Keppel Corporation - Phillip Securities 2020-12-02: Strategic Review Of O&M Unit & Divestments To Drive Potential Re-Rating

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KEPPEL CORPORATION LIMITED (SGX:BN4)

Keppel Corporation - Strategic Review Of O&M Unit & Divestments To Drive Potential Re-Rating

• Reaffirmation of capital recycling to unlock S$17.5bn a potential re-rating catalyst for Keppel Corp.
• 100-day programme to provide greater clarity on Keppel O&M and remove key overhang.
• Longer-term ROE target of 15% intact.
• Initiate coverage on Keppel Corp with BUY and SOTP-based target price of S$6.12, with a 10% holding-company discount.

Keppel Corp - Company Background

• Keppel Corporation (SGX:BN4) was incorporated as Keppel Shipyard in 1968. It diversified during the 1970s and 1980s into property development and overseas markets. In 1980, Keppel Shipyard was listed on the Stock Exchange of Singapore, offering 30mn shares at S$3.30 apiece. Keppel would eventually emerge as a major player in Singapore’s maritime and shipping industry and a global leader in offshore rig construction.
• Under Vision 2030, Keppel Corp has redefined its businesses into energy & environment, urban development, connectivity and asset management. The Group has started reporting based on these new segments.

Energy and Environment.

• This segment will comprise Keppel Corp’s interests in Keppel O&M, Keppel Infrastructure, Keppel Renewable Energy (established in 2019) and KrisEnergy (fully written-off).
• Keppel O&M remained loss-making in 3Q20, mainly due to reduced topline from COVID-19 disruptions. Work has resumed at Singapore yards, with 15,000 back at work as at end-Sep 2020.
• Keppel Infrastructure was more resilient, with 9M2020 revenue and EBITDA largely in line with last year.

Urban Development.

• This segment will comprise Keppel Corp’s interests in Keppel Land, Keppel Urban Solutions and Sino-Singapore Tianjin Eco-City. Keppel Land has a residential landbank for 44,000 units in Singapore, China, Vietnam, Indonesia and India. It has 8,750 overseas units worth S$4.2bn for recognition from 4Q20 to 2024. It also has a diverse commercial portfolio in Singapore, China, Vietnam, Indonesia, India, Philippines, Myanmar and the U.K., totaling 1.7mn sqm.
• Keppel Corp’s 45%-owned Tianjin Eco-City turned profitable in 2017. With residential property prices and demand in Tianjin remaining healthy, we expect the development to continue contributing S$55-60mn profits in the next few years. We expect the development to be fully sold off by 2028.

Connectivity.

• This segment will comprise Keppel Corp’s interests in M1, Keppel Data Centres and Keppel Logistics.
• M1 had about 2mn customers as at end-Sep 2020. It is a dominant telco player in Singapore. EBITDA was resilient at S$202mn in 9M20 vs. S$211mn in 9M19. M1 recently launched its 5G non-standalone network, which customers can access by adding a 5G booster pack to their mobile plans.
• Keppel Data Centres have eight data centres under development or completed with the potential for monetisation.
• Associate Keppel DC REIT owns 19 data centres across the Asia Pacific and Europe with a total net lettable area of 2.76mn sq ft.

Asset management.

• This segment comprises Keppel Corp’s interests in Keppel Capital, private funds and listed REITS and trusts.
• Keppel Capital is the asset-management arm of Keppel Group. Leveraging the Group’s extensive network and deep operational insights, Keppel Capital is in a unique position to create, operate and manage quality proprietary assets from energy and infrastructure to real estate. It had global AUM of US$24bn or S$33bn as at December 2019.
• Keppel Capital has two private fund-management units: Alpha Investment Partners (manager of private funds investing in asset classes including real estate and data centres) and Keppel Capital Alternative Asset (manager of private funds investing in new alternative asset classes including senior living, education and infrastructure). Asset management fees were S$123mn in 9M20 vs. S$105mn in 9M19.

Keppel Corp - Investment merits

Reaffirmation of capital recycling to unlock S$17.5bn a re-rating catalyst.

• Keppel Corp has identified S$17.5bn of assets that can be monetised over time. This road map provides greater certainty on the assets for monetisation as well as the timeline. While asset recycling has been a core part of their strategy, setting a clear target of monetising S$3-5bn of assets over the next three years provides visibility in the near term. Keppel Corp will reinvest the proceeds in vibrant new areas such as integrated urban development, data centres and renewable energy.

100-day programme to provide greater clarity on Keppel O&M and remove overhang.

• Keppel Corp has mapped out a Vision 2030 transformation plan and launched a 100-day transformation office to drive its next phase of growth. We expect its strategic review of its O&M and Logistics units to provide more clarity on the Group’s pathway to its ROE target of 15%. We understand from management that the outcome of the review – involving both organic and M&A options - will be known at the end of the 100 days.
• As the office was set up at the end of September, we are looking at a possible announcement in January 2021. We think the review may recommend scaling down its operations to focus on renewable energy or deconsolidating O&M. This will free up debt requirements and transition the business to an asset-light model, potentially providing stock catalysts.

Longer-term ROE target of 15% intact.

• Keppel Corp’s shipyards have resumed operations since Singapore exited its circuit breaker in June. Some 15,000 workers had gone back to their work sites as of end-Sep 2020. Recent contract wins of S$700mn have lifted its orderbook above S$4bn. This is expected to support its operations in the next two years. Keppel Corp's property segment is also expected to divest over S$7bn of assets in the next few years.
• We see Keppel Corp reinvesting the proceeds in new growth areas such as offshore infrastructure, renewables, integrated townships & smart cities, senior living and 5G services. A key part of its Vision 2030 is to break down silos within the group to enable them to work together as OneKeppel. We believe this will help the Group harness synergies, scale up even more and capture new profit pools that might not be available to individual business entities.

Vision 2030: to monetise assets worth S$17.5bn

Reaffirmation of capital recycling.

• Keppel Corp has identified S$17.5bn of assets that can be monetised. While there has always been value in Keppel Corp for unlocking, the question was always “when”. The latest details provide colour on the assets available for monetisation as well as a timeline. This provides greater clarity of the Group’s outlook.
• In total, Keppel Corp intends to monetise S$7.0bn of its landbank, which is held at historical cost. It also intends to monetise S$4.8bn of investment properties and assets being developed/stabilised for monetisation through Keppel-managed or third-party platforms. Non-core assets, including Keppel O&M oil rigs amounting to S$3.9bn, have also been identified for divestments. Various funds and investments amounting to S$1.8bn are also expected to be liquidated over time.
• While asset recycling has been a key part of Keppel Corp’s strategy, we think setting a clear target of monetising S$3-5bn of assets over the next three years provides greater clarity to investors. We believe Keppel Corp could be looking for buyers for its stranded rig-building contracts, which include five jack-up rigs and one Cando Drillship. We estimate their market value at US$700- 900mn or S$1.3-1.4bn. Keppel Corp could also divest commercial buildings in its portfolio like Keppel Bay, Keppel GE Tower or i12 Katong to REITs.
• We believe Keppel Corp will reinvest the proceeds in new, vibrant areas of growth such as renewable energy solutions, integrated urban development and data centres. At the heart of its Vision 2030 is its goal to provide solutions in sustainable urbanisation, clean energy and smart nation.
• To help it get there, Keppel Corp has established a Vision 2030 transformation office, including a 100- day programme. The office was set up at the end of September, which implies the Group could provide more details as early as January. This is expected to lead to a stock re-rating.

Strategic review of Keppel Offshore & Marine timely

Commenced strategic review.

• Keppel Corp is reviewing its O&M operations amid the sector’s downturn. It will explore both organic and M&A options. Organic options include reviewing the strategy and business model of Keppel O&M, assessing its current capacity and global network of yards and restructuring to seek opportunities as a developer of renewable energy assets. M&A options range from strategic mergers to disposals. Keppel Corp declined to provide details as the review in in a preliminary stage, but has stressed that all options are on the table.
• The review comes hot on the heels of a pullout by Temasek’s wholly-owned subsidiary, Kyanite Investment Holdings, from its S$4.1bn partial offer for Keppel in August this year. This was after Keppel Corp reported 2Q20 losses of S$697.6mn. The walkaway breached a precondition for the partial buyout. Kyanite Investment defended its move by invoking a material adverse change clause, which states that Keppel Corp’s profit after tax must not fall by more than 20% over the cumulative four quarters from the third quarter ended September 2019. Even though Temasek has pulled out of the deal, we believe Keppel Corp will still undertake its O&M review in consultation with Temasek. Recall that Kyanite initially announced it would make a comprehensive strategic review of Keppel Corp with the objective of creating sustainable value for all shareholders after the deal.
• We believe that ultimately, Keppel O&M will be deconsolidated. Three reasons for this:
  1. even though Keppel Corp had assets of S$9.5bn in FY19, O&M EBIT was only about S$145m. This means that Keppel Corp generated only 1.5% in returns from its offshore & marine assets, which is a drag on its performance;
  2. globally, there is still overcapacity in shipbuilding. Competition is expected to stiffen from consolidated or consolidating Chinese and South Korean shipyards. Just last December, China State Shipbuilding Industry Co (CSSC) merged with China Shipbuilding Industry Co (CSIC) [SHA: 600150]; and
  3. oil prices remain volatile. Upstream capex this year was cut by about 22% after the oil-price slump. For 2021, the outlook has improved in the last few months, but is still expected to remain subdued.
• In our view, the case for merging Keppel O&M and SMM is compelling, given the challenging outlook for the sector. A merger of the two Singapore yards is expected to produce savings from eliminating overlapping functions. The merged entity would enjoy greater bargaining power in procuring raw materials and equipment. Merger could also free up idle or less productive yards for other forms of development.
• We expect the segment to remain weak in FY20e and FY21e as new orders remain slow. According to Baker Hughes, U.S. oil and gas exploration and drilling rig count has fallen sharply in 2020, from 805 in December 2019 to 269 as at end-Sep 2020. International rig counts worldwide, excluding the U.S., have also declined, from 1,104 in December 2019 to 702 at end-Sep 2020.
• Data from IHS Markit suggest that 43 rig contracts have been terminated globally since the beginning of March this year. Few regions have been immune to terminations. Canada, the Gulf of Mexico, Latin America, the Mediterranean, Middle East and India all had their fair share of cancellations. These cancellations give an indication of how activity could shape up in the near future. 2020 was set to be better with many dormant regions resuming exploration and the commencement of long-awaited development drilling programmes. The global pandemic, however, up-ended this. As operators slashed budgets, semis and jack-ups found themselves the hardest hit.
• Keppel Corp’s net orderbook from this segment stood at S$3.5bn in 1H20. It recently secured a S$600mn contract from an energy company for the engineering, procurement and construction (EPC) of a vessel for the offshore renewable energy industry. New order wins have brought its year-to-date orders to S$1.0bn, a 3-year high.

Vision 2030: continuing the transformation

• Vision 2030 commits Keppel Corp to pivoting its focus to renewable energy solutions. We view their recent contract win of S$600mn in renewable energy is another step in this direction.
• Current projects include building converter stations and substations to support the offshore wind energy industry in the German sector of the North Sea. Keppel’s share of its latest contract is about S$560mn. Keppel Corp is also working on two offshore wind farm substations for OOO, a Danish renewable energy company, worth more than S$150mn. The contract comprises detailed EPC, testing and commissioning for two offshore wind farm 600MW substations.
• We see Keppel O&M’s capabilities in offshore rig design, construction and repair and specialised shipbuilding as highly synergistic with its core business. In 2019, the Group established a new business unit, Keppel Renewable Energy, to pursue opportunities as a developer, owner and operator of renewable energy infrastructure.
• Keppel O&M first entered the offshore wind market in 2010, when it secured a contract to build an electrical transformer and maintenance platform for a German offshore wind farm. This was followed by the commercialisation of its proprietary KFELS MPSEP, a multi-purpose self-elevating platform concept, in Keppel Corp’s first offshore wind turbine installation vessel. It previously delivered Blue Tern, one of the world’s largest and most advanced multipurpose offshore wind turbine installers, for the UK North Sea. It has a stake in Blue Tern.
• We see Keppel O&M tapping its expertise in offshore energy infrastructure to develop integrated solutions across the value chain of offshore wind farms. These would include offshore substations, foundations, installation and support vessels and accommodation platform solutions. We think its early mover advantage will give Keppel Corp a critical competitive advantage against their Chinese and Korean competitors.

Vision 2030: property has the biggest monetisation potential

• Under Vision 2030, Keppel Corp’s property segment has the biggest monetisation potential. While the company did not spell out projects or landbank, we think Keppel will accelerate sales of its existing landbank in Tianjin Eco-City and its remaining plots in Keppel Bay. It could also divest commercial buildings like Keppel Bay, Keppel GE Tower or i12 Katong to REITs.
• Land prices in many Asian cities have risen significantly over the years. As Keppel Corp’s landbank and residential properties are carried at cost, there could be further upside for the Group if these are monetised at current market values. A significant portion - S$7.0bn or 40% of its S$17.5bn target for divestment - is carried at cost, representing potential meaningful upside.
• We expect Keppel Corp to accelerate land sales in its 45%-owned Tianjin Eco-City. This property already turned profitable in 2017, contributing S$50mn profits to Keppel in the last 2-3 three years. With residential property prices and demand in Tianjin remaining healthy, we expect the development to continue contributing S$55-60mn profits in the next few years. We expect the development to be fully sold by 2028.
• Keppel Corp is expected to seek out bigger land parcels for development in countries where it has strong domain knowledge. These include China, Vietnam and India. We think Keppel Corp will look for land parcels with an average size of 700K sqm GFA or more. This size is similar to its Tianjin Eco-City (625k sqm GFA) and Saigon Sports City (781K sqm GFA). Plots of this size offer greater value-add in terms of opportunities for soft infrastructure than smaller land parcels.

Keppel Corp - Valuation

• We initiate coverage of Keppel Corp with a BUY recommendation and target price of $6.12. Our target price is based on SOTP-based valuation with a 10% holding-company discount. We value O&M at 0.6x book value, about a 16% discount to peers. We value its Property segment at a 40% discount to its RNAV, which is in-line with the sector average, and Infrastructure at 12x FY21e earnings, in-line with peers. We also value M1 at 12x FY21e earnings, a slight discount to the sector average of 13x. We value Keppel Corp’s stake in Sino-Singapore Tianjin Eco-city at 1.5x book value.
• We are cautiously optimistic on Keppel Corp’s plan to integrate its different units to develop comprehensive solutions to its customers as we believe fruition will take time. If executed well, however, we see the possibility for its conglomerate discount to narrow, potentially leading to higher valuations.
• Keppel Corp has been deepening their efforts in recent years to promote intra-company collaboration, they have adopted a OneKeppel approach to harness the synergies of the Group and capture new profit pools that might not be available to individual business entities. Some examples of these may include but are not limited to large-scale urban developments or floating data centre parks. The development of these projects involve different capabilities within the Group, allowing them to harness their offerings to enhance its suite of offerings. We think these initiatives will take time to realise however, and we attached a 10% holdco discount to the Keppel Corp to arrive at our target price of S$6.15.
• Over time, as the management continue to break down the silos within the different divisions, we see the potential for this discount to narrow over time, which could lead to higher valuations for Keppel Corp.
• See 27-page PDF report attached below for complete analysis on Keppel Cororation (SGX:BN4).
• See also Keppel Corp Share Price; Keppel Corp Target Price; Keppel Corp Analyst Reports; Keppel Corp Dividend History; Keppel Corp Announcements; Keppel Corp Latest News. 

Terence Chua Phillip Securities Research | https://www.stocksbnb.com/ 2020-12-02

SGX Stock Analyst Report BUY INITIATE BUY 6.12 SAME 6.12