Sembcorp Industries (SCI SP) - UOB Kay Hian 2016-09-23: Surely Sir, The Utilities Business Has Been Overly Discounted

Sembcorp Industries (SCI SP) - UOB Kay Hian 2016-09-23: Surely Sir, The Utilities Business Has Been Overly Discounted SEMBCORP INDUSTRIES LTD U96.SI

Sembcorp Industries (SCI SP) - Surely Sir, The Utilities Business Has Been Overly Discounted

  • Our analysis of SCI’s implied valuation for its non-marine business finds that it is trading at a 20% discount below its long-term historical mean. 
  • Additionally, implied prices for both its businesses are either priced for distress, or at a sharp discount to regional peers. The market has overly discounted headwinds in the business and an opportunity exists to accumulate. 
  • We also update on a minor hiccup in its India operations and trim 2016 earnings by 1%. 
  • Maintain BUY with a lower target price of S$3.29.


WHAT’S NEW


Almost a utilities company now; marine earnings to take a side seat. 

  • The low contract win rate going forward will keep Sembcorp Industries’ (SCI) marine earnings low. We expect annual contract wins of S$1.5b over 2016-18 and are forecasting earnings of S$100m-120m for 2017-18.
  • Contributions from this segment will likely shrink from 50+% to ~20% in the future, dwarfed by SCI’s utilities earnings. As SCI secures more awards for power projects, it is becoming more of a utilities company, with marine earnings on the side.

Non-marine business discount of 20% below long-term mean unwarranted. 

  • Taking current market prices of SCI and Sembcorp Marine (SMM), the implied non-marine business is trading at 8.5x 2015 PE. This is a 20% discount to its long-term historical PE mean of 10.6x. 
  • Even over the 2013-15 period which saw Singapore utility earnings decline 35%, the non-marine business continued to trade at above 9.0x historical PE. With Singapore utilities earnings bottomed out, the current discount appears unwarranted.

Implied valuations of SCI and SMM at sharp discounts. 

  • Our SOTP valuation of the non-marine business is S$2.38.The difference between SCI’s and SMM’s last share prices implies a S$1.79/share valuation for the non-marine business, implying 8.3x 1-year forward PE. 
  • Reversing the logic, the difference between SCI’s current share price and our SOTP valuation for the non-marine business implies SMM at a valuation of S$0.29/share, or 0.23x current P/B.

Either way, we argue that the market is over-discounting both businesses. 

  • Despite hiccups in India and overcapacity in Singapore, SCI’s utility business does not warrant an 8x PE multiple when the regional mean trades at 12.5x. SMM is priced for distress, when evidence points to the contrary.

An 18% upside even in a worst-case scenario. 

  • In the worst-case scenario that sees SMM make mark-to-market impairments on its seven rigs, the impact to our SOTP valuation is S$0.25/share. This reduces our valuation from S$3.29 to S$3.04, still presenting an 18-19% upside.


OTHER ESSENTIALS


TPCIL’s PLF for Jul-Aug largely in line at > 80%. 

  • Based on the latest data from India’s Central Electricity Authority (CEA), SCI’s TPCIL power plant’s performance in Jul-Aug 16 was largely in line, at 82% and 89% respectively. Data for Sep 16 is available up to 18 September, with plant load factor (PLF) currently at 85%.

PLF for Sep 16 to be lower than expected. 

  • Unit #2 at TPCIL reported a pump problem again on 16 September, with complete outage on the 17th. As of 21 September, the unit remained down, its fifth day of outage. Recall that in Jun 16, Unit #2 had a similar outage that lasted nine days. 
  • Assuming a similar timespan, we expect overall PLF for TPCIL to come in at 77-78% for September.

Full-year PLF should still come in at ~80%. 

  • Owing to the above-average performance of TPCIL in Jul-Aug 16, we expect the lower PLF in September to have a negative 1ppt impact on full-year PLF at most. Assuming both units maintain an average PLF of 85% in 4Q16, 2016 PLF should come in close to 80%.

SG Energy prices bottomed out, edging up. 

  • In the clearest sign that the Singapore energy market has bottomed out, USEP prices have edged up from the S$40-50/MWh band in 2Q16 to the S$50-60/MWh band in 3Q16. Prices are now comparable to 3Q15 levels. That said, significant overcapacity remains within the Singapore energy market. 
  • The uptick is viewed favourably for earnings, although not representative of a recovery. Singapore is expected to continue contributing roughly 30+% of Utilities net earnings even after India and China come fully on stream in 2018.

Marine: Rig concerns persist; contract wins remain weak. 

  • SMM reported ytd contract wins of S$320m, a stark contrast to the S$3b-4b annual contract wins previously. 
  • Concerns regarding its rig orders from Perisai, Oro Negro and North Atlantic Drilling (NAD) persist. Cancellations remain unlikely for now although we question how long can clients continue the deferrals.


EARNINGS REVISION/RISK


Trim 2016 net profit estimate by 1.2%. 

  • We tweak down our earnings for India, lowering our PLF assumption for Unit#2 from 80% to 75%. 
  • Our net profit forecast for 2016 declines from S$517m to S$511m (-1.2%) as a result of this change. 
  • Net profit estimates for 2017- 18 remain unchanged at S$492m and S$579m respectively.


VALUATION/RECOMMENDATION


Maintain BUY with a lower target price of S$3.29. 

  • Updating our SOTP valuation with our revised earnings forecasts and PE multiples for the respective geographies, our target price is lowered from S$3.35 to S$3.29. 
  • Our utilities earnings are pegged at 10.3x 1-year forward PE, based on the weighted average of the respective country’s sector mean PE. SCI is almost a utilities company as earnings overshadow the shrinking marine business. 
  • Utilities earnings have already bottomed out and are on a gradual mend, with earnings growth to eventually come in 2018. However, the market has overly punished SCI on both its utilities and marine businesses, pricing it at sharp discounts. 
  • Current share price implies a 29% upside, with dividend yield of 4.3%.




Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-09-23
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 3.29 Down 3.350



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