Keppel Corporation (KEP SP) - UOB Kay Hian 2017-10-20: 3Q17 Earnings Bottom Out; Upgrade To BUY

Keppel Corporation (KEP SP) - UOB Kay Hian 2017-10-20: 3Q17 Earnings Bottom Out; Upgrade To BUY KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation (KEP SP) - 3Q17 Earnings Bottom Out; Upgrade To BUY

  • Keppel Corp’s 3Q17 results were below expectations on lower-than-expected property and infrastructure earnings. 
  • Core earnings show signs of a turnaround and we are cautiously optimistic that the slowdown in China would not hurt the earnings outlook by too much. 
  • Keppel Urban Solutions - a new fee-generating initiative - was introduced. 
  • We cut 2017-19 net profit forecasts by 1-14%. Incorporating valuations for Tianjin Eco-City (TJEC) and updating our property valuations raise our target price to S$8.35.
  • Upgrade to BUY from HOLD on valuation grounds.



RESULTS


3Q17 results below expectations. 

  • Keppel Corporation (Keppel) reported 3Q17 headline net profit of S$291.8m (+30% yoy, +82% qoq), boosted by one-off disposal gains of S$115m from the sale of Keppel Lakefront (PAT: S$79m), sale of Wiseland Investment (PAT: S$33m) and sale of Keppel DC SG4 (PAT: S$3m). Excluding these and other oneoff items, 3Q17 core net profit was S$166.1m (-9.5% yoy, +13% qoq). 
  • 9M17 core earnings of S$437.2m was below expectations at 59% of our full-year estimate of S$742m due to lower-than-expected property and Infrastructure earnings.

O&M: Still at breakeven, not turning around soon. 

  • Operating profit from the offshore & marine (O&M) division was S$2.6m (-95% yoy, -92% qoq) on continued low work volume.
  • Management remarked that right-sizing of the O&M division was mostly done and does not expect a V-shaped recovery. Orderbook stood at S$3.9b (2Q17: S$3.4b), with > S$1b of new contracts secured ytd. TS Offshore has deferred delivery from 2017-2019.

Property: Core operating profit flat qoq at S$101m. 

  • Headline operating profit of S$226.0m included one-off divestment gains from the sale of Keppel Lakefront and Wiseland Investment. Excluding these gains, core operating profit was S$101m (+12% yoy, +2% qoq), mainly on recognition of earnings from property developments in China and Vietnam. 
  • Core operating margin was 18.5%, at the lower end of the 18-22% margins seen in prior quarters.

Homes sales strong in Vietnam, weak in China and Singapore. 

  • Home sales for 3Q17 were 1,320 units (-3.6% yoy, -46% qoq), on lower sales in China (570 units, -48% yoy and -47% qoq) due to tightening measures. Vietnam saw sales hit a record 620 units (+265% yoy, +121% qoq). Singapore sales were weaker at 80 units (-27% yoy, -11% qoq).

Infrastructure: Core operating profit of S$31.7m. 

  • This was a 10% yoy improvement and came on the back of commencement of revenue recognition from the Keppel Marine East Desalination plant. Operating margins were comparable qoq at ~5%.

Investments: No land sales from TJEC. 

  • Investments were dragged down by one-off share of losses from KrisEnergy, but almost offset by share of profit from K1 Ventures. No land sales were reported from Tianjin Eco-City (TJEC) for the period.
  • Net gearing declined to 50%. This is an improvement from the 58% in 2Q17.


STOCK IMPACT


Earnings showing sequential improvement. 

  • Core earnings appear to have bottomed out with the second qoq improvement in 3Q17 from the bottom in 1Q17. While earnings continued to be supported by the other divisions sans O&M, the key property segment might see a short-term slowdown in the near term. 
  • With most projects in China completing in 1H18, the slowdown in China sales could impact earnings. 
  • Earnings should pick up from 2H18 as Vietnam projects approach completion. That said, this view could change quickly as Keppel Corp's diversified portfolio allows for flexibility in launches, allowing it to target more favourable markets as soon as demand picks up.

Introducing KUS - Keppel’s latest initiative to get multiple bites of the same cherry.

  • Keppel unveiled Keppel Urban Solutions (KUS), which aims to be an integrated master developer of large-scale mixed-use developments in Asia-Pacific. The platform allows Keppel Corp to not only co-develop assets that generate recurring earnings, but to also reap development fees during the development process. 
  • The earnings model is highly scalable as Keppel Corp earns a fee (estimated 1.5-3%) of the project size while infrastructure projects tend to be huge.

Saigon Sports City: Potential for land sales. 

  • As a start, KUS will start with developing the 64ha-township called Saigon Sports City. The potential for land sales exists although this is unlikely to happen until a few years later when Keppel Corp has finished developing the basic infrastructure.


EARNINGS REVISION/RISK


Cut 2017-19 net profit forecasts by 1-14%. 

  • This comes on the back of lower earnings from the O&M, property and infrastructure divisions, but offset by assumptions on land sales from Tianjin Eco-City (TJEC). 
  • Our revised 2017-19F net profits are S$638m (-14%), S$798m (-1%) and S$846m (-5%) respectively.


VALUATION/RECOMMENDATION


Incorporating TJEC valuation into estimates. 

  • An analysis of Tianjin Eco-City (TJEC) points to potential profit of S$167m p.a. in land sales each year. The asset is estimated to be worth S$1.1b in our base case, with upside potential to reach S$1.8b if Keppel Corp manages to expand the plot ratio from 1.1x to 2.0x.

Upgrade to BUY and raise target price to S$8.35. 

  • Incorporating our valuation for Tianjin Eco-City (TJEC) adds an extra S$0.60/share to our SOTP valuation. We also update our property valuation to a RNAV basis (S$4.85/share, 20% discount). 
  • With its woes in O&M largely behind it, Keppel Corp is on the cusp of embarking on its strategy to become a property and fund management giant. 
  • On valuation grounds, upgrade to BUY.






Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-10-20
UOB Kay Hian SGX Stock Analyst Report BUY Upgrade HOLD 8.35 Up 6.710



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