Keppel Corporation - CIMB Research 2017-10-12: Unearthing Gems

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KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation - Unearthing Gems

• We upgrade Keppel Corp from Hold to Add, with a new SOP Target Price of S$8.58, incorporating a revised RNAV for Keppel Land and Tianjin Eco City, as well as 2x O&M P/BV.
• We came away positive from our recent NDR with Keppel Corp's CEO to US/Canada and see value in Keppel Corp's sustainable urbanisation strategy across business segments. .
• Keppel Corp is a safe stock to own to ride the bottoming offshore & marine cycle and the upcycle of Singapore’s residential market, thanks to its early landbank inventory.
• The stock has underperformed O&M peer Sembcorp Marine (SMM) by 45% and Singapore’s major developers by 50% YTD.
• Key catalysts:
  1. stronger O&M orders,
  2. 50th anniversary dividend in CY18 from active recycling of capital. 
  3. EPS changes for FY17-19 to better reflect properties sales.

In a nutshell - Growth engines.

• We came away positive from our recent NDR with Keppel Corp's CEO Mr Loh Chin Hua in Toronto/New York, agreeing with Keppel Corp's strategy of building several sustainable growth engines. 
• We think Keppel Corp is at an inflection point where the worst could be over. 
• Firstly, the long-drawn out passive development in Tianjin Eco City is finally bearing fruit with some handsome profits locked in. 
• Secondly, sentiment in the O&M industry is likely to be sustained by a steady oil price and potential turning in tides as
  1. drillers are starting to acquire premium rigs (Borr Drilling), and
  2. early signs emerge of a pick-up in jack-up utilisation. 
• Finally, we give credit where credit is due and fairly value its property division based on RNAV, of S$5.85.

Time to harvest Tianjin Eco City 

• We think investors have undervalued Keppel Corp's Sino-Singapore Tianjin Eco-City (SSTEC) given the slow progress in land sales and anemic prices since its inception in 2008. 
• After years of township planning, with better infrastructure built out, SSTEC now has more than 70,000 (from 20,000 in 2014) residents with 4,500 registered companies operating in the area. The city was planned for 350,000 residents. 
• The current shareholder structure of SSTEC: Keppel Corp 45% (post privatisation of Keppel Land), Singbridge International (10%) and 50% help by a Chinese consortium led by Tianjin TEDA Investment.
• We believe Keppel Corp is set to harvest the fruits of multi-year township planning as land prices in the city grew from Rmb1900/sm in 2015 to 13,800/sm in 2017. SSTEC sold 361,000 sm of GFA in 2017, fetching c. S$110m of profits (Keppel Corp has a 45% stake). This is more than 80% yoy growth from 2016 where it only made about S$60m. There was also some industrial land sale in 2Q17 yielding a profit of c. S$10m. 
• Proposal to sell land is subject to government’s approval and could take 6-12 months before quota to sell is granted. We believe the next significant lumpy recognition is likely to be in 1H18. SSTEC land sales are categorised in the “Investment” division- share of associates profit.

SSTEC could add S$0.58 per share, simplistically 

• 45% out of the 30sqkm landbank are sold. The remaining 16.5sqkm are split into 12sqkm for residential and 4.5sqkm for industrial use. We factor in annual sales of 361,000 sm GFA (up to 2028) with land price appreciation of 10% p.a and net margin of 25%. Our NPV of profits assuming a total sale of c.4m sqm plus current net asset of SSTEC values SSTEC at S$1.05bn (S$0.58/share). 
• Upside could come from higher-than-expected land appreciation (20% annual increase yields S$0.88/share) or more land sales than expected.

G-to-G efforts to make SSTEC a ‘mini’ Singapore 

• SSTEC is the second flagship Government-to-Government (G-to-G) project between Singapore and China after the China-Singapore Suzhou Industrial Park. The project was mooted by then-Singapore Senior Minister Goh Chok Tong and then-Chinese Premier Wen Jiabao in Apr 07, against the backdrop of rapid urbanisation and increasing global attention on the importance of sustainable development.
• In Feb 17, Singapore and China signed 4 Memoranda of Understanding (MOU) and a strategic framework agreement to cooperate on improving the infrastructure and services in SSTEC, comprising water resources management, digital media, healthcare, R&D and implementation of a 'smart city' masterplan. 
• By 2020, a semi-express line will link the eco-city to a high-speed railway running between Tianjin and Beijing, cutting the travel time between Tianjin city and SSTEC.   

Property: Giving credit where credit is due 

• We change our way of modeling the property division based on RNAV instead of P/BV. Our updated RNAV values the division at S$5.85. The RNAV includes development surplus as well as surplus from investment properties under development. 
• Applying a 20% discount, in line with our house valuation on Capitaland, the RNAV per share of Keppel Land would be S$4.68. Prior to privatisation, Keppel Land was trading at a long-term average discount of 27%. We think a 20% discount is fair given the more efficient capital allocation from the group.

One of the biggest land banks in Singapore. 

• Including the potential redevelopment of c. 500 units in Keppel Towers, Keppel Land would have a total of 1,624 units of landbank remain. This is second to City Developments (1,600-1,700 units) and higher than UOL (c. 800 units) and Capitaland (minimal). 
• We estimate Singapore to contribute about 33% of Keppel Land’s EBIT in FY17F and c.40% in FY18F on the back of higher home sales and ASPs, especially for Corals and Reflections. We also assume Keppel Plot 4 to begin development by 2018 and 6 by 2019.
• The plan to redevelop Keppel Towers (NLA: 430,560 sf) was deferred indefinitely from 2015. We think the deferment was an effort to preserve capital as the group was weathering the storm and uncertainty in the O&M division then (Sete Brasil and oil price crash). Therefore, it is time to reignite the project as O&M settles, to capture the upcycle in home prices in Singapore.

Low land cost. 

• Keppel Land has c. 62,800 units (lasting 10 years) of landbank regionally, carrying at cost. About 70% of these are seven years or older. One key example is Keppel Bay Plot 6, acquired in 2000 which could yield c.PBT margin of 30% based on ASP of S$2,300 and GFA of 226k sqft. 
• Our average PBT margin of China projects under development range from 12% to 58%.

2018 profit may dip but balloon again 2019. 

• As of 1H17, China made up about 60% of Keppel Land’s net profit. With the completion of c.1,200 homes in 2H17, we expect profits for China to be backloaded. We estimate the profit mix by end- 17 to be 47% from China, 30% from Singapore, and 20% from Vietnam.
• We estimate that PBT will dip 8% yoy for Keppel Land in FY18F mainly due to the completion of Chengdu Park Avenue Heights (1,392 units launched, 98% sold as of 1H17). 
• Tianjin will help to plug the gap with Seasons Garden Plot 9 (359 units) scheduled for completion in 2H18, with handsome profits. Recent units were transacted at c. Rmb18,000 psm. We project an PBT margin of c.30% when fully sold given the low land cost of c. Rmb600/sm.
• The momentum will pick up again in 2019 from Wuxi projects. Waterfront Residences Wuxi will see peak completion of 542 units (latest ASP in 1H17 was Rmb22,800 psm), followed by Park Avenue Heights’ 372 units. Shesan Riviera Shanghai will also see completion of 105 units, assuming more units to be launched in FY18.

Hold-sell analysis strategy –S$139m gain YTD. 

• Going forward, we expect more peripheral development sales from non-core cities as Keppel Land focuses on scaling up and competing meaningfully in major cities like Shanghai, Wuxi, Chengdu and Beijing. Case in point is the recent divestment of Nantong Residence (still under development) for S$292m which fetched a gain of c.S$75m (to be recognised in 3Q17). 
• Other divestment gains recorded YTD include S$32m for Cityone Development (Wuxi) and S$32m for PT Sentral Tunjungan Perkasa Indonesia. Potential returns could be boosted by recycling and reinvesting as shown in the latest acquisition of the 83,000sf site in the Jakarta CBD for S$60m.
• Net debt-equity-ratio for Keppel Land is about 0.2x, which puts it in a strong position to further deploy capital into key markets.

Valuation creation from commercial projects under development 

• We see further value creation from the investment properties under development that are worth c.S$641m, which should help to boost its RNAV. 
• The key projects to be completed are in China - Beijing Commercial (2019 with NLA of 902k sqft), Park Avenue Shanghai (2021 with NLA of 998k) and Seasons City Tianjin (2019 with NLA: 1.4m sqft). We have assumed cap rates of 5-6% to derive the market value.

Rig Market Bottomed 

Jack-ups seeing glimpses of hope 

• There is no doubt that global rigs are still in a surplus state. There are 93 units of jack-up rigs due for delivery from now until 2020. Most of these are deferred from 2015 and China made. Assuming these stocks are gradually soaked up in 2018, we are likely to see some recovery in orders by end-18. Signs of a recovery are there:
  1. stable day rates (c.US$100k/day) for high-specification jack-up rigs; and 
  2. utilisation starting to inch up in 2017 to c.55%. 
• During the last rig downturn, we started to strong pick-up in orders when utilisaton hit 65% in 2010.

High-risk jack-up rigs can fetch US$1.3bn at a 30% discount 

• Keppel O&M has seven jack-up rigs that are due for delivery in 2017 but we believe that realistically, this may not happen. We classify these rigs as “high” risk as operators do not have a proven track record or are still looking for funding. There are also four rigs that we classify as “medium” risks which are slated to be delivered in 2018-19.
• Benchmarking the latest market price transacted by Borr Drilling of US$144m per jack-up rig from Sembcorp Marine (SMM, Add, TP: S$2.51), representing a c. 30% discount to the original contracted price, we estimate that Keppel O&M would be able to fetch US$1.3bn if it disposes of the seven “high” risk jack-up rigs. This could improve net gearing from 0.58x to 0.4x at the group level.
• Note that it novated five jack-up rigs from Transocean to Borr Drilling in Mar 17 at US$216m/rig.

KEP’s order win doubled yoy to c.S$1bn, with no rigs 

• Keppel O&M has secured c.S$1bn of orders YTD, comprising mainly LNG vessels, LNG powered containerships and FPSO conversions. If the momentum continues, we believe normalised order wins in the non-rig segment could be about S$1bn- 1.5bn p.a. Our order win target is S$1.5bn for FY17 and S$2bn for FY18, conservatively assuming potential orders of one or two rigs by end-18.
• As at 1H17, Keppel O&M’s order book stood at c.S$3.4bn, excluding Sete Brasil’s semi-subs. We estimate the order book to grow by 20% yoy to S$3.7bn if it reaches our target. This would be the first increase after a four-year consecutive decline. 
• Given the surplus state of global rigs, we think it will take a while before drillers actively place orders for rigs. If Keppel O&M is able to repeat the previous pre-rig cycle boom, this could mean upside of another S$2bn-3bn of sustained annual orders.

Margins could recover by FY18F 

• O&M earnings are likely to hit bottom in FY17. As at 1H17, it was barely breakeven, with S$1.4m of profits and EBIT margin of c.4%, mainly due to the depleting order book and weak order wins (S$0.5bn) in FY16. 
• We forecast the EBIT margin recovering to c.8% by FY18F with the completion of the yard mothball exercise over the past 2 years, in addition to execution of YTD orders.

Long-term gas strategy intact 

• We agree with Keppel Corp’s strategy to cushion the cyclicality in rig-building by moving away from the conventional EPC model but being a gas enabler. Some of the steps are a JV with Shell to supply LNG bunker in Singapore. The JV, FueLNG completed its first commercial delivery in batches from Jul to Sep 17.
• We believe there could be a small scale LNG terminal and power barges newbuild in the pipeline, following the Heads of Agreement (HOA) that Keppel Corp signed with Pavilion Energy and Indonesian state-owned PT Perushaan Listrick Negara (PLN) in Sep 17. The HOA was established to explore opportunities in the development of small-scale LNG distribution in West Indonesia.

Keppel Capital doubling AUM to S$50bn 

• Keppel Capital’s income is derived from management fees from Keppel Infrastructure Trust (KIT) (100%), Keppel REIT (KREIT) (100%), Alpha Investment Partners (100%) and Keppel DC REIT (KDC REIT) (50%). It targets to double AUM over the next five years from S$25bn currently. 
• It has secured capital commitments of US$500m for the Alpha Data Centre fund for new data centre investments. This should enable the group to seize opportunities through private funds as well as create pull-through projects for business segments in the medium term. 
• There will be more collaboration across business verticals to better capture value. For instance, Alpha Investment Partners via Alpha Asia Macro Trends Fund (AAMTF) III co-invested (40%) with Keppel Land China (30%) in an office and retail mixed used development, SOHO Hongkou, in Shanghai for US$525m, to gain exposure to Grade A offices in the city.
• As at 1H17, Keppel Capital generated S$33m of recurring management fees.
• Based on the company’s aggressive growth target, we deem 18x as a fair multiple to value Keppel Capital, which yields a market capital of S$1.2bn (S$0.67 per share).

2018: 50th anniversary dividends? 

• We hope that Keppel Corp can work towards paying special dividends in CY18, as the group celebrates its 50th anniversary. The group paid out record levels of DPS in CY08 (40th year) and CY13 (45th year).
• We believe the divestment of land/projects in the properties division as well the crystalisation of funds in Keppel Capital can help to build up the dividend kitty. We leave our payout ratio unchanged at 46%, with total DPS of S$0.22 for FY17 (payable in CY18).

Valuations and Recommendations 

From trough to peak 

• Keppel Corp is trading close to the 2009 trough of 1x P/BV. In the past two rig upcycles, (2004-2008 and 2009-2011), its valuations rose by 256% and 173%, respectively.

Underperformed peers 

• YTD, Keppel Corp's share price has underperformed O&M pure play proxy, Sembcorp Marine, by c. 45% and Singapore property developers (Capitaland, City Developments and UOL) by c. 50%. 
• We believe it is the best stock to own to ride the potential upcycle in the rig market and/or the bottoming residential market in Singapore.

Upgrade from Hold to Add, revised target price of S$8.58 

• Our revised RNAV which incorporates higher valuations for SSTEC, Keppel Land and O&M (benchmarking 2x P/BV, in line with Sembcorp Marine's target) brings us to S$8.58.
• Key catalysts could come from
  1. stronger-than-expected recovery in O&M orders, 
  2. special dividends, and
  3. redevelopment of projects in the Singapore landbank.
• Key risks include a sudden plunge in oil price, impairment of undelivered rigs and Sete Brasil’s semi-subs.

LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2017-10-12

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