Sembcorp Industries - DBS Research 2018-08-06: India Turnaround

Sembcorp Industries - DBS Group Research Research 2018-08-06: India Turnaround SEMBCORP INDUSTRIES LTD SGX:U96

Sembcorp Industries - India Turnaround

  • Sembcorp Industries’ 2Q18 slightly above boosted by urban development profit and strong India turnaround.
  • India’s second power plant SGPL saw core losses narrowing to S$3m, from average of ~S$27m a quarter.
  • Bidding for Hyflux’s Tuaspring asset?
  • Reiterate BUY; Target Price lowered to S$3.90, largely to account for Sembcorp Marine’s lower Target Price.

Maintain BUY; Target Price adjusted to S$3.90, largely due to lower SMM Target Price.

  • Sembcorp Industries (SCI) offers a unique value proposition as a proxy to ride the cyclical O&M upturn, and is supported by a defensive utilities business.
  • India operations recorded all-time high profits in 2Q18. We believe continuous improvement in India will re-rate Sembcorp Industries’ Utilities business, which is undervalued at 0.5x P/BV and 6x PE against 6.5% ROE.

~ ~ Where SG investors share

India power segment on recovery path; remains a long-term growth engine.

  • The power market in India is recovering with narrower oversupply in the market and higher tariff. This should swing the India operations to profit in 2018. Sembcorp Energy India Limited (SEIL) operates 3,567MW power capacity comprising 2,640MW of thermal power and 927MW of renewable capacity as of end-December 2017. It has been awarded an additional 800MW of wind capacity since and management targets to grow renewable capacity in India by 300-500MW p.a. 
  • The potential IPO of SEIL could realise revaluation gains of S$100-200m, based on our ballpark estimate.

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, Vietnam and Myanmar.
  • While the marine spin-off did not happen in the 2017 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$3.90, translating into 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 - 2Q better than expected

SCI 2Q18 results came in slightly above expectations.

  • Sembcorp Industries’ net profit grew 7% q-o-q to S$82m despite bigger Marine losses, thanks to stronger India operations and urban development income.

Urban development segment generated S$35m profit in 2Q18 (vs S$10m in 1Q18).

  • This brings 1H18 profit to S$45m, making up 90% of our full-year expectation as land sales tend to be lumpy by nature.

India operations delivered the strongest quarterly profit of S$39m in 2Q18.

  • We understand that this includes the write-back of dispute income for SGPL amounted to S$11m. Still, S$39m quarterly profit is the strongest since the commencement of India operations. The second power plant without long-term PPA, which has been making S$27m losses per quarter saw core losses narrowing to S$3m in 2Q18. This is attributable to higher load factor, tariff and power demand amidst warmer-than-expected weather. 
  • While we noted that tariff has softened recently, we are encouraged to see improving supply/dynamics of the India power market.

Overall, Utilities segment grew 21% q-o-q to S$85m, bringing 1H18 profits to S$155m.

  • Sembcorp Industries’ UK operations reported a loss of S$3.9m this quarter dragged by S$7m losses from new acquisition UK Power Reserve (UKPR). UKPR is not expected to contribute materially in 2H18 and we expect profit contribution of S$20m.

Marine segment saw losses widening on expected losses for West Rigel sale.

  • Excluding forex impact, net losses widened from ~S$30m in 1Q18 to ~S$50m (SCI’s interest of S$31m) in 2Q18 largely due to ~S$24m loss that was recorded for the disposal of semi-submersible rig – West Rigel - which was concluded in May 2018. Headline losses amounted to S$50m in 1H18. 
  • We have lowered our EBIT margin by 1.4ppts in FY18 and pushed back revenue recognition in FY19 given the slow contract wins (S$730m or 24% of our full-year expectation) in 1H18. Our net profit forecast for FY18-19 is reduced from S$54-126m to S$16-64m (SCI’s interests: S$10- 39m).

Earnings revision.

  • Sembcorp Industries’ 1H18 net profit totalled S$159m (-8% y-o- y; +168% h-o-h), making up 44% of our full-year estimate. 
  • We expect stronger 2H18 driven by marine recovery. We have fine-tuned our FY18/19 forecast by -3.5% /+2.4%, following upward revision in India and urban development profits partially offset by lower Sembcorp Marine forecasts (~-5% for FY18/19).

Lower dividend.

  • Sembcorp Industries declared a 2-Sct interim dividend (lower than 3 Scts last year), which is lower than expected at payout ratio of 23% vs our expectation of 32%. We have reduced our payout ratio to 25% given management’s tone to conserve cash for growth.
  • Our Target Price is lowed from the current S$4.50 to S$3.90 to reflect lower Sembcorp Marine Target Price (from S$2.90 to S$2.50) and lowered PE multiple for utilities (11x in line with 0.5SD below mean vs 13x previously) in view of the higher risk premium.

SCI could be bidding for Hyflux’s Tuaspring?

  • Sembcorp Industries is reportedly among the eight interested parties for Hyflux’s Tuaspring project that combines a desalination plant (318,500 cubic metres per day of desalinated water) and a gas turbine power plant (411MW power generation capacity). Other potential bidders named include Keppel Corp and YTL Power.
  • The asset is believed to have book value of ~S$1.5bn as of end-March 2018. Hyflux, which started a court-supervised reorganisation process in May, expects to receive bids for Tuaspring by 1 October. Management is open to explore opportunities to bargain hunt distressed assets, and there are several up for sale in Singapore currently.
  • While power assets in Singapore are not in a desirable operating environment currently, plagued by oversupply issue, hopefully the industry consolidation will accelerate sector recovery. The desalination plants might be interesting asset with good quality contracts. At the end of the day, it boils down to valuation and plans to turn around the Tuaspring operations.

Pei Hwa HO DBS Group Research Research | 2018-08-06
SGX Stock Analyst Report BUY Maintain BUY 3.90 Down 4.500