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Simons Trading Research

Author: simonsg   |   Latest post: Fri, 17 May 2019, 2:55 PM

 

Sembcorp Industries - Sheer Overhang; Downgrade to HOLD

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  • SEIL Project 1 PLF worsened in Feb 19 despite Unit #1 resuming operations, while SEIL Project 2 showed y-o-y weakness. Dark spread is narrowing as India spot electricity prices are declining more than coal prices. Earnings are lowered 1-3% as a result.
  • At the same time, balance sheet concerns for Sembcorp Marine have created an overhang.
  • We lower our non-marine PE multiple and downgrade SEMBCORP INDUSTRIES LTD (SGX:U96) to HOLD. Target price: S$2.80. Entry price: S$2.35.

What’s New

A spotty 1Q performance for SEIL projects 1 and 2.

  • SEIL Project 1 (fka TPCIL) saw Unit #1 resume operation in end-Feb 19 as foretold by management. This improvement was however, offset by Unit #2 experiencing outages over 20-28 February, resulting in SEIL Project 1’s tentative PLF for Feb 19 (42.1%) coming in lower than that of Jan 19 (44.3%), when Unit #1 was completely down.
  • Average PLF for SEIL Project 2 (fka SGPL) over Jan- Feb 19 was marginally lower at 75% (2M18: 77%).

Dark spread has narrowed ytd.

  • IEX spot prices have fallen 28% q-o-q to Rs3.31/kWh (4Q18: Rs4.60/kWh, 1Q18: Rs3.49/kWh). Partly offsetting the decline in spot electricity prices was a corresponding decline in coal prices by 6% q-o-q. The net impact sees the dark spread narrow for 1Q19, which will negatively impact profitability for SEIL Project 2.

Balance sheet concerns mounting.

  • Sembcorp Industries' share price has slumped slightly since its 4Q18 results, as the higher gearing on Sembcorp Marine (SGX:S51)’s balance sheet renewed concerns on equity financing.
  • Given the higher working capital requirements for future work and elevated capex of ~S$300m for 2019, Sembcorp Marine’s balance sheet is tight. Parallels are being drawn with the recent recapitalisation of its Singapore-listed peer, which saw an equity injection of S$1.5b- 2.0b in 2018 for its O&M business.

Stock Impact

Lowering earnings estimates for India.

  • The spotty performance stemming from India points to a less than promising start for 2019. While Sembcorp Industries posted S$47m profit for FY18, this included ~S$49m in write-backs, settlements and tax benefits. The weak PLF showing for SEIL Projects 1 and 2 points to core losses for both in 1Q.
  • Taking into account the start of the new 250MW PPA to Bangladesh, we lower our 2019 earnings estimate for India to S$15m, from S$20m previously.

Share price overhang from SMM’s balance sheet risks.

  • Sembcorp Industries has often re-iterated it will support Sembcorp Marine through the cycle. Assuming Sembcorp Marine undertakes equity financing of the same quantum as its Singapore-listed peer, Sembcorp Industries will have to raise capital to subscribe to the equity call. Such a course of action will significantly improve Sembcorp Marine’s financial position, while partially offsetting the valuation downside for Sembcorp Industries.
  • For Sembcorp Marine, this comes in the form of:
    1. lower net gearing,
    2. higher working capital position,
    3. better profitability from lower interest expense, justifying a higher valuation multiple, and
    4. cleaner balance sheet to pursue new contracts that will further drive earnings growth.
  • Sembcorp Industries’ valuation will suffer from dilution, but this is partially offset by the aforementioned impact for Sembcorp Marine. However, until the risk of an equity call dissipates, Sembcorp Industries' share price is likely to experience an overhang.

Earnings Revision / Risk

Lower earnings by 1-3% on India.

  • Due to the lower forecasts for India, our earnings estimates for 2019-21 decline to S$391m (-1%), S$407m (-3%) and S$421m (-1%) respectively.

Valuation / Recommendation

Downgrade to HOLD, target price reduced to S$2.80.

  • Given the overhang and underperformance from the Utilities division, we have adjusted our target price down to S$2.80. This values Sembcorp Marine at an unchanged S$1.83 per share, with the Utilities segment valued at an implied 7.5x 2019F PE (prev: 9.6x), reflecting -0.5SD of its long-term mean since 2001 (7.8x). See attached PDF for SOP details.
  • Given the limited upside and uncertainty surrounding the stock, we downgrade our recommendation to HOLD.

Share Price Catalyst

  • Faster-than-expected turnaround of utilities earnings.

Source: UOB Kay Hian Research - 13 Mar 2019

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Labels: Sembcorp Ind

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