Keppel Corporation (KEP SP) - UOB Kay Hian 2018-01-26: 4Q17 Laying The Foundations For A New Chapter

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KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation (KEP SP) - 4Q17 Laying The Foundations For A New Chapter

• Keppel Corp’s 2017 core earnings of S$508m was below our and consensus expectations on an unexpected S$83m loss from the O&M unit, a reflection of low-margin orders secured in the downturn. 
• O&M’s runway to recovery remains a long one and we see an earnings recovery being boosted by the infrastructure and investment divisions. 
• Lower 2018-19 earnings forecasts by 3-9%. Keppel still remains the cleanest proxy to the O&M recovery. 
• Maintain BUY with a higher target price of S$9.30.

RESULTS

2017 core earnings of S$508.3m, below expectations on unexpected O&M losses. 

• Keppel Corporation (Keppel) reported a 2017 headline net profit of S$216.7m (-72% y-o-y) on an unexpected loss of S$83m in the Offshore & Marine (O&M) division. Results were further marred by provisions of the one-off financial penalty for its Brazil saga. The provisions were higher than initial guidance, owing to the inclusion of ~S$49m in related legal, accounting and forensics costs. 
• Adding back S$327m in net one-off items, core net profit was S$508.3m (-45% y-o-y), and below our and consensus expectations (UOBKH estimate: S$784m, consensus: S$873m).

O&M: A series of unfortunate events. 

• The 4Q17 results for the division disappointed. On top of a core operating loss of ~S$80m, a further provision of S$81m for Sete Brasil and impairments of S$54m (mostly related to a yard closure) were recorded. 
• No impairments were taken for the stranded rig assets. The core operating loss was attributed to lower work volume and low margin orders, a reflection of the orders taken during the downturn.

Property: Lower earnings, likely on sales/project mix. 

• Core operating profit for the property segment was S$82m (-42% y-o-y) after netting out Fair Value gains on investment properties. The lower earnings were likely due to recognition of a mix of lower margin and lower volume projects. 
• Operating margins were stable at 19%, and showed a sequential quarterly improvement (3Q17: 18.5%, 2Q17: 18.2%).

Homes sales: Tempered 4Q17 demand. 

• Quarterly home sales was the highest for 2017 at 1,695 units sold, though down by 23% y-o-y on: 
  1. cooling measures in China, and 
  2. lower volume from timing of launches in Vietnam. 
• That said, cooling measures appear to have a limited impact going by the strong 4Q17 sales figures for China (+56% y-o-y, +136% q-o-q). Vietnam was down on timing issues, Singapore sales were steady at 80 units and Indonesia saw the sale of ~170 units.

Infrastructure: Modest improvement. 

• The Infrastructure unit reported 4Q17 operating profit of S$37.5m (+37% y-o-y), helped by a one-off S$16.2m fair value gain from reclassification of Asia Airfreight Terminal (AAT). Core net profit for 4Q17 was S$18.7m (+0% y-o-y) while the corresponding 2017 figure was S$112m (+13% y-o-y). 
• The unit was helped by progressive revenue contributions from Keppel Marina East Desalination Plant project. 
• Coming quarters will see contributions from Keppel Infrastructure’s win of the S$5.3b Design-Build-Own Hong Kong Integrated Waste Management Facility (HK IWMF).

Investments: No land sales from TJEC. 

• No land sales were reported for the quarter. 
• The unit was dragged down partially by losses from associate KrisEnergy, as well as fair value losses on the warrants. 
• Asset management fees have picked up, rising from S$128m in 2016 to S$134m in 2017, a reflection of the increase in AUM to S$29b (2016: S$25b).

STOCK IMPACT

O&M outlook improving; earnings to reflect low margin orderbook in near- to mid- term. 

• The losses for the O&M division should have been expected, given that contract wins in any year lags earnings by one year. With two consecutive years of likely low margin orders, and future contract wins to be at low margins for a while, it may be difficult to see a tangible pick-up in earnings in the near- to mid-term. 
• Furthermore, the additional impairment for Sete Brasil suggests that impairment risks still remain; it seems imprudent to peg excessively high P/B multiples to the segment. Market is likely to have a rude awakening to this prolonged reality.

Infrastructure and investments, key growth areas. 

• These two key divisions are expected to help fuel earnings growth in the coming quarters. With initiatives such as Keppel Urban Solutions and Alpha DC Fund in place, 
• Keppel Capital is likely to grow by its expected S$5b p.a. in AUM, fueling the rise in recurring management fees. 
• Infrastructure is also expected to contribute more meaningfully in the coming years, driven by the HK IWMF project and its various upcoming data centre initiatives which we expect unit Keppel Telecommunications and Transportation (KPTT) to announce.

EARNINGS REVISION/RISK

Lower 2018-19 earnings forecasts by 3-9%. 

• Our earnings estimates for 2018-20 are S$818m (-9%) and S$1,140m (-3%) and S$1,158m (new) respectively. The changes reflect: 
  1. lowered O&M earnings, offset by higher earnings from: 
  2. Keppel Capital, and 
  3. infrastructure. 
• We caution that earnings estimates for O&M have downside risks.

VALUATION/RECOMMENDATION

Maintain BUY, raise target price to S$9.30. 

• We have raised our target price to S$9.30, owing to the higher earnings estimate for Keppel Capital, and a small upward revision to our Property RNAV. 
• Recognising infrastructure to be a growth area, we have revised our valuation for the unit to 2019F book value (previous: historical book value). 
• For O&M, while impairment risks still remain, we recognise the upside potential on a successful sale to Borr Drilling, as well as partial address of impairment issues in 2017. As such, we now peg it at 1.3x P/B, a 20% discount to its LT mean PB of 1.6x. 
• Total return, including dividend yield of 2.7% is ~11% and we maintain our BUY call. 
• Keppel remains our preferred pick to play the recovery in the offshore sector, being a cleaner proxy supported by multiple engines of growth over what is likely to be a prolonged earnings recovery.

Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2018-01-26

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 9.30 Up 8.750