Sembcorp Industries (SCI SP) - UOB Kay Hian 2018-02-26: 4Q17 The Rocky Transformation To Better Returns. Downgrade To HOLD.

Sembcorp Industries (SCI SP) - UOB Kay Hian 2018-02-26: 4Q17 The Rocky Transformation To Better Returns. Downgrade To HOLD. SEMBCORP INDUSTRIES LTD U96.SI

Sembcorp Industries (SCI SP) - 4Q17 The Rocky Transformation To Better Returns. Downgrade To HOLD.

  • Sembcorp Industries' 2017 core net profit of S$277m (-44% y-o-y) was 74%/72% of UOBKH/consensus estimates, below expectations. India and Marine remain a drag, and this is expected to continue for an extended period. The Utilities-focused strategic review represents a shift towards improving earnings quality (positive) but we fret over the shift towards more acquisitions. Earnings slashed by 13-20% as we turn less upbeat on India.
  • Downgrade to HOLD, with a lower target price of S$3.28. Entry price: S$2.90.


Core net profit of S$277m below expectations. 

  • Sembcorp Industries (SCI) reported headline 4Q17 net profit of S$22.8m (-85% y-o-y) on losses from its Marine division and a sharp drop in Utilities earnings owing to a S$25.4m provision for fines for an overseas wastewater project. 
  • One-offs amounted to S$25m at the PBT level, and we broadly estimate that after adjusting for Sembcorp Industries’s share of one-offs from the Marine division, it just broke even for 4Q17. 2017 headline net profit was S$230.8m (-42% y-o-y) with core net profit at S$277m (-44% y-o-y). 
  • Earnings were a miss, coming at 74%/72% of UOBKH/ consensus.

Utilities: India continues to disappoint. 

  • Excluding India, 4Q17 net earnings from the six geographies were broadly in line, albeit dragged by a S$25.4m provision for a fine.
  • Middle East was weaker y-o-y due to a turbine shutdown at the Salalah power plant.
  • China’s 4Q17 net profit saw a sharp q-o-q uptick owing to contribution from its Changzhi water plant. India remained a huge disappointment - as highlighted in Dec 17, the two plants underwent an annual maintenance shutdown, resulting in a quarterly loss.
  • Sembcorp Green Infra (SGI) reported losses owing to the low wind season.

Marine: Net loss of S$22m. 

  • Please refer to our note on SMM (Sembcorp Marine: 4Q17 Running on Fumes; Downgrade To HOLD) on this. With regards to the Strategic Review, no corporate action for the Marine division was mentioned. Management remarked that they will continue to support the division through the cycle.

Urban development: 4Q17 net profit of S$29.3m (+7% y-o-y). 

  • This was the division highest ever reported net profit. Full-year net profit was a record S$89.4m (+150% y-o-y), driven by a record high 280ha of land sales. Current orderbook stands at 251ha, and the earnings momentum is expected to continue on the back of strong demand in China, Vietnam and Indonesia.

Strategic review: Focused on Utilities. 

  • Key points are summarised below: 
    1. Targets divestment of S$0.5b over the next two years, excluding IPO of its India Utilities business, which is a divestment of a minority stake for now. It is also divesting its South African municipal water operations.
    2. Targets to raise ROE to double-digits in 5-years’ time.
    3. Increase renewables capacity to 4,000MW by 2022. This represents about 500MW of capacity per annum over four years, about double the amount it does in India at present. This will be achieved mainly via wind and solar plants, with a greater mix towards the former.
    4. Lower carbon output by 25%.
    5. Preparing for the Smart Grid. Management is looking at battery storage as a viable business line, as well as harnessing data analytics to prepare for the digitalization of the energy grid.
    6. Shifting from developer to an originator. Sembcorp Industries plans to do more acquisitions in the future. This sees the need to substantially adjust its balance sheet and cashflows to accommodate the future transactions.


Utilities to remain a drag. 

  • We have probably been overly positive on the potential of a turnaround in the India business. After a year of waiting, visibility of a long-term PPA for SGPL remains elusive and disheartens us. The losses will be a drag, and it will take time for prices to return to more profitable levels. 
  • The other geographies do not present significant earnings upside at face value; we will review this in detail at another time.

Improvement of ROE to double digits to take time. 

  • This will help improve valuations in the longer-run if well-executed. At face value, the key drag to returns are its Utilities and the Marine division. 
  • Improving the earnings quality from these two segments alone should be sufficient to achieve the double-digit target, and we think the 5-year runway represents the gestation period needed for marine to turnaround.

Shift towards greater acquisitions worries us. 

  • The market for Utilities asset is even more competitive than before. Based on Keppel Infrastructure Trust’s (KIT) conference calls, demand for Utilities assets within the region has seen bids drive down yields below KIT’s targeted 6-7%. There is a risk of overpaying for existing assets in this market. The need for liquidity to execute this strategy will impact cashflow, and we see risk of a dividend payout kept to the bottom of the 30-40% range.


Slash 2018-19F earnings by 13-20%. 

  • We have assumed sustained losses for SGPL in 2018-20. For now, we are pencilling in 2018-19 revised earnings estimates of S$362m (- 20%) and S$446m (-13%). Earnings for 2020 are introduced at S$521m. 
  • We will fine-tune our earnings estimates again at a later period.


Downgrade to HOLD, lower target price to S$3.28. 

  • Factoring in our lower target price of S$1.90 for Sembcorp Marine, our revised target price is S$3.28, implying 9x 2019F PE for the Utilities segment. 
  • We opt to wait for signs of Sembcorp Industries' execution of its new strategy, and see limited upside in the interim. Downgrade to HOLD, entry price S$2.90.

Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | 2018-02-26
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