Sembcorp Industries (SCI SP) - UOB Kay Hian 2018-06-29: India Outlook Improving, Downside Priced In; Upgrade To BUY

SEMBCORP INDUSTRIES LTD SGX: U96

Sembcorp Industries (SCI SP) - India Outlook Improving, Downside Priced In; Upgrade To BUY

Merchant power prices in India remain on the rise. With only 38% of SGPL’s capacity contracted at low tariff prices, there is sizeable capacity available to benefit from higher ST PPA prices or spot prices.
The IPO of the India unit remains on track, though local media suggests some headwinds.
Current valuations imply the non-marine unit to be trading at 6x PE, below its long-term forward mean PE of 8x.
Value has emerged, and we upgrade to BUY with unchanged target price of S$3.60.

India’s merchant power prices on the rise. As of May 18, DEEP portal prices are trading above Rs4.7/kWh. The DEEP platform is used by DISCOMS to bid for short-term ( < 1 year) power purchase agreements (PPA). Incidentally, this coincides with a shortfall in domestic coal supply, which has squeezed prices upwards.
PPA market moving into balance, but demand only likely to pick up in 2019. According to a local brokerage report, the PPA market is expected to move into balance around FY22/23 (YE Apr). DISCOMS that need new PPAs usually start their planning and bidding process about a year or two prior, suggesting that 2019 will be the earliest for new PPA demand to kick in.
2Q18 preliminary PLFs showing a q-o-q improvement. As of 24 June, the plant load factors (PLF) of Sembcorp Energy India (SEIL) and Sembcorp Gayatri Power (SGPL) were 84% (1Q18: 79%, 2Q17: 88%) and 91% (1Q18: 83%, 2Q17: 78%) respectively.

Rising prices a positive for a turnaround in India. SGPL is expected to see smaller losses as it enters into new short-term ST PPAs at the higher prices. Current PPAs were entered into at
Improving industry conditions should help with IPO, still targeted for a 2H18 launch. The improving industry outlook should help assuage potential investors’ fears of Sembcorp Industries’ (SCI) India IPO. That said, local media had on 13 June reported a delay in the IPO launch to 2QFY19 (3QCY18), citing investor concerns over the general macroeconomic environment as well as pricing. If true, the revised date remains within expectations for a 2H18 listing, though the investor concerns pose a concern.
Strong PLF performance for SGPL bodes well for y-o-y improvement. Given the strong 2Q18 performance thus far, as well as higher spot electricity price exposure, losses at SGPL are expected to narrow. However, partially offsetting this improvement is the weak performance from SEIL, which suffered from 8-9 days of outages in May. Overall, a net y-o-y improvement is to be expected.

Earnings tweaked by 0-2% for changes in India and UK. We have incorporated the earnings impact from the acquisition of UK Power Reserve. Earnings for SGPL have been tweaked. Our revised earnings estimates are now S$366m (0%), S$456m (-2%) and S$488m (-2%).

Sembcorp Industries' share price has weakened substantially since 13 June.
Current prices imply the non-marine portion to be trading at 6x PE, below the long-term mean PE of 8x. Alternatively, this would also imply that current valuations accord either zero or a negative value to the India business, which is not the case.
Given the limited downside, upgrade to BUY on valuations. Target price at S$3.60, implying a non-marine FY19 PE of 8.5x.

Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | https://research.uobkayhian.com/ 2018-06-29

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