Keppel Corporation (KEP SP) - UOB Kay Hian 2017-07-07: Gas Strategy Hints At Building A Recurrent Earnings Stream

Keppel Corporation (KEP SP) - UOB Kay Hian 2017-07-07: Gas Strategy Hints At Building A Recurrent Earnings Stream KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation (KEP SP) - Gas Strategy Hints At Building A Recurrent Earnings Stream

  • Keppel’s underlying gas strategy entails more than just being a preferred vendor for LNG solutions; it hints towards building up a base of FLNG assets that generate recurring income. The compelling economics of FLNG units support this, with equity IRR as high as ~40%. 
  • Keppel could create a FLNG trust, in the footsteps of Golar LNG Partners. However, this will take years to unfold and near-term headwinds cap share price upside. 
  • Maintain HOLD with an unchanged target price of S$6.55. Entry price: S$5.90.



WHAT’S NEW

  • We were invited by Keppel to a vessel tour of their FLNG conversion project, Hilli Episeyo, followed by a presentation on their gas strategy on 3 Jul 17.


STOCK IMPACT


Building up a recurrent earnings stream for O&M. 

  • The underlying theme behind Keppel’s strategy appears to be building an FLNG asset base that generates a recurring income stream. This could be achieved by selectively taking stakes in the FLNG orders it undertakes. 
  • Given the rising role of gas, this strategy provides Keppel with a highly scalable model to reap the benefits of higher FLNG vessel demand in the future.

Hilli Episeyo equity IRR of 14% on half its processing capacity. 

  • The economics of FLNG conversion projects yield a payback period of as low as 5-7 years. Using the Hilli Episeyo project as an example, we estimate an equity IRR of 14% (assuming 3-year construction time) and EBITDA yield of 14%. These numbers are even more compelling when accounting for the fact that these returns are based only on its initial 8-year contract, and half its processing capacity. 
  • Assuming the vessel’s full capacity, the equity IRR rises to an astounding ~40+% over its 8-year contract only (vessel has economic lifespan of 20 years). The high speed to market and short payback period makes FLNG a highly attractive investment class.

Possibilities exist for the formation of a FLNG trust. 

  • The high yield and short payback period makes FLNGs highly suitable for packaging into a yield instrument.
  • Keppel’s co-partner and client, Golar LNG, has already done this through the incorporation of Golar LNG Partners (GMLP). Packaged as a Master Limited Partnership (similar to Singapore’s business trust), GMLP currently provides a dividend yield of 11.2%. The payout does not seem excessive, as the distribution coverage ratio is > 1.0x, highlighting its sustainability. 
  • Over time we envision Keppel could do the same after building out a sizeable asset base.

Vessel refits: Yet another recurrent income stream. 

  • At the same time, by enabling the build-up of the gas industry, Keppel will stand to gain from re-fitting vessels it had previously converted. FLNGs may require a refit of installed modules to handle the characteristics of each gas field they get deployed to, and Keppel would be the preferred contractor of choice should that be required. A sizeable asset base will be required for this, to match the short conversion time (several months) against the vessels’ multi-year deployments.

Each vessel could add 4 S cents to valuation. 

  • Based on Hilli Episeyo’s pro-forma earnings, we estimate that the unit will generate roughly S$4m-6m p.a. in investment income for Keppel’s 10% stake. This is likely to be recognised under Keppel Capital’s investment income, which we value at 19x PE. On a per share basis, this translates to 4 S cents per share. 
  • Additional stakes in similar vessels would be highly accretive to Keppel.


Dual-engines of share price growth. 

  • Given the scalability of the business model, this strategy provides Keppel with two engines of value growth: 
    1. via construction earnings under the O&M business; and 
    2. recurrent income stream via its stake in the completed vessels.

Long-term strategy not expected to bear fruit in the near term. 

  • We caution that this is a long-term strategy that will take several years to pan out. The strategy is also contingent on Keppel being able to invest in the projects they want.


EARNINGS REVISION/RISK

  • No change.


VALUATION/RECOMMENDATION


Maintain HOLD; unchanged target price of S$6.55. 

  • We have left our SOTP target price unchanged at S$6.55 for now, preferring to incorporate valuation changes post its 2Q17 results release on 20 July. 
  • While we recognise the long-term potential of Keppel’s gas strategy, much of this remains a work in progress, with no significant earnings contributions expected until years later. In the near-term, share price faces headwinds from the O&M business division. 
  • Contract wins could catalyse share price, but this should have been already priced in, given our S$1.5b contract wins expectation (Ytd: S$364m).
  • Maintain HOLD. Entry price: S$5.90.




Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-07-07
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 6.550 Same 6.550



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