Sembcorp Industries - UOB Kay Hian 2022-02-24: Strong 4Q21 Sets Up A Solid 2022-23 Outlook

SEMBCORP INDUSTRIES LTD (SGX:U96)

Sembcorp Industries - Strong 4Q21 Sets Up A Solid 2022-23 Outlook

While 2021 marked Sembcorp Industries’s return to profitability post the demerger of Sembcorp Marine (SGX:S51), its net profit of S$279m (+78% y-o-y) was a slight miss. Nevertheless, there were key positives from the result: on a y-o-y basis, we witnessed profit margin expansion, higher ROE and free cash flow, and lower debt levels.
Importantly, Sembcorp Industries’s outlook remains robust given its two China renewables acquisitions which will start contributing this year. Maintain BUY. Target price upgraded to S$2.95.

Sembcorp Industries (SGX:U96) reported 2021 revenue and net profit of S$7.8b (+43% y-o-y) and S$279m (+78% y-o-y) respectively which at the bottom line slightly missed our estimates. Sembcorp Industries declared a final dividend of S$0.03 per share which results in a full-year 2021 dividend of S$0.05 per share (or 32% payout ratio), slightly ahead of our estimates.
The key positives in the results include a strong ROE for 2021 of 7.9% which is a material increase from the 3.0% seen in 2020. In addition, free cash flow nearly doubled y-o-y to S$1.3b helped by improving profitability across all of Sembcorp Industries’s business segments – of note, we witnessed higher energy demand and profitability in 4Q21 which positively affected SCI’s Singapore, India and the UK businesses.
Strong 4Q21 sets up a solid outlook for 2022 and 2023. On the back of the strong operational performance in 4Q21, Sembcorp Industries appeared to be quietly confident that this could continue into 1H22. We highlight that the company has earnings growth coming through from its two China acqusitions in 2021 which added 1.3GW or 33% of renewables capacity net to Sembcorp Industries, as well as the potential for more floating solar farms in Singapore.

Sembcorp Industries’s net debt fell nearly 10% y-o-y to S$6.0b as at end- 21 as it repaid project finance debt for Sembcorp Energy India and Sembcorp Green Infra. As at end-21, 34% of its total debt was project finance. Importantly, its debt/EBITDA declined from 6.5x in 2020 to 5.7x at end-21, and on our forecasts, its net debt/equity is expected to decline from 1.3x to just over 1x by end-24.
Sembcorp Industries is looking to refinance its floating rate debt, and has disclosed that every 1% increase in its interest rate will increase its interest cost by about S$30m.
ROE expansion in Sembcorp’s renewables business. A key aspect to look out for in Sembcorp Industries’s results going forward is the ROE for its renewables business. Its 2021 results show an ROE of 4.6% however this is expected to increase as these assets mature.
Currently, with an average age of 4-5 years for its renewables assets, an ROE of 5-7% is to be expected. However, as assets mature and earnings and cash flow contributions increase, coupled with paying down of project debt, ROE is expected to trend up to 10% and head northwards to 20% as they get older.

Sembcorp Industries’s India business performed better than expected in 2Q21 as its P2 plant’s uncontracted nature, and thus exposure to the Indian Energy Exchange (IEX), allowed it to fully take advantage of the strong electricity prices in 4Q21. However, P2 remained unprofitable in 2021 as it was required to use international coal, thus increasing its cost base.
Note that in Jan 22, Sembcorp Industries signed two long-term supply contracts for 825MW from its P2 plant – as a result, 85% of Sembcorp Energy India’s 2.6GW capacity will be under mid-or long-term contracts.

Singapore represents 10% of Sembcorp Industries’s group emissions of 26m tonnes a year. While Sembcorp Industries does not disclose its carbon tax bill, the current tax rate of S$5/tonne implies an annual bill of S$13m.
With the Singapore government planning to raise this to S$25/tonne in 2024 and 2025, and then in stages to S$50 to $80/tonne by 2030, Sembcorp Industries’s carbon tax bill could increase exponentially, ceteris paribus.
However, Sembcorp Industries will likely divest some or all of its carbon producing plants, and in any case the government has stated that there will be a transition framework in place to help companies manage such higher carbon taxes. These include providing existing companies with allowances based on efficiency standards and decarbonisation targets – thus Sembcorp Industries would not have to pay carbon taxes for these allowances.
Importantly, Sembcorp Industries will also be able to use high-quality international carbon credits to offset up to 5% of its taxable emissions from 2024.

We upgrade Sembcorp Industries's 2022 and 2023 earnings forecast by 14% and 23% respectively to take into account:
- new profit contributions from two acquisitions in China, one of which was completed in Jan 22 and the other one to be completed by end-1H22; and
- stronger-than-expected 2H21 results from its energy business which may translate into decent 1Q22 results.
Maintain BUY rating on Sembcorp Industries with a higher P/B-based target price of S$2.95 which is pegged to a target P/B of 1.3x. This target P/B multiple has been increased from 1.2x to 1.3x to reflect the better energy outlook given our belief that the COVID-19 peak is behind us, and also to partially reflect the company’s nascent transformation from a brown to green energy producer.
We continue to foresee an upward re-rating of Sembcorp Industries’s valuation multiples due to the scarcity value of solid ESG companies in Singapore. At our target price, Sembcorp Industries would trade at 13x 2022F earnings which is reasonable, in our view.
See
Catalysts: Sustained economic recovery post COVID-19 peak, thus leading to increased energy and ies usage.

Adrian LOH UOB Kay Hian Research | https://research.uobkayhian.com/ 2022-02-24

SGX Stock Analyst Report BUY MAINTAIN BUY 2.95 UP 2.590