• The strong performance was further boosted by the divestment of 77 King Street, Sydney, by Keppel REIT for A$160m at 40% above cost. The division also benefitted from a S$7.8m write-back of impairment for Keppel Center in the Philippines. 

 Infrastructure: Down 36% yoy on lower prices and volumes. 

• Net profit from the infrastructure business fell 36% yoy from S$22m to S$14m. This was led by lower energy and infrastructure profits, which suffered from lower prices and volumes in its power and gas business. 

 Investments: impacted by absence of gains and loss from associates. 

• Net profit from the Investment division was down 96% yoy from S$75m to S$2.9m. This was due to an absence of gains from sale of investments, which amounted to S$50m in 1Q15, and Keppel’s share of losses from KrisEnergy, which lags KrisEnergy’s reporting by one quarter. 

STOCK IMPACT 

 O&M contract wins remain a major earnings risk. 

• Ytd, Keppel has secured only one contract worth S$190m (2015: S$1.8b). We maintain our contract win assumption of S$2b for 2016 unchanged despite the potential to significantly undershoot this target in the challenging environment. 
• Near-term project bids show potential for reaching our assumption. Publicly- known projects being bidded include: 
  1. BP's Mad Dog 2 production semi-sub, with contract award possibly in 2H16. No figure were provided on the size of this project but is expected to be sizeable given that the overall project is currently estimated at US$10b. 
  2. Replacement of FSO Benchamas Explorer (no contract value). 
  3. Qatargas living quarters (US$150m). 
  4. Hess Equs semi-sub production platform (no contract value). 

 Property to drive earnings contributions this year. 

• Property earnings attributable to shareholders formed 47% of 1Q16 earnings vs 17% a year ago. In contrast, O&M earnings have shrunk from 56% in 1Q15 to 45% in 1Q16, in line with the slump in the oil & gas industry. 
• With O&M earnings expected to weaken further on continued deferments and poor contract wins, property earnings will take center-stage. This will be strongly led by Keppel’s property developments in China and Vietnam, which form 60% and 23% of its portfolio respectively. 

 Net gearing up to 56% from 53%; expect it to creep up. 

• With deliveries dragged out and a tail-heavy payment structure for its O&M JU orders, cash flow will be tight. 
• Keppel reported net gearing of 56% and we expect this to creep up to 62%. Management commented that they would be watching their gearing very closely. 

EARNINGS REVISION/RISK 

 Cut 2016 net profit forecast by 18%. 

• We cut our 2016 net profit forecast by 18% from S$1.28b to S$1.05b to account for the weaker-than-expected O&M division, imputing a lower operating margin assumption. 
• Our 2017 and 2018 forecasts are now at S$1.13b (- 1.8%) and S$1.22b (-7.2%). The lower decline in 2017 forecast is due to a change in revenue recognition of the 10 deferred rigs. 

VALUATION/RECOMMENDATION 

 Downgrade to HOLD and trim target price to S$6.40. 

• Share price has rallied 25% since our upgrade a quarter ago. 
• We lower our SOTP target price to S$6.40, assuming the O&M unit at 1.15x 2017F P/B. 
• With only 6% upside, we downgrade our call from BUY to HOLD. 
• Recommended entry price is S$5.40 and below. 

SHARE PRICE CATALYST 

• Oil price recovery

Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-04-19

UOB Kay Hian Analyst Report HOLD Downgrade BUY 6.40 Down 6.50