Sembcorp Industries - DBS Research 2020-05-19: Defensive But Not Immune

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SEMBCORP INDUSTRIES LTD (SGX:U96)

Sembcorp Industries - Defensive But Not Immune

• Challenging 2020 though confident to churn positive operating cash flow.
• Energy & Marine businesses affected by COVID-19.
• Urban segment expected to delivery steady profits.
• Sembcorp's FY20/21F earnings cut by 15%/7%; Maintain HOLD; Target Price lowered to S$1.70.

Sembcorp Industries 1Q20 business update

Expect positive operating cash flow in 2020.

• Sembcorp Industries (SGX:U96) remains confident to maintain positive operating cash flow in 2020 underpinned by its long-term contracts and diversified portfolio of businesses, even though COVID-19 has hit its operations to some extent.

Energy not spared.

• While Sembcorp's Energy segment which includes power and wastewater treatment, are relatively more resilient, mostly backed by long-term contracts, the reduction in economic activity due to lockdowns in multiple markets has affected merchant operations, leading to a decrease in energy demand and prices particularly in Singapore, India, and the UK. Power demand in April 2020 has declined by 10-25% y-o-y for these markets.
• With this downtrend expected to continue for the rest of the year, performance of Sembcorp's Energy business in 2020 is expected to be markedly lower than 2019.
• In addition, we could see one-off items including:
  1. Currency losses on its Chile divestment, which is expected to complete in 3Q20. The accumulated currency translation loss was S$30m as of end 2019.
  2. Potential inventory loss resulting from ~40% plunge in energy prices, which has significantly reduced the net realisable value (NRV) of inventory of gasoil reserves in Singapore that is required to fulfil certain regulatory requirements. As at Mar-2020, the NRV is estimated to be S$59m, representing a S$45m (pre-tax) reduction in book value.

Urban expected to provide steady core profits in 2020 despite near term slowdown.

• The pace of land and property sales for the Urban business has been affected by the COVID-19 pandemic with government measures to contain the virus and delays in regulatory approvals. The uncertain economic outlook could also lead to lower take-up and demand, or delayed launches for some of the business’ integrated developments and properties. Notwithstanding these, Sembcorp's Urban business is expected to generate steady recurring profits in 2020 underpinned by its orderbook.

Marine on Survival mode; losses to continue.

• In Sembcorp Marine (SGX:S51)’s outlook statement, it stressed that in light of the challenging and deteriorating business environment, the current priority is to ensure adequate liquidity to sustain operations and ride through this severe downturn. The group will continue to focus on safety and timely execution of projects and explore pockets of opportunities less affected by the current business climate. It expects losses to continue in the foreseeable quarters.

Sembcorp Industries earnings forecast revised lower:

• We trimmed our FY20/21F earnings by 15%/7% to reflect the weaker marine and energy businesses in 1H20. We have yet to factor in one-offs that could arise.
• Maintain HOLD; Sembcorp's target price lowered to S$ 1.70, as we factor in a lower valuation for marine and reduced our earnings projections. While Sembcorp is already trading at a steep 50% discount to book, re-rating potential hinges on ROE enhancement (from current ~5%) stemming from earnings recovery of its utilities businesses in India and the UK and marine segment.
• See Sembcorp Share Price; Sembcorp Target Price; Sembcorp Analyst Reports; Sembcorp Dividend History; Sembcorp Announcements; Sembcorp Latest News.

Key re-rating catalyst:

• Emerging markets as long-term growth engines. Sembcorp’s India operations swung from a loss of S$58m in FY17 to a profit of S$32m (excl. one-offs) in FY19, and growth ahead would help to drive overall group earnings. The power market in India seems to be recovering with the current peak surplus expected to reverse by FY20, according to independent research house CRISIL, and drive up tariffs. Besides India, Sembcorp has also made forays into other emerging markets – Bangladesh, Vietnam and Myanmar.

Where we differ:

• We hold on to our view of a potential merger between Keppel Corp (SGX:BN4)’s O&M arm and Sembcorp Marine given the keen competition in the sector. We believe a spin-off of its marine arm could re-rate Sembcorp’s undervalued utilities business that is being overshadowed by the cyclical marine business. However, this event could take another year or so to materialise.

Pei Hwa HO DBS Group Research | https://www.dbsvickers.com/ 2020-05-19

SGX Stock Analyst Report HOLD MAINTAIN HOLD 1.70 DOWN 2.200