Keppel Corp (KEP SP) - UOB Kay Hian 2017-01-27: 4Q16 O&M Kitchen Sinking

Keppel Corp (KEP SP) - UOB Kay Hian 2017-01-27: 4Q16 O&M Kitchen Sinking KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corp (KEP SP) - 4Q16 O&M Kitchen Sinking

  • Keppel Corporation reported 2016 net profit of S$784m, which included several write-offs, largely arising from a rightsizing of its O&M unit. Excluding this, core net profit was S$903m, above our expectations. 
  • The rightsizing sees the closure of three Singapore yards and mothballing of two overseas yards. 
  • Property now dominates earnings at 79% of 2016 earnings, although profit margins for the property trading business remain suspect. Revise earnings by +5%, and revise target price to S$6.45.
  • Maintain HOLD. Entry price: S$5.90.



RESULTS


4Q16 above our expectations. 

  • Keppel Corporation (Keppel) reported headline 4Q16/2016 net profit of S$143.1m (-65% yoy), and S$783.9m (-49% yoy) respectively.
  • Excluding numerous one-offs from impairments from the offshore & marine (O&M) unit, core 4Q16/2016 net profit was S$326m (-44% yoy) and S$904m (-36% yoy) respectively.
  • Full-year core net profit was above expectations, representing 113% of our full-year estimate, but in line with consensus. Earnings surprise came mainly from an expansion in O&M operating margin and higher-than-expected property earnings.

O&M unit made a headline loss on S$277m in impairments.

  • The O&M unit reported a loss of S$138.5m for 4Q16, but a S$28.5m profit for 2016. Excluding the S$277m in oneoffs, it was profitable at S$306m for 2016. 
  • Actual values of impairment items specific to the O&M unit were not disclosed, but were recorded amongst the following line items: 
    1. provision of S$81.2m from stocks and work-in-progress (WIP), 
    2. impairment of S$87.4m in fixed assets and, 
    3. S$120.8m impairment in investments and associated companies.
  • The cause of each impairment (in order of listed items above) was: 
    1. impairment of the CAN-DO drillship (none for rigs on orderbook), 
    2. impairment of yard fixed assets based on difference from realisable values and book value, and
    3. impairments on yard investments arising from the mothballing of two overseas yards (Brazil and Bintan).

O&M unit’s 4Q16 core operating margin jumped to 18.8%. 

  • Excluding the one-off items for the O&M unit, core operating margin was 18.8%, a significant improvement from the 12-14% seen in previous quarters. This was attributed to a write-back on certain project costs as well as repair job margins being significantly better.

Property earnings down 27% yoy. 

  • The property unit reported lower net profit of S$269.1m (-27% yoy), with EBIT margin down slightly at 35% (4Q15: 38%). 
  • The earnings drop was due to lower fair value gains on property and absence of cost write-back for a property project, offset by reversal of impairment of hospitality assets. 
  • For the full year, Keppel Land reported a higher net profit of S$586m (+4% yoy) after the adjustment of divestment gains to Keppel Capital, although headline numbers suggest a 6% yoy decline in net profit.

Investments net profit down 81% yoy. 

  • Keppel Capital reported net profit of S$64m (+10% yoy) for 2016. The unit suffered an impairment of S$46m for 2016, which we suspect might be related to KrisEnergy.


STOCK IMPACT


O&M remains in a long winter. 

  • The prognosis for 2017 remains grim, and sees Keppel take the decision to close three of its nine Singapore yards as it rightsizes its capacity to the current environment. The O&M orderbook stood at S$3.7b as of end-16, with 20 newbuild and conversion jobs to be delivered this year. 
  • Contracting outlook remains gloomy despite the uptick in oil prices, and earnings from the O&M unit will be small going forward.

Yard impairment risks remain if orders return slower than expected. 

  • While Keppel has made decisive moves to rightsize its capacity, the impairments might not yet be fully over. Based on the 2015 Keppel O&M annual report, Keppel has 17 yards remaining across the globe post closure/mothball. 
  • With rig orders not likely to return till 2019 at the earliest, large capacity yards such as AmFELS, Baku Shipyard and Verolme are potential candidates for closure if low orders persist.

Property unit dominates earnings; profit margins suspect. 

  • Property now dominates Keppel’s earnings (79% of 2016 earnings) and will be the key earnings driver going forward. 
  • While Keppel Land continues to see steady property demand and remains a solid profit centre in the downturn, its opaqueness leaves us guessing on the sustainability of its profit margins. This is inferred from a decline in net profit from property trading, despite an increase in both the number of homes sold in 2016 (5,720 units, +25% yoy) and the unit value of homes sold (S$0.4m, +36% yoy).


EARNINGS REVISION/RISK

  • Maintain contract assumption of S$1.5b/2.0b for 2017/18. These assumptions remain unchanged. We introduce our 2019 contract win assumption at S$2.0b.
  • Earnings revised upwards by 5% for 2017/18. Our earnings assumptions for 2017/18 have been revised to S$851m (+5%) and S$793m (+5%) respectively on an improvement in O&M margin, offset by a decline in margins for its poperty unit. 2019 earnings is introduced at S$830m.


VALUATION/RECOMMENDATION


Maintain HOLD, with target price of S$6.45. 

  • We raise our SOTP target price slightly to S$6.45 (prev: S$6.25) as we adjust our RNAV value for Keppel Land (42% discount) and company net debt. 
  • The O&M business unit is pegged to 1.2x 2017F P/B, based on a regression of ROE against P/B. 
  • While Keppel’s earnings have likely bottomed, supported by the property division, it is not expected to drive earnings growth as we suspect there is margin compression. 
  • Earnings outlook for the O&M unit remains dim as orders lag the recovery in oil price. 
  • With a lack of earnings catalyst for 2017, we expect dividends to remain flat or under pressure. 
  • Maintain HOLD.




Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-01-27
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 6.45 Up 6.250



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