Sembcorp Industries - DBS Research 2018-02-26: Unlocking Value Through IPO, Divestment

Sembcorp Industries - DBS Vickers 2018-02-26: Unlocking Value Through IPO, Divestment SEMBCORP INDUSTRIES LTD U96.SI

Sembcorp Industries - Unlocking Value Through IPO, Divestment

  • Utilities earnings dragged by provisions in 4Q17.
  • Repositioning as a Global Integrated Energy Player.
  • Unlocking value through IPO and divestments.
  • Reiterate BUY; Target Price adjusted to S$4.40.

Maintain BUY; Target Price lowered to S$4.40, after lowering our target price for Sembcorp Marine (SMM) from S$3.10 to S$2.90.

  • While the market may be disappointed as there were no drastic actions announced, such as Sembcorp Marine (SMM) divestment in the Strategic Review, key strategies to grow utilities business and more active capital recycling should be positive for Sembcorp Industries (SCI) in enhancing its ROE. 
  • We continue to like Sembcorp Industries as it offers a unique value proposition as a proxy to ride the cyclical O&M upturn, and is supported by a defensive utilities business.

Repositioning; Recycling Capital. 

  • Sembcorp Industries is repositioning its Utilities business to be a global integrated energy player, rebalancing its portfolio in terms of markets and products, with targets to double the renewables portfolio. Its focus on more proactive capital recycling will allow Sembcorp Industries to augment its balance sheet (lower gearing by 0.15x), and enhance ROE. 
  • Including IPO of the India assets, we estimate that proceeds will easily exceed S$1bn over the next 2-years, much higher than ~S$870m of IPO/divestment proceeds achieved over the last 5 years.

Where We Differ:

  • We believe in the long-term growth prospects of Sembcorp Industries’ utilities arm, which has expanded its global footprint and recently made forays into key emerging markets – India, Bangladesh and Myanmar. 
  • While the marine spin-off did not happen in the recent strategy review, we hold on to our belief of a potential merger between Keppel’s O&M arm and Sembcorp Marine in view of keener competition in the sector. The potential spin-off of its marine arm could re-rate Sembcorp Industries’ undervalued utilities business that is overshadowed by the cyclical marine business.


  • Given its diverse earnings stream and various listed assets, we derive our fair value for Sembcorp Industries based on the sum of its different parts. 
  • For its holding company position, we applied a 10% conglomerate discount to the reappraised net asset value (RNAV) to derive a Target Price of S$4.40, translating to 1.1x P/BV.

Key Risks to Our View

  • Key risks to earnings are further deferments/cancellations of marine projects, deterioration of Singapore's power spark spreads, and execution hiccups at its Indian power plants.

WHAT’S NEW - A kitchen sinking year; unveiling Strategic Review 

Results highlights - A kitchen sinking year. 

  • Net profit in 2017 declined 44% y-o-y to S$230.8m, hit by weak Marine segment that was barely profitable, losses in SGPL, refinancing charges, and impairments and write-offs.

Utilities dragged by provisions in 4Q17. 

  • Group headline net profit came in below expectations, declining 32% q-o-q to S$22.8m in 4Q17. 
  • Besides Marine’s weakness (61%-owned SMM reported net loss of S$34m in 4Q17), utilities segment was dragged by S$25.4m provision for potential fines and claims arising from alleged environment offences in an overseas water plant. Otherwise, core utilities profit of c.S$70m was largely in line.

India operations affected by scheduled maintenance shutdown and coal price. 

  • India utilities incurred larger than expected losses of ~S$36m (TPCIL: -S$4m; SGPL: -S$27m; SGI: -S$5m) in 4Q17 due to scheduled maintenance shutdown and higher coal cost. For TPCIL, the higher coal cost will be reflected in tariffs with a 6-month lag under the long-term PPA.

China operations were stronger than expected

  • China operations were stronger than expected, rising 270% q-o-q, lifted by the contribution from maiden full quarter contribution of Changzhi plant and write back of bad debts.
  • This mitigated the weaker India performance.

Marine net loss amounted to S$33.8m for 4Q17 (Sembcorp Industries’ share of S$20m). 

  • Stripping out forex gain (S$20m), tax credit (S$19m) and inventory & work-in-progress write back (S$32m), losses would have been c.S$100m, of which we believe a substantial portion was attributable to expected cost overrun for variation orders on several projects as customers have yet agreed to pay.
  • We believe total cost overrun for disputed variation orders exceeded S$100m last year. We expect a gradual improvement ahead as some of the cost overruns for disputed variation orders in 2017 could be recouped this year and better economies of scale from higher activity level towards 2H18 should help.

Sembcorp Industries declared 2Scts final dividend bringing full year dividend to 5Scts, representing 1.5% yield.

Strategic Review 

  • Overall, key strategies to grow its utilities business and proactive capital recycling is positive for Sembcorp Industries in enhancing ROE. Although we were hopeful of more concrete plans in relation to Marine segment, be it a demonstration of synergies within the group or divestment through dividend in specie.
  • Please refer to our previous expectation on Sembcorp Industries’ review: Sembcorp Industries: Strategic Review Next Week? 

Repositioning as an Integrated Energy Player. 

  • The Utilities business will focus on growing three business lines - Gas & Power; Renewables & Environment; and Merchant & Retail, with the aim of having a balanced portfolio in developing and developed markets in four key markets, namely Singapore & Southeast Asia; China; India and the UK.
    1. Gas & Power business will target opportunities in thermal power, gas importation and retail as well as regas infrastructure 
    2. Renewables & Environment business will focus on renewables, water and wastewater treatment as well as waste-to-resource growth opportunities in the low-carbon and circular economies 
    3. Merchant & Retail business, with its newly added merchant capabilities, will enable the business to capture opportunities closer to customers in multiple markets and enhance competitiveness and returns 

What’s new? 

  • The repositioning involves changes in key market focus, portfolio rebalancing between developing and developed markets and trend towards cleaner and sustainable assets such as renewable energy. In addition, upstream and midstream integration will be further enhanced through gas transportation and Merchant & Retail expansion. 
  • There will also be more deployment of digital technologies to enhance operations and capture new opportunities.

Doubling renewable energy assets to ~4000MW by 2022.

  • Besides China and India, in which Sembcorp Industries has strong market positioning, management sees opportunities in the UK/Europe, Australia/New Zealand, Singapore & SEA. Sembcorp Industries plans to expand more into wind power (in particular onshore wind) which has higher barriers to entry than solar. The split between wind and solar will likely be 75%:25%.
  • Our take: Renewable energy is a cleaner form of alternative energy source that complements conventional thermal power. The economics has improved vastly in recent years with the falling levelised cost of electricity. In emerging markets, the return could be double that of developed markets like Europe, compensating for higher regulatory and business risks especially on offtakers. The experience accumulated in China and India should help in managing the risks.

More active and systematic capital recycling to fund acquisitions. 

  • In addition to the proposed IPO of India assets, Sembcorp Industries targets utilities divestments of up to S$0.5 billion over the next two years. As a good start, the Group has entered into a conditional sale agreement to divest its 100% stake in Sembcorp Utilities South Africa for gross proceeds of ZAR 790m or S$89m.
  • Our take: Including the IPO of India assets, proceeds would easily exceed S$1bn over the next 2-years, much more than ~S$870m of IPO/divestment proceeds achieved over the last 5 years. Its focus on more proactive capital recycling will allow it to augment its balance sheet (lowering gearing by 0.15x), deliver sustainable growth, and enhance ROE.

Target for double digit ROE. 

  • Management guided that they aim to improve the ROE from current mid-single digit to double-digit over the next 5-years through improvements in both Marine and Utilities segments.
  • Our take: This can be achieved through divestment of noncore/non-performing assets, and earnings growth. Two key drivers are Sembcorp Marine and SGPL’s turnaround. For Sembcorp Marine, we expect earnings to recover following an increase in its order-book but ROE will likely to stay at the single digit level in the next two years. For SGPL, it appears that the improving power supply/demand dynamics in India will lead to government’s commitments for long-term PPAs. ROE recovery is a critical factor for Sembcorp Industries’ re-rating in our view.

IPO of India Assets. 

  • Sembcorp Industries has reorganised and consolidated all its India Energy assets under Sembcorp Energy India Limited (SEIL, 93.7% stake), comprising TPCIL, SGPL and SGI. On 23 Feb, Sembcorp Industries initiated the process for an IPO of Sembcorp Energy India Limited on BSE Limited and the National Stock Exchange of India.
  • Our take: Based on our back-on-the-envelope calculations, the IPO of SEIL could yield approx. ~S$200m revaluation gains in total, of which nearly half could be realised gains if Sembcorp Industries divests 43% of its interest and retains ~50% stake in SEIL.
  • The divestment could free up ~S$600m cash for Sembcorp Industries. We are conservative in our calculations as the valuation for SEIL could be higher in the event
    1. SGPL secures a long-term PPA earlier than expected;
    2. market recovery, and
    3. renewable segment sees stronger growth and returns ahead.

Marine - some synergies possible. 

  • Management believes that Sembcorp Marine is well-positioned to benefit from industry recovery with its diversified, innovative solutions across the offshore and marine value chain, both within and beyond the oil and gas sector. Sembcorp Industries will thus continue to support the business through the cycle.
  • Our take: While marine spin-off did not happen in the recent strategy review, we hold on to our belief of a potential merger between Keppel’s O&M arm and Sembcorp Marine in view of keener competition in the sector. Spinning-off its marine arm could re-rate Sembcorp Industries’ undervalued utilities business that is currently overshadowed by the cyclical marine business. Meanwhile, Sembcorp Industries could demonstrate some form of synergies through placing orders with Sembcorp Marine for gas solutions such as FSRU, Gravifloat modularized LNG terminals, LNG vessels etc.
  • In addition, Sembcorp Marine could also supply Sembcorp Industries with offshore windfarm facilities if attractive offshore windfarm opportunities arise.

Urban Development –industrialisation and urbanisation trends. 

  • Sembcorp Industries’ urban development business is uniquely placed to capture opportunities from industrialisation and urbanisation in its core markets – China, Vietnam and Indonesia.
  • Our take: Urban Development is synergistic to Sembcorp Industries’ utilities business, as post land / property development, Sembcorp Industries could continue to support the utilities of the new industrial / commercial / residential estates. Sembcorp Industries’ land and property development expertise could also be helpful if Sembcorp Marine decides to redevelop the Admiralty Shipyard into a waterfront township.


  • Maintain BUY with a slightly lower Target Price of S$4.40, mainly to account for Sembcorp Marine’s Target Price revision from S$3.10 to S$2.90. FY18/19F earnings are reduced by 10-13% largely due to the earnings revisions for Sembcorp Marine. 
  • For India thermal power plants, we have also reduced our earnings projections by S$18m in view of the higher coal cost, partially offset by higher renewable earnings of S$6m after the stake increase in Sept17.

Pei Hwa HO DBS Vickers | 2018-02-26
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 4.40 Down 4.500