Keppel Corporation - DBS Research 2018-01-08: Multi-pronged Rerating Ahead

Keppel Corporation - DBS Vickers 2018-01-08: Multi-pronged Rerating Ahead KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation - Multi-pronged Rerating Ahead

  • Property segment’s steep 30% discount to RNAV poised to narrow; Tianjin Eco-City land sale could add 73 Scts to valuation.
  • O&M activities set to rise as oil price stays above US$60/bbl.
  • Brazil bribery seems one-off and should not affect operations.

Property – Under-Appreciated and Under-Valued 

  • We are raising our valuation for Keppel’s property segment from 1.0x to 1.35x, to better reflect the potential of its lower cost land bank, and picking up in sales volume to realise RNAV. This translates to 10% discount to RNAV, in line with its closest Singapore property peer - CapitaLand. The revision adds S$1.57 to our SOTP-based target price. 
  • Every 0.1x increase in P/BV multiple boosts Keppel’s share price by 45 Scts.

A blue-chip property proxy; property accounts for half of Keppel’s profit. 

  • Contribution of Property to Keppel’s bottomline has increased drastically from approximately 20% previously to nearly half currently, as O&M, once the star performer that accounted for two-thirds of profits, is merely at breakeven now.

Keppel’s property business is undervalued at 0.9-1.0x P/BV vs peers’ 1.0-1.1x... 

  • Stripping out the fair value of the other three segments, implied valuation for Keppel’s property is undemanding at 1.0x P/BV. 
  • Assuming the market has fully priced in the potential of Tianjin Eco-City land sale (land sale rights is not recorded on its book given the “pay as you sell” arrangement), which we value at 73 Scts per Keppel share, the property segment is only valued at 0.9x P/BV. This represents 10-18% discount to Singapore developers’ 1.0x P/BV and Chinese mid-cap developers’ 1.1x P/BV.

… and an unwarranted steeper discount to RNAV. 

  • Stripping out the fair value of the other three segments, Keppel’s property segment is valued at 0.7x RNAV (or 0.6x RNAV if we exclude potential value for Tianjin Eco-city land sale), much lower than its Singapore large cap developer peers’ 0.7-1.0x RNAV.
  • Keppel has a huge land bank of 6.5m sqm, predominantly for residential projects, of which 68% is in China and 24% in Vietnam. Half of the landbank is currently under development.

Acquired at relatively low land cost especially in Tianjin. 

  • Keppel strategically acquired the landbank at much lower cost 5-10 years ago, largely during 2007-2012. Approximately 40% of the undeveloped GFAs are for residential / mixed use / township developments in Tianjin Eco-City, that was acquired from Keppel’s 45% JV Sino-Singapore Tianjin Eco-City Investment and Development Co Ltd (SSTEC) prior to 2009, for an estimate cost of around Rmb1,000 psm. 
  • The land sale price in Tianjin Eco-City has since surged ~14x to Rmb13,800 psm as of Jun-2017, implying lucrative returns when the land is developed, which are yet reflected in our RNAV.

Strategic divestment unlocks value. 

  • In line with its strategy to stay focused on four key countries, Singapore, China (five key cities of Shanghai, Beijing, Tianjin, Chengdu and Wuxi), Vietnam and Indonesia, Keppel has proactively embarked on capital recycling exercise and crystallised returns for existing projects. 
  • We observe that such divestments in 2017 yielded 35%-148% gain over book value, which reinforces our view that Keppel’s property segment should trade above peers’ valuation and book value.

Pricing in potential of Tianjin Eco-City 

G-to-G project living up to its mission. 

  • Tianjin Eco-City has made steady progress in realising its vision of being a model for sustainable development. Today, more than 70,000 people live and work in Tianjin Eco-City. It has also attracted over 4,500 registered companies with over RMB 200bn in registered capital. 
  • The eco-city has established five leading industries - cultural innovation (文化创意), Internet plus hightech (互联网+高科技), elite packages (精英配套), cold chain logistics (冷链物流) and coastal tourism (滨海旅游). It focus is on cultural innovation and Internet plus high-tech as its two pillar industries.

Turned profitable in 2017... 

  • We had previously not accounted for the valuation of Tianjin Eco-city project, which was in the red due to high initial investment for infrastructure and slow take-up rates. The project started to breakeven last year and recorded decent profit of over S$100m (Keppel’s share of 45% stake) in 1H17.

… following land sale and ASP spikes. 

  • Residential land sales are generally patchy. Sales doubled to 361k sqm in 9M17 (largely sold in 1Q17), from 2014. We expect land sales to accelerate over the next 3 years given the rising acceptance of Tianjin Eco-city and promising property market in Tianjin, and fully sold by 2028 (assuming 5-year extension from original timeline of 2023).
  • The ASP for residential land has also surged by 170% p.a. over the past two years to Rmb13,800 psm in 1H17. We have assumed moderate price growth of 10% / 5% in 2018/2019 and 2% p.a. thereafter.

RNAV lifted to S$9.80 

  • Our SOTP-based target price is lifted from S$7.60 to S$9.80 after incorporating the increase in property valuation from 1.0x to S$1.35x PB (+S$1.57) and factoring in the potential RNAV for Tianjin Eco-City residential land sale (+S$0.73). 
  • The impact of fines (re Brazil corruption) is partially offset by disposal gains.

O&M recovery provides further uplift 

Higher oil price to filter through the value chain. 

  • We are optimistic that the recovery of oil prices above US$60/bbl will incentivise oil majors to increase capex in their upcoming business plan announcements, which are typically announced together with full year results in Jan / Feb. We are already seeing a strong uptick in project sanctioning and tenders for production related facilities in particular FPSOs, which will drive order wins of Singapore rigbuilders. 
  • In addition, gas related products such as Floating Liquefied Natural Gas (FLNG) vessel, Floating Storage Regasification Unit (FSRU) are also expected to gather steam. These high value-add products could potentially emerge as the next “KFELs B Class” – Keppel’s most successful jackup rig design that is held in high regard by operators.

Trump’s proposal to open up US offshore leasing potentially a boon for rig demand 

Major opening up of US offshore leasing areas proposed by Trump. 

  • In the first week of Jan 2018, the Trump administration declared a proposal to allow offshore oil and gas drilling in 25 out of 26 regions of the Outer Continental Shelf (OCS), with the intention to hold 47 lease sales between 2019-2024. 
  • As a recap, over 90% of the OCS territory has been marked as offlimits for energy exploration and production since 1982; only limited areas such as parts of the Gulf of Mexico have been opened for business. Thus, Trump’s proposal signifies a complete about-face in the US offshore energy policy. Interior Secretary Ryan Zinke said the plan will make the US “the strongest energy superpower”.

Not set in stone yet. 

  • We understand that various opposition bodies, including environmental groups, business associations and state officials, are exploring legal options to try and block the proposal. The proposal must also pass environmental reviews, more public hearings as well as secure Congress approval.

Potentially a boon for rig demand. 

  • In 2016 the Bureau of Ocean Energy Management estimated that there were 89.8bn barrels of undiscovered technically recoverable crude oil and 327.4tn cubic feet of undiscovered technically recoverable natural gas within the US OCS – a bonanza for oil companies. 
  • To put those numbers in perspective, North American offshore oil production is estimated to be 1.33bn barrels in 2017 (based on Clarksons data). If the Trump administration’s proposal is approved, the prospect of this large resource base could accelerate the demand recovery of rigs particularly jackups given the relatively shallow-to-mid depth waters of the US OCS.

Order wins bottoming out; expect pace to accelerate into 2018.

  • Annual order wins for Keppel and peer Sembcorp Marine (SMM) have rebounded to S$1.1bn and S$900m, from S$500m and S$320m respectively. We expect them to secure S$2.5bn worth of new orders each in 2018, from FPSOs, FLNG and FSRUs solutions.
  • We believe strong order wins could drive a re-rating of O&M players from current 1.5x P/BV (taking cue from pure O&M play SMM’s valuation) closer to our current valuation peg of 1.8x (1SD below mean) as contract wins hit S$1.5bn mark (vs S$1bn in 2017) and further re-rate to 2.4x (0.5 SD below mean) if it moves towards our target of S$2.5bn. This could raise our fair value by S$0.46 Scts or 5% to S$10.26.

Brazil corruption should be one-off and not affecting Keppel’s future contract bidding 

  • While we can’t vouch for Keppel, we take solace in Keppel’s long track record, proactive actions upon emergence of the incident, tightened internal controls and separation of the executives involved. Furthermore, the incident should not affect Keppel’s ability to bid for future contracts. 
  • We have factored in the financial loss in our earnings model and valuations.

Reached global resolution in relation to corrupt payments made by its former agent in Brazil. 

  • Keppel announced on 23-Dec2017 that Keppel Offshore & Marine (KOM) has reached a global resolution with criminal authorities in Brazil, United States and Singapore in relation to corrupt payments made by KOM's former agent in Brazil, Mr Zwi Skornicki to Brazilian government officials between 2001 and 2014 for various projects with Petrobras and Sete Brasil, comprising 7 FPSOs and 6 rigs.
  • Keppel Offshore & Marine (KOM) has accepted a conditional warning from the Corrupt Practices Investigation Bureau (CPIB) in Singapore, entered into a Deferred Prosecution Agreement (DPA) with the U.S.
  • Department of Justice (DOJ) which requires KOM to fulfill certain requirements in the next 3 years before dismissal of the charges, and has reached a Leniency Agreement with the Public Prosecutor's Office in Brazil, the Ministério Público Federal (MPF).

Financial penalty amounted to S$570m or 31 Scts per share. 

  • As part of the resolution, KOM will pay fines in an aggregate amount of US$422m (or approx. S$570m), to be allocated between the U.S., Brazil, and Singapore. This will reduce Keppel’s NAV by 31 Scts per share and increase net gearing by 75 bps. 
  • The impact could be partially offset by the divestment in Keppel Marina Zhongshan that is expected to yield a gain of c.S$290m upon completion by 4Q17/1Q18.

Corporate governance – stricter controls & separation with executives involved. 

  • Keppel has proactively conducted internal investigations when bribery allegations first emerged in the Brazilian media in 2015 and voluntarily notified the authorities in the relevant jurisdictions to cooperate in connection with the suspicious transactions as announced in Oct 2016. As a recognition of Keppel's cooperation in the investigations and its extensive remedial measures, the authorities determined that an independent compliance monitor was not necessary, and KOM received a 25% reduction, the maximum cooperation and remediation credit possible, off the bottom of the applicable fine range under the U.S. Sentencing Guidelines.
  • Management reiterated Keppel’s zero tolerance for corruption and moved quickly to put in place stricter controls and embedded best practices across the Keppel Group. Disciplinary action has been taken against individuals involved in the misconduct including separation and financial penalties.

Operations unaffected. 

  • The global resolution has brought the case to a close. Keppel will continue its operations in the US and Brazil. This is not expected to affect Keppel’s existing contracts or its ability to bid for contracts in the US, Brazil and other countries in the future.

Minimum impact on dividend payout. 

  • Keppel will ring-fence the financial penalty when considering the final dividend to propose for the year ended 2017.

Reiterate BUY; Target Price lifted to S$9.80.

  • Reiterate BUY with higher TP of S$9.80 on property rerating, after raising valuation peg for property segment from 1.0x to 1.35x P/B, in line with a 10% discount to RNAV that is similar to Capitaland and imputing potential RNAV uplift from Tianjin Eco-city land sale.
  • Keppel’s decent dividend yield of 3-4% (based on 40% payout ratio) also lends support to its share price.

WHERE WE DIFFER: Property’s steep discount to RNAV poised to narrow. 

  • Keppel’s property segment remains undervalued at 0.9x P/BV, below Singapore developers’ 1.0x, notwithstanding Keppel’s huge historical landbank of 6.5m sqm at lower cost. Half of the landbank is currently under development and expected to complete by 2020, with RNAV to be realised over the next 3-5 years. 
  • Out of its remaining undeveloped landbank, 40% is development projects in Tianjin Eco-City, which Keppel acquired in 2009 at less than one tenth of the current land price and yet reflected in our RNAV. 
  • In addition, the ongoing portfolio rebalancing exercise will unlock values of completed projects. Hence, we believe the current steep 30% RNAV discount should narrow to ~10%, similar to peer Capitaland, pushing share price closer to our highest-on-the-street TP of S$9.80.

O&M on the cusp of recovery. 

  • O&M’s contract wins in 2017 bucked the declining trend as the division clinched S$1.1bn worth of new orders, which doubled over 2016. The momentum should continue into 2018 with S$2.5bn new orders assumed. New orders are expected to come from gas and FPSO projects which are buoyed by sustained oil prices above US$60/bbl. 
  • The recovery of new orders towards our target could prompt further re-rating of the O&M business from our current target valuation of 1.8x (-1SD) to 2.4x (-0.5SD) P/BV and lift TP by a further S$0.46.


  • Our TP of S$9.80 is based on sum-of-parts valuation:
    1. O&M segment is valued at 1.8x P/BV,
    2. infrastructure at 15x PE on FY18F earnings,
    3. property segment at 1.35x P/BV,
    4. investment (Keppel Capital) at 15x FY18F earnings, and
    5. market values/estimated fair values are used for listed subsidiaries. 
  • Our TP translates to 1.3x FY18 P/BV.


O&M segment could fare worse than expected. 

  • We forecast annual revenues from Keppel O&M to fall to the ~S$2.6bn level in FY17 and FY18, from S$7-8bn during FY12-14. The continued depletion of its orderbook and deferments/cancellations could pose downside risks to our forecast.

Pei Hwa HO DBS Vickers | http://www.dbsvickers.com/ 2018-01-08
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 9.80 Up 7.600