Sembcorp Industries - DBS Research 2017-11-04: Awaiting Strategic Review Outcome

Sembcorp Industries - DBS Vickers 2017-11-04: Awaiting Strategic Review Outcome SEMBCORP INDUSTRIES LTD U96.SI

Sembcorp Industries - Awaiting Strategic Review Outcome

  • Sembcorp Industries' 3Q17 hit by Marine’s weak earnings, and impairment.
  • Utilities performance was largely in line.
  • 2017 a transition year; expect earnings recovery in 2018.
  • Maintain BUY; TP adjusted to S$4.20.



Maintain BUY; TP raised to S$4.20, after rolling over our valuation base to FY18F. 

  • While weakness in India may take longer to resolve, we continue to like Sembcorp Industries (SCI) as it offers a unique value proposition as a proxy to ride the cyclical O&M upturn, and is supported by a defensive utilities business. 
  • Our S$4.20 TP translates to 1.1x P/BV, which we believe is fair in view of its 6% ROE and 2% dividend yield. The stock offers 24% potential upside.


Strategic review gives rise to speculation. 

  • Under the helm of the new CEO, Sembcorp Industries is undertaking a complete review of its businesses and strategic direction, focusing on performance, sustainability and value creation. The review is expected to conclude in 4Q17.
  • While premature to shed more light on the future direction of Sembcorp Industries, this may revive market speculation on potential rationalisation of SCI, Sembcorp Marine (SMM) and Keppel Corporation (Keppel).


Where we differ: “Big three rationalisation theory” and longterm growth prospects of utilities. 

  • Since Aug-2015, we have flagged the potential of a merger between Keppel’s O&M arm and Sembcorp Marine (SMM) during the structural downturn. The potential spin-off of its marine arm could re-rate Sembcorp Industries' undervalued utilities business that is currently overshadowed by a weak marine outlook. 
  • We believe in the long-term growth prospects of Sembcorp Industries' utilities arm, which has expanded its global footprint and recently made forays into key emerging markets – India, Bangladesh and Myanmar.


Valuation

  • Given its diverse earnings stream and various listed assets, we derive our fair value for Sembcorp Industries (SCI) based on the sum of its different parts: For its holding company position, we have applied a 10% conglomerate discount to the reappraised net asset value (RNAV). 
  • We derive a TP of S$4.20, translating to 1.1x P/BV.


Key Risks to Our View

  • Key risks to earnings are further deferments/cancellations of marine projects, deterioration of Singapore's power spark spreads, and execution hiccups at its Indian power plants.



WHAT’S NEW


3Q hit by impairment. Core utilities profit was in line: 

  • Group headline net profit came in below expectation, declining 39% q-o-q to S$33.6m in 3Q17. Besides Marine’s weakness, utilities segment was dragged by S$56.3m impairment charge, relating to write down of old boiler asset and goodwill of cogen plant in Singapore. Otherwise, core utilities profit of S$84m was largely in line. Singapore operations performed well, underpinned by centralised utilities and gas businesses as well as write-back of the Jurong Aromatic Corporation (JAC)’s provision made for receivables previously (S$14m).
  • SMM reported headline net profit of S$2.7m in 3Q17, below expectations of S$30-40m. Stripping out forex gains of c.S$30m, partially offset by the expected S$13m loss from Borr-Drilling deal in the form of inventory write-downs, SMM could have reported a small loss of S$14m in the quarter.
  • However, the results are inconclusive as earnings was also affected by the reversal of revenues and costs previously recognised for the two cancelled Perisai jack up rigs, which we estimate to be around S$350m. The net impact from the reversals was not disclosed, except broad guidance that they would largely be offset against each other.
  • Strategic Review is concluding soon and management will announce the outcome in due course, detailing the change in strategies for various business segment. We look forward to changes that will drive the long-term sustainability and return enhancement of Sembcorp Industries (SCI).


Earnings revision. 

  • We have lowered our FY17-18F net profit forecasts by 25/2% largely to reflect the earnings cut at Marine, and factoring in the impairment charge in 3Q.
  • Target Price is adjusted to S$4.20, after rolling over our valuation to FY18. 
  • Given its diverse earnings stream and various listed assets, we derive our fair value for Sembcorp Industries (SCI) based on the sum of its different parts: market valuations of its stakes in listed companies Sembcorp Marine (SGX-listed, 60.6% stake), Gallant Venture (SGX-listed, 11.96% stake) and Salalah (Muscat stock exchange, 40% stake) as well as earnings from utilities and urban development. 
  • For its holding company position, we have applied a 10% conglomerate discount to the reappraised net asset value (RNAV).




Pei Hwa HO DBS Vickers | http://www.dbsvickers.com/ 2017-11-04
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 4.20 Up 4.000



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