Sembcorp Industries - DBS Research 2020-06-01: MSCI Rebalancing Sell-Off A Buying Opportunity

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SEMBCORP INDUSTRIES LTD (SGX:U96)

Sembcorp Industries - MSCI Rebalancing Sell-Off A Buying Opportunity

• Sell-off triggered by MSCI Singapore Index rebalancing creates a window of opportunity.
• Sembcorp Marine (SGX:S51) cash call risk is priced in.
• Compelling valuation with 28% potential total returns.
• Too cheap to ignore. Upgrade to BUY; Target Price unchanged at S$1.70.

Sharp correction due to MSCI rebalancing; unwarranted low valuation of 0.34x P/BV.

• Sembcorp Industries' share price corrected nearly 10% in a day, following MSCI Index rebalancing that took place last Fri. It is now trading at an unwarranted low valuation of 0.34x FY20 P/BV with 61%-owned Sembcorp Marine (~26% of Sembcorp Industries (SGX:U96)’s valuation) trading at 0.66x P/BV while non-marine businesses are at an implied 0.29x P/BV.
• Upgrade to BUY with 25% potential upside to unchanged Target Price of S$ 1.70.

Sembcorp Industries’s earnings expected to remain in positive territory with mid-single digit ROE.

• While Sembcorp Marine’s ROE has deteriorated from a peak of > 30% before GFC to being loss-making in recent years, the non-marine business should continue to deliver steady ROE at around the mid-to-high single digits.
• Our current SOTP target price of S$1.70 (implies an undemanding 0.5x P/BV), takes into account Sembcorp Marine’s Target Price of S$0.72/share (0.7x P/BV) and 0.4x P/BV for its non-marine businesses.

Non-marine segments have been overshadowed by exposure to the cyclical marine sector.

• We believe there is room for upward revision in non-marine’s valuation multiple to 0.6- 0.7x P/BV as operating environment in India, the UK and Singapore improves, partially offset by some downside risks to Sembcorp Marine as order wins momentum could be slower than expected amid global capex cut.
• BVPS for Sembcorp Industries is estimated to be S$3.97 for FY20, of which c.18% or S$0.72 is from the marine business, while energy & urban businesses form the remaining 82% or S$3.25.

Cash call risk for Sembcorp Marine is priced in.

• Current share price of S$1.36 implies 0.4x P/BV for the non-marine business, and nearly zero value for Sembcorp Marine. In fact, one could argue that investors have factored in a negative equity value for Sembcorp Marine, and hence dragging the non-marine segment to such a depressed valuation.

Restructuring plan remains a wild card.

• With Temasek’s partial offer for Keppel Corp (SGX:BN4) seemingly progressing well, a potential value-creating restructuring plan among Keppel, Sembcorp Industries and Sembcorp Marine remains a wild card.
• In our thematic report
  • Shipbuilding - DBS Research 2019-02-01: Merger On The Cards?
  • Shipyards - DBS Research 2017-07-20: Creating Global Champions.
  issued in early 2017 and 2019, we highlighted possible scenarios of the restructuring - Keppel Corp and Sembcorp Marine to own a stake in the merged shipyard entity while Sembcorp Industries stays focused on its non-marine business, thus reducing the huge risk premium arising from owning the cyclical marine business.

Others concerns that aggravated recent share price weakness:

COVID-19 impact:

• Operationally, Energy segment, comprising mainly power and water treatment, is relatively more resilient, mostly backed by long-term contracts. However, the reduction in economic activity due to lockdowns in multiple markets have affected its merchant operations has led to lower energy demand (by 10-25% y-o-y in Apr-2020) and lower prices particularly in Singapore, India, and the UK.
• Meanwhile Urban segment is expected to provide steady core profits in 2020 despite the near-term slowdown, underpinned by its orderbook. The pace of land and property sales for the Urban business has been affected by the COVID-19 pandemic. The uncertain economic outlook could also lead to lower take-up and demand, or delayed launches for some of the integrated developments and properties.

One-off items in upcoming results.

• We could see exceptionals such as:
  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 fulfill 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.
• See Sembcorp Industries Share Price; Sembcorp Industries Target Price; Sembcorp Industries Analyst Reports; Sembcorp Industries Dividend History; Sembcorp Industries Announcements; Sembcorp Industries Latest News.

Pei Hwa HO DBS Group Research | https://www.dbsvickers.com/ 2020-06-01

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