Keppel Corporation - DBS Research 2020-08-03: Temasek Partial Offer – Deal Or No Deal?

KEPPEL CORPORATION LIMITED (SGX:BN4)

Keppel Corporation - Temasek Partial Offer – Deal Or No Deal?

Massive impairment of S$919m in 2Q20 dragged Keppel Corp into largest ever net loss of S$698m.
Excluding impairment, Keppel Corp would have reported commendable core profit of S$222m (+45% y-o-y).
Temasek will decide whether to invoke MAC pre-condition by 31 Aug.

Keppel Corp (SGX:BN4) reported a net loss of S$698m for 2Q20, hit by whopping impairments totalling S$919m largely for O&M segment. Excluding the impairments, it would have made decent core profit of S$222m (+45% y-o-y), bringing 1H20 profit to S$381m, in line with expectations with 1H making up 49% of our full year estimate.
While management has guided potential impairments on Floatel, other impairments on doubtful debt and contract assets for O&M segment were surprisingly huge. Total impairment of S$919m is the worst we have seen for the O&M segment, compared to S$230m for Sete Brasil projects in 2015 and S$619m for corruption penalties in 2017.

The massive impairment has led to the non-fulfilment of Material Adverse Change (MAC) clause, which required Keppel Corp to report not more than 20% decline in 12-month Trailing Profit After Tax (12M Trailing PAT) or approx. S$557m. With this latest set of results, Keppel Corp’s 12M Trailing PAT stands at a loss of S$165m and will require S$887m PAT in 3Q20 in order to meet the MAC clause. This seems rather unrealistic, given the average quarterly profit of S$200m over the past 4 years.

As stated in the Partial Offer announcement, “The Partial Offer will not be made unless and until all the Pre-Conditions have been satisfied and/or waived (at the discretion of the Offeror) on or before 5.00pm on 21 October 2021”. It remains unclear if Temasek will grant Keppel Corp a waiver for failing to meet the MAC pre-condition, and a decision will be made by end August.
We had previously expressed that our stance lies towards a waiver by Temasek in view of the longer-term value of Keppel Corp and a bigger restructuring plan behind this offer. However, the risk of Temasek reconsidering the offer or offer price has certainly risen given the unexpectedly huge magnitude of impairment. The possible scenarios:
1. Waive MAC, offer price lowered by dividends declared (15 Scts in total = 12 Sct final DPS for FY19 + 3 Sct interim DPS for 1H20) from S$7.35 to S$7.20.
2. Waive MAC, seek SIC approval to revise offer price.
3. Walk away.
As a recap, the pre-conditions of the MAC clause set out in Temasek’s partial offer are:
1. Keppel Corp does not recognize more than S$500m of additional provisions attributed to any claim, litigation, investigation or proceeding during this time;
2. Net Asset Value (NAV) does not fall by more than 10%;
3. Trailing 12-month profit after tax at each quarterly result must not fall below S$557m (decline not more than 20% from trailing 12-month net profit of S$696m at Sept 2019).

Property division posted a net profit of S$162m in 2Q20, increasing by 25% y-o-y and 3.6x q-o-q, driven largely by revaluation gains on investment properties.

Keppel Corp sold ~780 homes in 2Q20, down 54% y-o-y, affected by COVID-19, particularly in Vietnam and India. The China market continues to recover, with 85% was sold in China, 1% in Vietnam, 7% in Singapore, 5% in Indonesia, and 2% in India. It has sold 8,790 overseas units worth ~S$4.3bn to be recognised from 2H20-2024.
Keppel Corp continues to see good demand for well-located projects in high growth cities in China and Vietnam, though for the latter, new launches have slowed down pending approval of authorities. Its commercial portfolio of 1.7m sm GFA (~50% under development) bodes well for stable recurring income going forward.
In Singapore, the redevelopment plan for Keppel Tower and launch of two residential projects – Nassim Woods and Keppel Bay Plot 4 - seem to be delayed due to COVID-19 situation.

O&M reported huge losses of S$962m in 2Q20, following an S$887m impairment taken on doubtful debts on receivables (S$179m), contract assets (S$431m), stocks (S$42m) and Floatel (S$237m). Excluding impairment, the segment made a core loss of ~S$67m due to lower yard activity especially during circuit breaker period in Singapore. Sequential improvement could be expected as yard operations gradually resume.
Net orderbook declined to S$3.5bn, from S$4bn a quarter ago, in the absence sizeable contracts in 1H20. Awilco’s semi-submersible rig order was terminated. YTD new contracts worth S$107m were from offshore wind and FPSO projects. Management continued to see enquiries for renewables and demand for conversion of production assets.

Infrastructure net profit rose 81% y-o-y to S$78m in 2Q20, aided by divestment gains of a 2.33% stake in Keppel DC REIT (SGX:AJBU) that amounted to ~S$48m Recurring profit was steady at ~S$30m.

This was driven by land sales in Tianjin. In Apr-2020, SSTEC sold a plot of land in Tianjin Eco-city, which should have contributed approx. S$31m profit in 2Q20. M1 contributed steady net profit of approx. S$20m a quarter. Keppel Corp has impaired all the equity investment in Kris Energy (SGX:SK3) in 1Q20 and ceased recognition of its P&L since.

We have revised down our Keppel Corp's FY20/21 earnings to -S$171m and S$827m respectively after factoring in the impairments and weaker O&M business. Excluding impairment, Keppel Corp would have reported a commendable core profit of S$222m (+45% y-o-y) in 2Q20, demonstrating benefits of diversified businesses.
Keppel Corp's share price has been beaten down since the emergence of impairment news, trading 7.5% below pre-offer share price (S$5.84), which we believe has discounted the partial offer premium and factored in a challenging outlook.
See Keppel Corp Share Price; Keppel Corp Target Price; Keppel Corp Analyst Reports; Keppel Corp Dividend History; Keppel Corp Announcements; Keppel Corp Latest News.
Valuation is undemanding at 0.9x P/BV, which is c.1SD below mean.

Pei Hwa HO DBS Group Research | https://www.dbsvickers.com/ 2020-08-03

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