Keppel Corp - Maybank Kim Eng 2016-09-21: Evaluating divestment opportunities

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KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corp (KEP SP) - Evaluating divestment opportunities

O&M may not be cash generative soon.

• In our view, capital locked in O&M may not be monetised soon as market conditions are still not conducive for rig owners to take delivery. O&M has historically been a major cash generator to fund investments in other segments and dividends. 
• We assess if Keppel needs more cash, whether it could sell non-core assets or take on more debt. 
• Other than possibly selling M1 (M1 SP, SELL, TP SGD2.04) and the T27 data centre, we see low odds of Keppel divesting traditional suspects near term. Thus, ‘value unlocking’ seems limited for now. 
• Maintain SELL on O&M headwinds, asset write-down risks and lack of re-rating catalysts. SOTP-TP lifted from SGD4.50 to SGD4.54 on changes in market values of listed entities.

Assessing divestment possibilities 

• With Keppel’s traditional cash-generating O&M business facing headwinds, we assess if Keppel may look to divest other businesses or would gear up if there are any major investment needs. 
• Based on our analysis, we view M1 as the most possible divestment candidate while likelihood for the others are low as they would either result in immaterial cash flows or substantial realised losses if sold at current market values.

M1 a possible candidate 

• We view M1 as non-core to Keppel as it is not synergistic with its key businesses and given its inability to exercise significant control due to its effective 15% stake. Moreover, our telco analyst is negative on M1 due to threat of new entrants in Singapore. If Keppel shares a similar view, it may make sense to divest this investment. 
• At current market value, selling M1 could generate about SGD342m in cash and a divestment gain of SGD196m, based on our estimate.
• Depending on divestment value, we think the sale of M1 would more likely be taken as a positive and could unlock value of at least SGD0.11 per share for Keppel’s shareholders.
• Potential buyers of Keppel’s stake in M1 would naturally be current major shareholders such as Axiata, which owns a 28.5% stake, and Singapore Press Holdings, which owns 13.4%. According to news reports, Axiata has said before it may consider raising its stake in M1 if the price is right.

Other listed entities may be less likely

KrisEnergy. 

• We believe this is not a core business for Keppel. However, divesting this investment now would not generate much cash for Keppel and could result in a realised loss of about SGD416m.
• Based on its FY15 annual report, the carrying value of its effective stake in KrisEnergy was SGD490m at Dec-2015, even when market value was SGD99m then. Keppel said in its annual report that no impairment was necessary as KrisEnergy is held for the long term and its expected recoverable amount, based on a DCF model, is higher than the carrying amount. The market value of KrisEnergy has since fallen further to about SGD56m.
• As an associate, Keppel need not recognise an impairment even if its carrying value is significantly lower than market value as long as it can argue that its long-term recoverable value is higher than its market value.
• But it may be prudent to do so and if Keppel decides to take some impairment charge, it could be as much as SGD0.23 per share if it is written down to listed market value.
• Nevertheless, any impairment will not have a significant impact on our SOTP valuation as KrisEnergy is already valued on a listed-market value basis. But it would 1) lower equity value thereby reducing debt headroom; and 2) have some negative impact to stock sentiment.

Dyna-Mac – possible impairment of SGD0.04/sh. 

• Dyna-Mac fabricates topside modules for FPSOs, which is synergistic with Keppel’s O&M business and does provide Keppel O&M with some strategic advantage.
• But we view this as non-core as we think divesting this business is unlikely to materially affect Keppel’s ability to secure FPSO contracts. 
• Carrying value of Dyna-Mac was not disclosed in its annual report but we estimate it using Keppel’s initial investment of SGD87.5m in the company in Mar 2011. Based on our estimate, cash from divesting DynaMac is insignificant at SGD26m and it could recognise a loss of SGD71m of SGD0.04 per share based on current market value of Dyna-Mac. 
• Similar to KrisEnergy, the impairment will not affect our SOTP valuation materially as Dyna-Mac is already valued on a listed market value basis but would have some impact in reducing equity value and affecting stock sentiment.

Keppel REIT. 

• We believe Keppel REIT is a core investment that facilitates Keppel’s strategy of capital recycling for its property segment. However, we think it could afford to trim down its 46% stake more and still maintain that strategy. 
• Nevertheless, disposing some stakes at the current market value would result in loss recognition and it may not be the best time to do so now.

Keppel Infrastructure Trust (KIT). 

• The rationale of KIT as a core investment is similar to the reason for Keppel REIT. KIT may serve as a potential vehicle for Keppel to divest any mature infrastructure development. 
• Given its reduced stake of 18% after the merger with Cityspring Infrastructure Trust to form the current KIT, we do not expect Keppel to shave its stake further.

Keppel DC REIT (KDC). 

• KDC performs a similar function as Keppel REIT and KIT in our view and is thus a core investment for Keppel. One of its data centres, T27 is expected to be prime for divestment in 2016 and we estimate this could be divested to KDC for c.SGD200m. 
• In 2014, Keppel divested two of its data centres, S25 and T25 to KDC prior its listing for SGD262.8m and SGD162m respectively. 
• T27 is a data centre with a GFA of 134,000 sqft and 47,000 sqft of lettable area that is located adjacent to T25. Comparatively T25 has a GFA of 106,726 sqft and a net lettable area of 36,888 sqft.

Mature property assets could be candidates 

• Judging by its trends in 2016, we believe mature property assets could be another area that Keppel may look to divest. Most of its divestments this year came from this area, including the recent divestment of LifeHub@Jinqiao, Shanghai for USD517m. Keppel classified most of these divestments as a normal part of its capital recycling.Keppel’s subsidiaries and associates as at Dec 2015 are listed on this 19-page document link, Keppel Group of Companies. 
• We believe there may be many small assets/investment holdings that could be divested but their values are unlikely to be significant. 
• Divestments that may have more significant impact could come from one of the properties/assets listed below, but other than for T27 held by Keppel Datahub 2, we are not aware of any that Keppel intends to divest soon.

No urgent need to divest, but debt headroom may not be what it seems 

• Nevertheless, Keppel may not be in a real need to divest assets yet as it could arguably still gear up. 1H16 net gearing was 0.62x with net debt of SGD7.3b. It theoretically has sufficient headroom to take on SGD4.5b of debt and still keep its net gearing below 1x.
• But we think its real debt headroom may not be what it seems from a debt-toequity perspective as its headroom may also be limited by the following considerations:
• Its FY16E net-debt-to-EBITDA is 5.5x is decent but not exactly low.
• Its FY16E EBITDA interest coverage of 6.3x is also not great in our view.
• Its equity value may be lower if it needs to make any write-downs to its 1H16 NAV of SGD11.8b.

No major “value-unlocking” catalysts near term 

• Based on our assessment, we think there are not many “value-unlocking” transactions that could catalyse Keppel’s stock price in the near term but downside risks remain imminent.
  • Possible positives: Divestment of 
    1. M1 and 
    2. T27 data centre. 
  • These may not have been totally priced in and would be positives for the stock. But based on our estimates, M1 divestment at market value could possibly add SGD0.11/share to valuation. 
  • We do not know the cost for T27 but even if we assume its entire SGD200m potential sale value is pure gain for Keppel, its attributable gain would be about SGD0.095/share. 
  • Adding this to M1’s potential gain would lead to an addition of at most SGD0.21/share to valuation. This is insufficient to swing our views.
  • Possible negatives: Further impairment/write-downs for: 
    1. KrisEnergy; 
    2. Dyna-Mac; 
    3. Sete Brasil rigs; and 
    4. other rigs in its portfolio. 
  • While we mentioned that impairment of KrisEnergy and Dyna-Mac would not have an impact on our valuation, we believe it would still be detrimental to stock sentiment and reduce debt headroom.
  • Furthermore, we believe the risk of further write-downs in other rigs in its portfolio remains.
• Therefore we keep our SELL call on the stock with a SOTP-TP slightly lifted from SGD4.50 to SGD4.54 purely due to changes in market values of listed entities.

Swing Factors

Upside

• Sete Brasil settles its financing woes, is able honour all its contracts and pays Keppel its dues.
• Ability to turn contract cancellations around by re-selling and making better profits because of forfeiture of original client’s deposit.
• Asset divestments that results in significant gains and value unlocking, which is possible in Keppel T&T and infrastructure segments.

Downside

• Sete Brasil files for bankruptcy, dishonouring all its six semisub contracts with Keppel O&M.
• Contract cancellations by other drilling rig owners, resulting in asset write-downs and losses.
• Property segment fails to compensate for drop in O&M segment profits.

Yeak Chee Keong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-09-21

Maybank Kim Eng SGX Stock Analyst Report SELL Maintain SELL 4.54 Up 4.500