Sembcorp Industries - DBS Research 2017-05-04: Shaping the Future

SEMBCORP INDUSTRIES LTD U96.SI

Sembcorp Industries - Shaping the Future

1Q17 results were broadly in line, boosted by strong urban development earnings.
India’s TPCIL outperformed but dragged by startup losses of SGPL.
Undertaking a strategic review to re-position SCI

Sembcorp Industries (SCI) offers a unique value proposition, as a proxy to ride the cyclical O&M upturn and has a defensive utilities business.
Our TP translates to 1.0x P/BV, implies 27% upside to current share price.
We believe this is fair in view of its 6% ROE and 2% dividend yield.

Overall group net profit of S$119.1m in 1Q17 was better than our expectations of S$100m on outperformance of Urban Development segment.
Urban development’s net contribution surged from S$1.2m a year ago to S$37.2m, thanks to high land sales in Nanjing, offsetting the startup losses of S$26m at SGPL, SCI’s second power plant in India.
TPCIL, its first power plant in India, registered a stellar quarter with net contribution of S$12m as the plant was running at full steam.
We were pleasantly surprised with the new Chongqing power plant in China, which managed to break even in 1Q17 despite higher coal prices.

The first unit of SGPL commenced operations in Nov-2016 and second unit in Feb-2017. The plant incurred relatively high startup losses of S$26-27m each quarter in 4Q16 and 1Q17.
Besides the potential teething issues, earnings can be volatile in the absence of long-term PPA and coal cost pass-through mechanism, while market is competitive in short term. SCI is actively exploring short-term contracts as an “alternative supplier” to help to fill the gap of generation by other power plants, which should yield better margins than just covering cash cost in the case of the spot market.

SMM reported headline net profit of S$39.5m (approx.. S$23.7m attributable to SCI), boosted by gains of S$46.8m arising from the disposal of a 30% stake in Cosco Shipyard Group.
Stripping out the disposal gain, SMM would have incurred a loss of c.S$7m vs our expectation of S$20m profit.
EBIT margins dipped further to 1.8% (vs 7.8% in 1Q16 and average of 6.4% in FY16). Management clarified that there were some variable costs incurred for a floater project, of which revenue has yet to be recognised pending conclusion with a customer. Otherwise, margins would have been “comparable to previous quarters”. Hence, we should see some “write-back” of the additional cost incurred in 1Q17, with the conclusion of variable orders relating to the floater project over the next few months.
The finalisation of modularised LNG terminals are key earnings drivers for SMM, each typically ranging from S$200- 300m (for importing LNG terminals) and up to c.S$1bn (for exporting LNG terminals).
SMM is reportedly in final talks with
1. Chinese conglomerates Poly Group and GCL Group for LNG solutions; and
2. Global LNG for a large LNG vessel.

Management shared during the results briefing that SCI is undertaking a complete review of its businesses and strategic direction.
While SCI does strategic reviews on a regular basis, with a different perspective from its new CEO, SCI is reviewing how it could build a better business model especially as some businesses are operating in challenging environments. The outcome of the review is expected to be revealed and implemented in six months’ time.
While it is premature to shed more light on the future direction of SCI, it might revive market speculation on rationalisation of the three home-grown industrial plays, namely SCI, Sembcorp Marine (SMM) and Keppel Corporation (Keppel).

Since Aug-2015, we have flagged up the potential merger between Keppel’s O&M arm and SMM in a structural downturn. There are various directions to embark on the rationalisation exercise of the big three homegrown industrial plays - SCI, SMM and Keppel Corp.
We believe at the end of exercise, Keppel Corp will remain as a conglomerate with multi-pronged businesses - SMM as pure marine play and SCI as a pure utilities play. In that case, SCI could emerge as a clear winner in this exercise as the spin-off of marine arm could re-rate SCI’s undervalued utilities business that is currently overshadowed by the weak marine outlook.

Given its diverse earnings stream and various listed assets, we derive our fair value for 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) and 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). We derive a TP of S$3.80, translating to 1.0x P/BV.

HO Pei Hwa DBS Vickers | http://www.dbsvickers.com/ 2017-05-04

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