Keppel Corporation - UOB Kay Hian 2020-08-03: 2Q20 Larger-Than-Expected Impairments


Keppel Corporation - 2Q20 Larger-Than-Expected Impairments

  • Keppel Corporation reported a 2Q20 loss of S$698m due to larger-than-expected impairments of S$919m, resulting in one of the MAC clauses within the Temasek partial offer being triggered. Should the three inter-conditional resolutions at the Sembcorp Industries and Sembcorp Marine EGM (slated for 11 August) be passed, we expect Temasek to waive the MAC clause and revise down its partial offer.
  • Excluding impairments, Keppel Corporation’s 2Q operational results were largely in line.
  • Maintain BUY. Target price lowered slightly to S$7.10.

Keppel Corporation's 2Q20 Results

In the red due to impairments.

  • Keppel Corporation (SGX:BN4) reported a 26% y-o-y decrease in 2Q20 revenue to S$1.3b. However, as a result of S$919m in impairments for the quarter, the company reported a net loss of S$698m. We highlight that excluding the impairment, its 2Q20 net profit of S$222m (+45% y-o-y) would have slightly exceeded our expectations.
  • Despite the loss of S$537m for 1H20, Keppel Corporation has elected to declare an interim dividend of S$0.03/share (1H19: S$0.08/share). See Keppel Corp Dividend History.

The ball is in Temasek’s court.

  • Keppel Corporation’s CEO stated that the 2Q20 loss has triggered the Material Adverse Change (MAC) clause but rightfully did not venture a view as to whether Temasek would go ahead with the partial offer.
  • In our view, Temasek has the right to waive the MAC clause, and we believe that it will continue with the partial offer albeit at a lower price given that Keppel Corporation’s end-1H20 P/NAV of nearly 1.3x is higher than the 1.2x at end-3Q19 when the initial partial offer was announced.

Temasek partial offer – what happens now?

  • Given the breach of the MAC clause, Temasek has three options:
    1. Waive the breach of the MAC clause and continue on with the partial offer at $7.35 per share;
    2. Waive the breach of the MAC clause but revise the partial offer down to a P/B of between 1.1x to 1.2x, implying an offer price of between S$6.29-6.86/share (note that the Oct 19 partial offer valued Keppel Corporation at 1.21x); or
    3. Invoke the MAC clause and wholly withdraw the partial offer. Note that in this case, there is no moratorium on a revised partial offer and Temasek can come back with another offer at any time.
  • We highlight that on 1 Aug 20, Temasek had announced that it would make a decision on whether it will invoke the MAC clause, based on the 2Q20 loss, by 31 Aug 20. If the MAC clause is invoked by Temasek, then the pre-conditional partial offer will be withdrawn.

Temasek will continue with the offer, in our view.

  • As stated above, we remain reasonably confident that Temasek will continue with the offer but revise the offer price downwards. Note that the Sembcorp Industries (SGX:U96) and Sembcorp Marine (SGX:S51) EGMs, relating to the rights issue for the latter and the demerger of both companies, will happen concurrently on 11 Aug 20. Should shareholders vote for the Sembcorp Industries-Sembcorp Marine demerger, the likelihood of Temasek going forward with the Keppel Corporation partial offer will be much higher, in our view.
  • With Sembcorp Marine demerged from Sembcorp Industries, Temasek will then be in a better position to engineer a merger of Keppel Corporation’s O&M business with Sembcorp Marine.
  • At the end of the day, the game plan to create a single Singapore-based O&M company to compete with the likes of the Korean or Chinese O&M behemoths makes economic sense, and is better carried out during a cycle trough rather than mid-or peak cycle in our view.

Impairments aplenty.

  • As a result of the double whammy of COVID-19 and lower oil prices in 2Q20, Keppel Corporation has elected to do a comprehensive impairment testing of its O&M segment (affirmed by a third party O&M valuation specialist), taking into account lower utilisation rates, rig dayrates and lower demand, amongst others. As a result, the company has taken the unusual step of recognising a very large impairment totalling $919m in 2Q20 while other years have seen material impairment recognition only at year-end.

As a result of the above impairment charges, the O&M segment saw an operating loss of S$711m in 2Q20

  • As a result of the above impairment charges, the O&M segment saw an operating loss of S$711m in 2Q20 vs an operating profit of S$11m in 2Q19. Keppel Corporation’s orderbook as at end- 1H20 was S$3.5b, with 1H20 order wins of $107m vs our expectation of S$500m for 2020. The company does not currently have a firm date for resumption of work at its Singapore yards and is working closely with the authorities to open in a safe manner.
  • At the start of 2020, the Singapore yard had 24,000 workers; however, this declined to a trough of 1,200 workers during 2Q20, but has since rebounded to 5,000 at the beginning of Jul 20.

Nascent recovery in property business with exposure to the right segments.

  • The property segment posted a 106% y-o-y increase in 2Q20 operating profit to S$201m. During the results briefing, Keppel Corporation stated its belief that the China property market has likely troughed in China, and that the cities in which it operates in will continue to see “good prospects” in 2H20. In 1H20, it sold 1,050 homes vs 1,140 in 1H19 (-8% y-o-y) which is a solid performance given the COVID-19 challenges during 2Q.
  • We also highlight that Keppel Corporation registered a valuation gain for its investment properties due to its exposure to prime commercial assets across the different countries and very minimal exposure to retail or hospitality. At end-1H20, Keppel Corporation had a residential landbank of 45,000 units and a commercial portfolio of 1.7m sf of GFA, with about 50% of this being developed.

The infrastructure segment saw a strong quarter with 2Q operating profit of S$65m (+143% y-o-y).

  • This was helped by a gain of S$47m from the sale of units in Keppel DC REIT (SGX:AJBU), higher contribution from environmental infrastructure division and dividend income from Keppel Infrastructure Trust. Importantly, the 2H20 outlook is positive as the Keppel Marina East Desalination Plant started operations on 29 Jun 20 and will steadily ramp up towards full utilisation in 2021.
  • Management commented that Singapore electricity demand is currently showing signs of recovery, and it expects demand to continue to pick up in 3Q20.

The Investments divisions was largely flat, generating an operating profit of S$22m for 2Q20

  • The Investments divisions was largely flat, generating an operating profit of S$22m for 2Q20 which, due to a fair value loss on investments, resulted in a net loss of S$27m for the quarter. While M1’s 1H20 EBITDA was flat at S$141m, its NPAT was slightly lower y-o-y due to accelerated depreciation. The company guided for its share of 5G capex at less than S$200m over the next five years.

Watching its costs.

  • During the analyst briefing, management stated that it will look at rightsizing its current workforce as it will need to watch fixed costs closely, especially for its O&M business. In addition, Keppel Corporation’s CEO and management will take base salary reductions of 5-10% while its board of directors will take a 10% cut to their fees.

Gearing at 1.0x but balance sheet still manageable

  • Net gearing increased from 0.85x at end-2019 to 1.0x at end-1H20 due to investments, working capital requirements and payment of the final dividend for 2019, as well as the impact from lower equity due to the significant impairments recorded in 2Q20. Excluding the impairments, net gearing would have been 0.92x.
  • While management believes that it has adequate credit lines to finance its operations, it was unwilling to disclose the amount of these credit lines during the results briefing.

Keppel Corporation - Valuation & Recommendation

Adrian LOH UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-08-03
SGX Stock Analyst Report BUY MAINTAIN BUY 7.10 DOWN 7.150