Keppel Corporation (KEP SP) - UOB Kay Hian 2017-04-21: 1Q17 Earnings Supported By S$143m In One-offs, O&M Barely Breaks Even

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KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation (KEP SP) - 1Q17 Earnings Supported By S$143m In One-offs, O&M Barely Breaks Even

• Keppel’s 1Q17 core earnings missed our and consensus expectations by a huge margin. 
• Headline earnings of S$260m (-24%) was supported by S$143m in one-offs. Excluding this and fair value gains, core net profit was S$104m (-50%). 
• The key drag was the O&M unit, which saw earnings decline by nearly 100%. 
• The outlook remains challenging on the O&M front. Property appears stable, but we note challenges. 
• Cut 2017 earnings estimate by 14%, and lower target price to S$6.55. 
• Maintain HOLD. Entry price: S$5.90.

RESULTS

1Q17 core results down 50% yoy, below expectations. 

• Keppel Corporation (Keppel) reported headline net profit of S$260.4m (-24% yoy), which included S$143m in one-off items, mostly due to the write-back of impairments and gains on disposals. 
• Excluding these as well as S$13m in fair value gains, core net profit was S$104m (-50% yoy). This represented 12% of our prior full-year estimate of S$868m, significantly below our and consensus expectations. 
• The large deviance was largely attributed to the O&M division, which barely broke even at S$95,000 for 1Q17.

O&M operational updates. 

• FPSO for Yinson was delivered. FPSO P-66 had sailaway for final topside integration, with Golar Hilli FLNG, BW Offshore Catcher FPSO and SOCAR Semi on schedule for delivery this year. Fecon delayed its three jackup orders to 2H19 (previously: 2017). Gandria notice-to-proceed now revised to 31 Jul 17.

O&M barely broke even at S$95,000. 

• The O&M segment reported a net profit of S$95,000 for 1Q17, largely led by a 41% yoy decline in revenue. Operating margin was at 0.8%, a historical low. 
• Management remarked that there were no one-offs during the quarter, though restructuring costs could be elevated as direct workforce was reduced by another 1,250 (-6% yoy) during the quarter. Repair volumes were down slightly yoy while repair revenues were stable.

Property earnings down slightly at S$103m. 

• Keppel’s property unit reported lower revenue of S$262m (-48% yoy), but comparable net profit of S$103m (-3% yoy) vs that in the prior period. 
• Homes sales was higher at 980 units (+4% yoy) with total sales value of S$530m. Bulk of the sales came from China (China: 730, Vietnam: 110, Singapore: 130, Others: 10). 
• Net profit of S$29m was recorded from divestment of its 80% stake in a Surabaya company.

Infrastructure net profit up 129% yoy. 

• The infrastructure division’s net profit was at S$32m (+129% yoy), largely helped by Keppel Infrastructure, which reported a net profit of S$30m. This includes gains on the divestment of stake in GE Keppel Energy Services (estimated at S$4.5m).

Investments recorded S$112m in one-off divestment gains. 

• The asset management division saw net profit reverse from a loss of S$4m to a profit of S$125m, helped by S$112m in likely one-off divestment gains and reversal of impairments. Net profit from asset management fell to S$13m (-13% yoy).
• Net gearing largely unchanged at 0.57x, compared to 0.56x in the prior period. Free cash outflow for 1Q17 was S$80m (1Q16: outflow of S$306m).

STOCK IMPACT

O&M: The worst may be over, but it definitely is not improving. 

• The near breakeven in profit is startling, as Keppel had already significantly lowered its cost base by mothballing two overseas yards and reducing its direct workforce by 18,000 or 49% since 2015. 
• With only S$3.5b in net orderbook to be recognised over 2017-21, turnover from projects will be subdued, heavily supported by repair turnover. 
• Fresh contract wins remain absent, and more cost cutting is to be expected if the situation persists. One comfort from this is Keppel’s active management to keep the business minimally profitable. The other solace is its yards were acquired at low cost, so gains could possibly be recognised on divestment.

Almost fully driven by property earnings; challenges exist. 

• Despite Property’s continued stable net profit contribution, we note challenges exist in its portfolio. Close examination of its launch completion schedules shows completion for its Stamford City (Jiangyin), Hill Crest Residences (Kunming), Seasons Height (Tianjin) and West Vista (Indonesia) projects pushed back into 2019 and beyond. 
• The delays in China is consistent with management’s comment that home sales in China are slowing. That said Keppel retains the advantage of not being rushed to sell units, with great flexibility in managing development launch dates.

1Q17 a quarter of divestments. 

• We note that divestment gains have supported Keppel’s earnings to a very large extent in 1Q17. 
• A read through points to the need to recycle assets and free up cashflow to meet the shortfall from O&M. This cannot go on forever. Should the O&M division continue to burn cash and the downturn remain protracted (we think it will until 2020 at least), the division being viewed as non-core could be possible.

EARNINGS REVISION/RISK

Cut 2017 earnings forecast by 14%. 

• Given the sharper-than-expected drop in O&M profit, we have cut our 2017 core earnings forecast to S$745m (-14%). 
• Our 2018-19 core earnings forecasts are at S$791m (-0%) and S$862m (+5%) after adjustment of the O&M orderbook recognition schedule. 
• Our contract assumptions remain unchanged at S$1.5b for 2017, and S$2.0b for 2018/19. We caveat that they may be further downward revisions for this division going forward.

Lumpy earnings, skewed towards 2H17. 

• With the property segment likely to dominate earnings going forward, earnings are likely to be skewed towards 2H17 given that profits are recognised on completion, which is mostly scheduled for 2H17.

VALUATION/RECOMMENDATION

Maintain HOLD, lower target price to S$6.55. 

• Our SOTP target price falls to S$6.55 after lowering the earnings forecast for O&M and adjusting our P/B multiple to 1.0x to reflect the lower O&M ROE. This does not take into account any equity adjustments required on divestment of its yards. 
• Property is valued at 0.8x historical P/B. 
• With the outlook still challenging for Keppel, and core earning weak, the stock remains a trading play at best.
• Maintain HOLD.

Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-04-21

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 6.55 Down 6.980