Sembcorp Industries - DBS Research 2018-11-05: Look Beyond 4Q


Sembcorp Industries - Look Beyond 4Q

  • Decent utilities profits in 3Q18; though SGPL disappointed with wider losses. 
  • Look beyond potential weakness of India operations in 4Q; expect a better 2019. 
  • Expect operational improvement in India and marine earnings recovery. 
  • Reiterate BUY; Target Price reduced to S$3.70. 

Maintain BUY

  • Maintain BUY; Target Price reduced to S$3.70, largely due to lower Semcorp Marine 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. While Sembcorp Gayatri Power Limited's (SGPL) losses widened in 3Q, it should narrow as Bangladesh PPA is set to commence in 1H19.
  • We believe continuous improvement in India will re-rate Sembcorp Industries’ Utilities business, which is undervalued at 0.66x P/BV and 7.8x PE against 6% ROE.

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. 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.

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$3.70, 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 - SGPL's losses widened in 3Q

Decent 3Q18.

  • Sembcorp Industries reported a decent 3Q18 with net profit of S$82m, similar to a quarter ago. 9M18 group profit amounted to S$241m (-9% y-o-y) making up only 66% of our full-year expectations due to disappointment from Marine segment which is expected to remain in the red.

Steady Utilities performance; though SGPL disappoints.

  • Utilities segment achieved ~20% y-o-y growth (excluding one-offs) to S$82m in 3Q18, driven by improvement in China and India operations.
  • While the second India power plant (SGPL) swung back to its usual loss range of S$20-25m in 3Q18 (from S$3m loss in 2Q18), we believe the loss will narrow as the recently secured Bangladesh PPA (~20% of capacity) commences in 1H19. 9M18 utilities profits totalled S$246m.

Urban development segment generated S$8m profit in 3Q18.

  • This brings 9M18 profit to S$53.1m, which is comparable to the same period last year. This forms about 78% of our full-year expectation.

Further provisions for environmental offence claims.

  • As its majority-owned overseas JV is involved in an alleged environmental offence for the discharge of off-specification wastewater last year and has been served with a further claim at end-September (up to S$100m), Sembcorp Industries has made a further provision of S$25m in 3Q18, bringing total provisions for this alleged offence to S$50.4m. The provisions made in the quarter was offset by S$15m divestment gains, and some settlement with Operations and Maintenance contractors and customers (~S$20m).
  • Please refer to our report titled “Further claim relating to an environmental offence” on 1-Oct for more details relating to the alleged environmental offence.

Earnings revisions.

  • We have lowered our FY18 estimate by 18% largely due to earnings cuts for Sembcorp Marine (from S$15m profit to S$101m loss, removing cost recovery of up to S$100m for variation orders and factoring in continuous operating losses). In addition, we have also removed contribution from the first India power plant SEIL in 4Q18 (~S$14m/quarter). SEIL is currently operating at a sub-optimum level as one of the two boilers are shut down for investigation on technical issues.
  • We understand that insurance will likely cover the “loss of income” for disruption beyond 21 days and finalisation of payment, etc, if any, will likely be next year.

Hyflux exploring other options for Tuaspring plant.

  • Hyflux (SGX:600) is reportedly evaluating other options for its Tuaspring plant and potential investment from strategic investors (Medco & Salim Group). These latest developments have reduced the probability of Sembcorp Industries acquiring Tuaspring plant, in our view.
  • Maintain BUY; Target Price adjusted to S$3.70, to reflect lower Sembcorp Marine Target Price (from S$2.50 to S$2.40) and earnings estimate for India operations.
  • We continue to like Sembcorp Industries as a safer proxy to O&M recovery, backed by a defensive utilities business. Stripping out Sembcorp Marine's current valuation, the utilities business is trading at an undemanding valuation of 7.8x PE and 0.66 P/BV.

Pei Hwa HO DBS Group Research | https://www.dbsvickers.com/ 2018-11-05
SGX Stock Analyst Report BUY MAINTAIN BUY 3.70 DOWN 3.900