Keppel Corporation - CGS-CIMB Research 2020-07-31: Is There A Need To Kitchen-sink?

KEPPEL CORPORATION LIMITED (SGX:BN4)

Keppel Corporation - Is There A Need To Kitchen-sink?

Keppel Corp took in c.S$889m of O&M impairment in 2Q20, resulting in loss of S$699m. This caused a breach of the Material Adverse Change (MAC) clause for Temasek’s partial offer.
Temasek can
1. issue a waiver to keep the offer,
2. walk away from the deal due to the breach or
3. seek approval from Security Industry Council (SIC). and review the offer price.
Our SOP Target Price is cut to S$6.46, to reflect lower O&M book value.

Keppel Corp (SGX:BN4) reported 2Q20 loss of S$699m vs. our expectation of S$30m loss. Ex-impairment, 1H20 profit of S$397m was broadly in line with our S$379m.
Since 2015, KEP O&M typically took in more impairment at year-end or 4Q. Management made reference to COVID-19, sharp reduction in global oil and gas demand, reduction in day rates, utilisation and cancellation of charters. Hence, the need to review (with assumptions confirmed by Pareto Securities) and assess the value in use of the undelivered rigs and receivables.
The S$889m of impairment in O&M comprises S$227m for Floatel’s assets, S$179m of provision for doubtful debts and S$431m of contract assets. We think Keppel Corp has factored in potential cancellation/deferral of orders of rigs including the two Awilco semi-subs, undelivered jack-up rigs for Clearwater, Fecon, TS Offshore and Borr Drilling.
Keppel Corp said the review is thorough and provision is adequate.

YTD Keppel Corp has secured S$107m of orders vs. our 2020 expectations of S$500m. Order book stood at S$3.5bn.
5,000 staff are back in the yard currently. Despite the lockdown, 2Q20 O&M revenue was not as bad as feared at S$270m (-53% q-o-q, -44% y-o-y) with the help of work being carried out across its global yards - Brazil, US and China.
As Keppel Corp’s share of the impairment amount for Floatel exceeds the carrying value of its investment, the equity carrying value of S$281m as at 30 Jun 2020 has been written down to zero. This means no more future share of associate losses for O&M. As such, we are now expecting profit of S$18m in 2H20F with the help of the job support scheme (JSS).

Property recorded a net profit of S$162m in 2Q20, thanks to a net revaluation gain of S$141m, mainly due to reclassification of inventory to investment property at fair value.
Overall home sales grew 73% q-o-q to 780 units, driven by +118% q-o-q to 720 units in China. Despite COVID-19, home sales in China only dropped by 8% y-o-y to 1,050 for 1H20.

Investment reported net profit of S$25m in 2Q20 with steady profits from Keppel Capital and M1. TEC recognised a land sale gain of S$31m.
As equity value for KrisEnergy was written down to zero previously, there was no more share of losses from the business. There was also no impairment made on Kris Energy (SGX:SK3) for its zero coupon bond.

Infra recorded a net profit of S$77m in 2Q20, which includes S$47m of dilution gain from Keppel DC REIT (SGX:AJBU). We do not rule out further dilution of its indirect stake (c. 25.2%) in Keppel DC REIT given the strong share price performance of the latter.

Recall that Temasek may need to fork out a total of S$4.08bn for the additional 30.55% stake in Keppel Corp at S$7.35/share. With the breach of Material Adverse Change (MAC) that PAT does not fall by more than 20% over the cumulative four quarters from 3Q19 (or c.S$557m), Temasek can
1. issue a waiver to keep the offer,
2. walk away from the deal or
3. review/lower the offer price with the approval of the Security Industry Council (SIC).
We believe the current Keppel Corp share price has factored in some risk of deal cancellation.
Assuming the deal remains, Temasek would be paying an implied 1.28x NAV of Keppel Corp’s 1H20 NAV of S$5.70 (vs. 1.21x previously on 9M19’s S$6.06). Sembcorp Marine (SGX:S51) and Sembcorp Industries (SGX:U96) traded at 0.4x/0.5x 1H20 NAV, respectively. Without Temasek’s partial offer, there will be no change in Keppel Corp’s business model and its 2030 vision but our hope of a potential merger between the yards (KEP O&M and Sembcorp Marine) may not happen so soon.

Net gearing rose to 1.0 as at 1H20 vs. 0.85 at FY19 and management aims to keep it at current level. Interim dividend of S$0.03 declared. FY20F EPS cut 138% to reflect 2Q20 impairment.
Our Target Price reflects lower O&M book value, pegged to 0.5x P/BV (previously 1x), benchmarked to peers and challenging outlook. It trades at c.0.9x FY20F P/BV, close to - 1 s.d. of 10-year mean.
If Temasek walks away from the deal, Keppel Corp's share price could react in a shock and touch previous trough of 0.82x P/BV in early 2016 during last oil crisis, or S$4.88.
See Keppel Corp Share Price; Keppel Corp Target Price; Keppel Corp Analyst Reports; Keppel Corp Dividend History; Keppel Corp Announcements; Keppel Corp Latest News.
Other catalysts: stronger-than-expected recovery in 2H from asset recycling.

LIM Siew Khee CGS-CIMB Research | https://www.cgs-cimb.com 2020-07-31

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