Sembcorp Industries - DBS Research 2020-02-07: Lack Of Significant Catalyst; Kitchen-sinking 4Q19

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SEMBCORP INDUSTRIES LTD (SGX:U96)

Sembcorp Industries - Lack Of Significant Catalyst; Kitchen-sinking 4Q19

• While Sembcorp Industries (SGX:U96) is already trading at a steep discount to book at 0.6x against 5-6% ROE and 2% yield, recent incidents have dampened confidence on acquisition growth and its earnings recovery outlook. We have lowered our valuation multiple for the Energy business from 8x PE to 5x PE (implied P/B lowered from 0.7x to 0.4x) given the disappointment.
• Recovery of its India operations and marine business as well as execution in emerging markets are key catalysts to restore investor confidence on its ROE improvement potential.

Kitchen-sinking 4Q19

• Sembcorp Industries issued a profit warning, guiding losses for 4Q19 due to exceptional items of negative S$165m, comprising impairment of S$245m plus a provision of S$6m, partially offset by divestment gains of S$86m.
• Impairment of ~S$245m arising from:
  1. S$158m impairment on UK Power Reserve (UKPR) assets, based on the expected value-in-use as at end- 2019. Operations was impacted by a combination of economic and industry factors including an increase in energy capacity and a reduction in underlying demand due to energy efficiency and reduced industrial production. As a result, flexible energy-generation operators such as UKPR have been called on less frequently to balance the system. The impairment represents ~40% of Sembcorp Industries’s acquisition consideration of GBP216m (~S$385m) about one and a half years ago in June 2018.
  2. S$64m impairment arising from the divestment of its water business in Chile. Sembcorp Industries has also announced the divestment of its water business in Chile for S$49m, or ~0.4x P/BV, resulting in potential loss of S$64m. In addition, there might be currency translation loss recognised upon completion of sale in 2020. The realisable value for the assets has been impacted by deterioration of Chile’s economic, social and regulatory environment since October 2019, leading to escalating operational costs, aggravated by depreciation of Chilean peso.
  3. S$23m impairment in China for its wastewater treatment assets. Impairment is taken for relevant facilities in Jiangsu which is not able to meet the new and more stringent effluent discharge standards that will come into force from January 2021.

Bottom-line impact.

• Sembcorp Industries’s FY19 results will be released on 21 February. Prior to the profit warning, we were expecting S$73.5m net profit for 4Q19 and S$336m for full-year 2019. On our esimates, these exceptional items would result in a net loss of ~S$90m for 4Q19 and lower FY19 profit to ~S$170m. If not for the one-offs, its energy business would have reported earnings growth this year.
• We have trimmed our FY19 earnings estimate to reflect the impairments and reduced FY20F earnings by 3.5% to account for lower contribution from UKPR.

Dividend payout.

• Management clarified that dividend payout will be based on the company’s core earnings trend and shall not be affected by one-offs. Sembcorp Industries declared 2-Sct interim dividend for 1H19 and the market expects a final dividend of ~2.5 Scts, translating into a dividend yield of ~2%.

Hit on confidence and sentiment.

• Apart from financial impact, the impairment on UKPR assets within a short span of one and a half years post acquisition might dampen investors’ confidence on the company’s overseas acquisition/expansion strategy. This is a double whammy as the company was also recently fined in China for discharge of off-specification water by its JV in Nanjing (Jiangsu Province, China).
• Furthermore, returns on its ~S$4bn investment in India – 2,640MW power plants fully operational since 2016 - remain suboptimal, affected by structural issues in India’s power sector, albeit profitable in the past two years.

A precursor to restructuring?

• While management could not comment on M&A rumours and stressed that this is part of the company’s yearly asset impairment tests, the relatively sizeable and aggressive impairment could give rise to speculation that the business review is another step to restructuring between Sembcorp Industries and Keppel Corporation (SGX:BN4).

Downgrade to HOLD.

• We expect a knee-jerk reaction to this profit warning. The net one-offs of negative S$165m represents ~2.5% of Sembcorp Industries’s book, and UKPR was expected to contribute 3-4% to bottomline.
• While Sembcorp Industries is already trading at a steep discount to book at 0.6x against 5-6% ROE and 2% yield, recent bouts of misfortunes have dampened confidence on acquisition growth potential and earnings recovery outlook. We have lowered our valuation multiple for Energy business from 8x PE to 5x PE (implied P/B lowered from 0.7x to 0.4x) given the disappointment.
• See Sembcorp Share Price; Sembcorp Target Price; Sembcorp Analyst Reports; Sembcorp Dividend History; Sembcorp Announcements; Sembcorp Latest News.
• Recovery of its India operations and marine business as well as execuction at new merging markets are key catalysts to restore investor confidence on their ROE improvement potential.

Pei Hwa HO DBS Group Research | https://www.dbsvickers.com/ 2020-02-07

SGX Stock Analyst Report HOLD DOWNGRADE BUY 2.20 DOWN 2.900