KEPPEL CORPORATION LIMITED
BN4.SI
Keppel Corporation (KEP SP) - Gas Strategy Hints At Building A Recurrent Earnings Stream
- Keppel’s underlying gas strategy entails more than just being a preferred vendor for LNG solutions; it hints towards building up a base of FLNG assets that generate recurring income. The compelling economics of FLNG units support this, with equity IRR as high as ~40%.
- Keppel could create a FLNG trust, in the footsteps of Golar LNG Partners. However, this will take years to unfold and near-term headwinds cap share price upside.
- Maintain HOLD with an unchanged target price of S$6.55. Entry price: S$5.90.
WHAT’S NEW
- We were invited by Keppel to a vessel tour of their FLNG conversion project, Hilli Episeyo, followed by a presentation on their gas strategy on 3 Jul 17.
STOCK IMPACT
Building up a recurrent earnings stream for O&M.
- The underlying theme behind Keppel’s strategy appears to be building an FLNG asset base that generates a recurring income stream. This could be achieved by selectively taking stakes in the FLNG orders it undertakes.
- Given the rising role of gas, this strategy provides Keppel with a highly scalable model to reap the benefits of higher FLNG vessel demand in the future.
Hilli Episeyo equity IRR of 14% on half its processing capacity.
- The economics of FLNG conversion projects yield a payback period of as low as 5-7 years. Using the Hilli Episeyo project as an example, we estimate an equity IRR of 14% (assuming 3-year construction time) and EBITDA yield of 14%. These numbers are even more compelling when accounting for the fact that these returns are based only on its initial 8-year contract, and half its processing capacity.
- Assuming the vessel’s full capacity, the equity IRR rises to an astounding ~40+% over its 8-year contract only (vessel has economic lifespan of 20 years). The high speed to market and short payback period makes FLNG a highly attractive investment class.
Possibilities exist for the formation of a FLNG trust.
- The high yield and short payback period makes FLNGs highly suitable for packaging into a yield instrument.
- Keppel’s co-partner and client, Golar LNG, has already done this through the incorporation of Golar LNG Partners (GMLP). Packaged as a Master Limited Partnership (similar to Singapore’s business trust), GMLP currently provides a dividend yield of 11.2%. The payout does not seem excessive, as the distribution coverage ratio is > 1.0x, highlighting its sustainability.
- Over time we envision Keppel could do the same after building out a sizeable asset base.
Vessel refits: Yet another recurrent income stream.
- At the same time, by enabling the build-up of the gas industry, Keppel will stand to gain from re-fitting vessels it had previously converted. FLNGs may require a refit of installed modules to handle the characteristics of each gas field they get deployed to, and Keppel would be the preferred contractor of choice should that be required. A sizeable asset base will be required for this, to match the short conversion time (several months) against the vessels’ multi-year deployments.
Each vessel could add 4 S cents to valuation.
- Based on Hilli Episeyo’s pro-forma earnings, we estimate that the unit will generate roughly S$4m-6m p.a. in investment income for Keppel’s 10% stake. This is likely to be recognised under Keppel Capital’s investment income, which we value at 19x PE. On a per share basis, this translates to 4 S cents per share.
- Additional stakes in similar vessels would be highly accretive to Keppel.
Dual-engines of share price growth.
- Given the scalability of the business model, this strategy provides Keppel with two engines of value growth:
- via construction earnings under the O&M business; and
- recurrent income stream via its stake in the completed vessels.
Long-term strategy not expected to bear fruit in the near term.
- We caution that this is a long-term strategy that will take several years to pan out. The strategy is also contingent on Keppel being able to invest in the projects they want.
EARNINGS REVISION/RISK
- No change.
VALUATION/RECOMMENDATION
Maintain HOLD; unchanged target price of S$6.55.
- We have left our SOTP target price unchanged at S$6.55 for now, preferring to incorporate valuation changes post its 2Q17 results release on 20 July.
- While we recognise the long-term potential of Keppel’s gas strategy, much of this remains a work in progress, with no significant earnings contributions expected until years later. In the near-term, share price faces headwinds from the O&M business division.
- Contract wins could catalyse share price, but this should have been already priced in, given our S$1.5b contract wins expectation (Ytd: S$364m).
- Maintain HOLD. Entry price: S$5.90.
Foo Zhiwei
UOB Kay Hian
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Andrew Chow CFA
UOB Kay Hian
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http://research.uobkayhian.com/
2017-07-07
UOB Kay Hian
SGX Stock
Analyst Report
6.550
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6.550
