Keppel Corporation - UOB Kay Hian 2016-07-22: 2Q16 Cash Strains Amidst A Harsh Winter

Keppel Corporation - UOB Kay Hian 2016-07-22: 2Q16 Cash Strains Amidst A Harsh Winter KEPPEL CORPORATION LIMITED BN4.SI 

Keppel Corp (KEP SP) - 2Q16: Cash Strains Amidst A Harsh Winter

  • Net earnings of S$206m was below expectations, driven by weakness in the O&M business. 
  • Management now calls the downturn a “longer, harsh winter” and cautions against a quick recovery. Yards may be mothballed to reduce costs. 
  • Even earnings for the property business are showing signs of margin pressure. 
  • The dividend cut of 33% signals potential strains in Keppel’s cash flow. 
  • Slash earnings by 7-21% on lower contract win assumptions and lower property earnings. Earnings will remain weak for a prolonged period. 
  • Maintain HOLD with a lower target price of S$5.70. Entry price: S$5.10.



RESULTS


2Q16 net profit of S$206m below expectations. 

  • Keppel Corp (Keppel) reported 2Q16 net profit of S$206m (-48% yoy), and S$416m (-45% yoy) for 1H16. This was below expectations at 40% of our full-year estimate. 
  • Continued weakness in the O&M division (- 65%), and a lack of one-off gains in the Infrastructure business (-72%) contributed to the weaker results. Core net profit was S$188m for 2Q16. 
  • Excluding one-offs in the prior period (S$219m disposal gain and S$55m gain from restructuring), 2Q16 represented a 30% improvement against the previous period.

Lower work volume sinks O&M earnings. 

  • Net profit weakened sharply by 65% yoy to S$61m, as lower work volumes saw revenue fall 54% from S$1,580m to S$720m. Operating margin of 12.8% was flat yoy, preserved through reduction in overheads and its workforce. 
  • Management guided that if necessary, it will temporarily mothball yards to reduce overheads. Interest expense rose by 31% qoq to S$34m for 2Q16, but up 334% yoy, a result of higher borrowings from working capital requirements whilst facing client deferrals.

Property earnings coming under pressure. 

  • Despite registering a 15% yoy increase in revenue, earnings fell 9%. Operating margins for the unit appear to be under pressure, judging from the 4.9ppt yoy decline from 27% to 22%. 
  • For the quarter, Keppel sold approximately 1,200 homes (+9% yoy), with most coming from China. Keppel also saw an uplift in demand at its Tianjian Eco-City during 1H16, as it sold 3,800 homes (2015: 2,900), and saw two plots of residential land transacted at record prices of RMB8,000 psm of GFA.

Infrastructure earnings down 72% on one-offs. 

  • Infrastructure earnings was down 72% to S$28m, with the large difference owing to large one-off gains in the prior period arising from divestment gains of its Keppel Merlimau Cogen and dilution re-measurement gains.

Net gearing inched up to 62%. 

  • As a result of increased borrowing to meet working capital requirements for its O&M unit, net gearing inched up from 56% in 1Q16 to 62% in 2Q16. This remains below the net gearing ceiling of 100% that management is comfortable with. With working capital requirements for the O&M unit “plateaued”, this is expected to taper off in time.

Interim dividend down a third to S$0.08. 

  • Keppel announced an interim dividend of 8 S cents, a 33% decline from 12 S cents in the prior period. The ex-date is 27 Jul 16.



STOCK IMPACT


Cashflow stress mounts. 

  • The cut in dividend is a marked indication that Keppel’s cashflow is facing strain. Operational and free cashflow remains deeply negative, and its current debt due of S$1.85b is only slightly less cash+ST investment total of S$2b. Balance sheet is starting to get stretched. 
  • While Keppel’s working capital requirements is plateauing, the continued negative operational cashflow does not bode well for its financial health.

A harsh winter for the O&M business. 

  • In a marked change of tone, Keppel remarked that its O&M unit was not only facing a longer winter, but a “harsh one”. Demand for new drilling rigs will not “return soon”. We had in an earlier report estimated this to come earliest in 2020. 
  • Whilst Keppel is diversifying into other product classes, contracts values are not likely to repeat those seen in the last rig construction boom.

Project deferrals continue. 

  • Keppel has agreed to defer delivery of three jackups for Grupo R and one jackup for Parden Holdings to 2017. These rigs were originally scheduled for delivery in 4Q15. 
  • On the question of the status of its two FLNG orders with Golar (Gimi and Gandria), management declined comment, hinting that the project remains in limbo.

No provisions for now. 

  • Given the continued deferrals, it is possible that Keppel may have to make allowance for impacted rig orders. For now, management said none was needed, owing to the quality of the receivables. Provisions are evaluated on a quarterly basis. Management maintained that provisions for Sete Brasil (S$230m) are sufficient, and that the process will be protracted.



EARNINGS REVISION/RISK


Reduce contract win assumptions to S$1.8b for 2016, S$2b each for 2017 and 2018. 

  • We lower our assumptions to S$1.8b/S$2b/S$2b from S$2b/S$3b/S$4b respectively in light of the dismal business outlook.

Slash earnings by 7-21%. 

  • Our earnings estimate for 2016 is reduced by 7% from S$1,049m to S$975m, while 2017/2018 earnings are reduced by 19%/21% respectively. This incorporates the lower contract win assumption and weaker Property earnings into our estimates. These represent core earnings and do not account for the likely fair valuation gains from its investment properties at year end.

Dividend payout ratio reduced from 45% to 41%. 

  • This translates to a total dividend payout of 22 S cent for 2016, implying a 3.9% dividend yield.



VALUATION/RECOMMENDATION


Maintain HOLD; lower target price to S$5.70. 

  • We lower our target price to S$5.70, reducing our 2017F P/B valuation benchmark for the O&M business from 1.15x to 1.0x. 
  • A dim earnings outlook with a near-term recovery unlikely, a less-than-attractive implied yield of 3.9% and limited share price upside leaves us neutral on this counter. 
  • Maintain HOLD. Entry price: S$5.10.



SHARE PRICE CATALYST

  • Contract wins.





Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-07-22
UOB Kay Hian Analyst Report HOLD Maintain HOLD 5.10 Down 6.40


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