Sembcorp Industries Negative Surprise - UOB Kay Hian 2020-02-07: Large Impairment Charges To Impact 2019 Profit

SEMBCORP INDUSTRIES LTD (SGX:U96) | SGinvestors.io SEMBCORP INDUSTRIES LTD (SGX:U96)

Sembcorp Industries Negative Surprise - Large Impairment Charges To Impact 2019 Profit

  • Sembcorp Industries (SGX:U96) surprised with a profit warning as it will take a large impairment charge of S$245m in its 2019 results. Its UK power business continues to suffer from challenging conditions while its China water business will be negatively affected by new local-government regulations. The impairment in Chile arose due to the sale of a non-core asset at below net asset valuation. See Sembcorp Industries Announcements.
  • We have lowered our earnings estimates for 2019-21.
  • Maintain HOLD. See Sembcorp Industries Target Price. Entry price: S$2.05.



WHAT’S NEW


Large impairment charge announced.

  • After market close, Sembcorp Industries (SGX:U96) announced a material impairment charge of S$245m that will negatively affect its 4Q19 and full-year 2019 results. As a result of these non-cash impairments, Sembcorp Industries’ energy business is expected to make a net loss in 4Q19 but record a positive net profit for 2019.
  • The company stated that excluding the impairment charges, the underlying net profit of the energy business is expected to record a y-o-y increase vs. 2018. See Sembcorp Industries Announcements.

List Of Impairments (Location – Type of asset)

  • United Kingdom – Power: Energy capacity higher than expected; demand lower than expected due to energy efficiency and lower industrial production (impairment charge = S$158m).
  • Chile – Water: Non-core asset; escalating operational and regulatory costs (impairment charge = S$64m, excludes currency translation loss of c.S$30m which will be adjusted upon completion of sale in 2020)
  • China – Water: 23 New and more stringent effluent-discharge standards will come into force in Jiangsu province, affecting Sembcorp Industries’ Nanjing plant (impairment charge = S$23m)

UK power remains a tough business.

  • Sembcorp Industries commented that market conditions remain challenging and it has operated below expectations for 1.5 years, ie since market entry. The company mentioned a few issues plaguing the UK energy market, including a change in the way in which the energy regulator purchases power, and energy capacity in the UK being higher than originally expected, ie baseload power-plants are not closing down as their owners seem to be able to tolerate lower-than-expected cash returns.
  • In addition, energy demand has been lower than expected due to anaemic industrial production in the country.


STOCK IMPACT


Despite challenges, Sembcorp Industries appears to be wedded to UK remaining a core business for the company.

  • The company stated in the analyst conference call that it was not able to give forward guidance on the profitability of the UK business. We note that at the time of the UK power-asset purchase in 2017, Sembcorp Industries had commented that the business was generating S$7m in net profit after tax.
  • Despite the large S$158m impairment on the UK business, Sembcorp Industries stated categorically that UK power remains a core business for the company and that the focus on developed markets has not changed. We are somewhat perplexed that the company’s commercial due diligence did not highlight the risk that the UK market may suffer from excess energy supply and lower-than-expected demand.

Divestment of the Chilean water assets has been a long time coming

  • Divestment of the Chilean water assets has been a long time coming given that it is a non-core asset and thus part of the strategic rebalancing of Sembcorp Industries’ portfolio so that it can focus on its key geographies. According to the company, the asset had been on the market for around one year but it had not been able to secure a buyer.
  • Given the current economic and social problems in the country thus potentially leading to regulatory returns declining in the near to medium term, Sembcorp Industries made the decision to sell the asset for S$49m and recognise a S$64m impairment.
  • In addition, there is an accumulated currency translation loss of S$30m that could change upon the close of the transaction later in 2020. In the past 12 months, the Chilean peso has declined 16% vs the Singapore dollar.

China: Regulatory risk rears its head.

  • With new local-government regulations on water effluent discharge standards set to take place from Jan 21, and the company’s assets inability to meet those new local standards, Sembcorp Industries has had to take an impairment charge amounting to S$23m. We note that these new local standards apply to the Nanjing and Zhangjiagang plants in Jiangsu province; however the impairment only affects the Nanjing plant.
  • The company will report its 4Q19 and full-year results on Friday 21 Feb 20 before the market opens.


EARNINGS REVISION/RISK


Adjusting for the impairment.

  • We have materially lowered our 2019 net profit forecast by c.70% on the back of yesterday’s announcement.

Forward earnings momentum likely to be negative.

  • We have also marginally lowered our 2020 and 2021 earnings by 1-2% on the back of continued weakness in the UK power business. We highlight that prior to these earnings changes, our 2020 and 2021 earnings estimates were already below consensus by 4% and 11% respectively.
  • We believe that over the next 6-12 months, earnings revision momentum will continue to be negative.


VALUATION/RECOMMENDATION


Maintain HOLD recommendation.

  • We have lowered our target P/B multiple for the utilities to 0.7x which is a c.25% discount to the company’s past 5-year average P/B multiple of 0.95x. In our view, this discount is warranted given the company’s exposure to regulatory risk which today’s impairment charge has highlighted.
  • See Sembcorp Industries Target Price. Potential entry price is $2.05.


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Adrian LOH UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-02-07
SGX Stock Analyst Report HOLD MAINTAIN HOLD 2.17 DOWN 2.190



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