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Simons Trading Research

Author: simonsg   |   Latest post: Wed, 13 Nov 2019, 11:56 AM

 

Sembcorp Industries - Turning Greener

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  • Management reassures investors with strategies to augment balance sheet and improve ROE during NDR.
  • Energy and Urban solutions see growth in emerging markets.
  • Over-penalised for marine weakness; Sembcorp Industries’s valuation now at 0.5x P/BV despite delivering 5-6% ROE.
  • Reiterate BUY; Target Price S$3.20.

Maintain BUY; Target Price S$ 3.20

  • SEMBCORP INDUSTRIES LTD (SGX:U96) offers a unique value proposition as a defensive utilities business, and as a proxy to ride the cyclical O&M recovery. Stripping out Marine’s current valuation, Energy business is deeply undervalued at 0.5x P/BV and 5x PE against 6-7% ROE.
  • In fact, the stock is trading close to our ~S$2 fair value of Sembcorp Industries’s businesses excluding Marine, implying its marine business comes free.

Emerging Markets Are the Long-term Growth Engines

  • Sembcorp Industries’s India operations swung from a loss of S$58m in 2017 to profit of S$47m in 2018, and the positive trend should continue. The power market in India is recovering with current peak surplus expected to reverse by FY20, according to independent research house CRISIL, driving up tariffs.
  • Besides India, Sembcorp Industries has also made forays into other emerging markets – Bangladesh, Vietnam and Myanmar.

Where We Differ

  • We believe in the long-term growth prospects of Sembcorp Industries’s Energy arm, which has expanded its global footprint into key emerging markets – India, Bangladesh, Vietnam, and Myanmar.
  • We hold on to our belief of a potential merger between Keppel Corporation (SGX:BN4)’s O&M arm and Sembcorp Marine (SGX:S51) in view of keener competition in the sector. We believe a spin-off of its marine arm could re-rate Sembcorp Industries’s undervalued utilities business that is being overshadowed by the cyclical marine business.

Valuation

  • We derive our fair value for Sembcorp Industries based on the sum of its different parts, with a 10% conglomerate discount to the RNAV, to arrive at a Target Price of S$ 3.20. This represents 0.8x P/BV.

What's New - Post Non-Deal Roadshow Takeaways

  • During our recent NDR with Sembcorp Industries in Toronto, Chicago and New York, we sensed that investors generally see value emerging for Sembcorp Industries, though they are hoping to have better visibility on re-rating catalysts. Key questions revolved on its balance sheet augmentation, ROE enhancement, strategy for India, Energy growth strategy, and marine recovery.

Set on recovery path

  • Both Energy and Marine (through Sembcorp Marine) businesses have probably seen their worst and are set on a recovery path. Management previously guided in their Strategic Review released in Feb- 2018 that they aim to improve ROE from current mid-single digit to double-digit over the next 5-years through improvements in both Marine and Energy segments.
  • ROE recovery is indeed a critical factor for Sembcorp Industries’s re-rating in our view. This can be achieved through divestment of noncore/non-performing assets, and earnings growth. Two key drivers are Sembcorp Marine's and India’s turnaround.

Fast growing Energy demand in emerging markets

  • Singapore remains the largest earnings contributor to Energy’s bottomline. The oversupply situation should ease by 2023 as a few plants are old - about 2000MW could come off by then, eliminating the excess supply. In India, recovering trend is expected to continue as well, lifting current low single digit ROE.
  • Energy demand and economic well-being typically go hand-in-hand. In terms of GDP growth, low single digit growth is expected in more developed countries like Singapore and Middle East; mid-single digit growth in China while high single digit growth could be expected in Rest of Asia or emerging markets. In recent years, Sembcorp Industries has made forays into other emerging markets besides India – Bangladesh, Vietnam and Myanmar – and this should underpin the longer-term growth prospects of its Energy segment.

Focus on improving cash flows and stable returns

  • Acknowledging the current less than ideal net gearing of > 1x, Sembcorp Industries has placed much emphasis on improving cash flow and paring down debt.
  • Sembcorp Industries has freed up ~S$300m of capital through divestment of non-core assets (such as slow cash flow generation assets, coal-fired power plants etc), on track to meet its S$500m (excluding India IPO plan) target by 2020.
  • Management plans to divest or pare down stake in some assets in India and China while reinvesting in Singapore and UK. India’s coal-fired power plants generate lower returns yet have longer receivables. Sembcorp Industries’s PPA was with the state government, which generally pays slower than Central government. First choice will be an IPO, which Sembcorp Industries had attempted a year back but held back awaiting better market conditions. The cash proceeds will be utilised to fund renewables expansion in India, where Sembcorp Industries has emerged to be one of the largest players there.
  • In China, given the tight capital controls, Sembcorp Industries plans to recycle capital and focus more on environmental and renewable projects in China.
  • In UK, while management remains optimistic on the longer-term prospect, it will likely wait for better clarity on Brexit uncertainties before concluding any major growth plan.

Turning greener for sustainability

  • With the push for sustainability, renewable energy is expected to grow from 30% of capacity to target of 50% gradually by 2022. While renewable energy typically fetches lower return of mid-to-high single digit as compared to low teens for conventional energy, income could be more predictable with long-term PPAs.

Beneficiary of trade war

  • Beneficiary of trade war with more Petrochemical and industrial investments in SEA. For instance, ExxonMobil announced in early April that it is undertaking a multi-billion-dollar expansion of its Jurong Island integrated manufacturing complex in Singapore. Gas and engineering giant Linde has signed a long-term agreement with ExxonMobil Asia Pacific in June, which will see it investing US$1.4bn to expand its existing gasification complex at Jurong Island. These will drive demand for Sembcorp Industries’s one-stop centralised utilities solutions there.
  • On the back of US-China trade war, there has been trade diversions and inflow of foreign investment into SEA as companies started to shift their manufacturing activities to this region. This bodes well for Sembcorp Industries’s Urban segment - land sales growth in Vietnam.

Marine recovery takes time

  • Order win is the critical factor to watch for Sembcorp Marine as orderbook is running low at ~S$2.1bn (approx 1x revenue coverage) and YTD contract wins are lagging at ~S$575m (vs street expectations of S$2-3bn at the start of the year). Offshore and Marine sector continues to improve, albeit gradual, especially for the offshore production segment.
  • Sembcorp Marine has been actively responding to an increasing pipeline of tenders and enquiries for production and gas-related projects and management remains hopeful on securing new orders in the foreseeable quarters. But, competition remains intense and order intake could increase at a moderated pace.

Source: DBS Research - 12 Sep 2019

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