Keppel Corp (KEP) kept investors in suspense last week as it remained in a trading halt since 21 January. It will resume trading this morning. During the suspension, the company announced its offer to buy Keppel Land (KPLD) shares as well as its full year profit which increased 2% year on year despite a slump in oil prices…

On Friday (23rd January), KEP announced its offer to buy Keppel Land (KPLD) shares for as much as $4.60 a share. That is a 26% premium in comparison to the last trading price of KPLD. Before the offer, KEP already owned 54.6% of the real estate company.
 
The company said that taking KPLD private would allow the group to better streamline its organizational structure. CEO Loh Chin Hua said that they are doing this as they believe in the long-term fundamentals in property and that urbanization will continue. “We have not been shy about taking bold moves, if it’s the right one,” he added. If the offer goes through, the earnings per share of KEP will increase by 13% to $1.18 from $1.04.
 
Macquarie Equities Research (MER) agrees that the bid to privatise KPLD is a bold move but will be a value accretive one. MER has an ‘Outperform’ rating on the stock and increased its 12-month price target to $10.85. Here are excerpts from the research report…..
 
 
Event
With a long term plan to make KEP “one of the world’s top 20 conglomerates”, KEP announced its offer to privatize Keppel Land, its 54.6% subsidiary.
 
MER assumes that KEP would acquire the rest of 45.4% at the high-end of the offer price of S$4.38-4.60, thus shelling out S$3.23bn in cash.
 
Given the 100% consolidation of KPLD, Keppel Bay and Tianjin Eco City now, KEP’s sum-of-parts valuation (SOTP) rises to S$13.56, to which MER applys a 20% conglomerate discount and thus arrive at a new target price of S$10.85 (vs S$10.50 earlier).
 
Impact
Impact 1: Earnings accretive: Post consolidating 100% of KEP’s property business, MER’s earnings estimates have gone up by 5-10% for the next 3 years.
 
Impact 2: Property becomes a larger chunk of KEP’s profits: MER’s estimates suggest that the property business will comprise ~30% of KEP’s consolidated profits from 2015 onwards (vs 25% earlier). The division split post merger would be 50% O&M, 30% property, 15% infra and 5% others.
 
Impact 3: SOTP goes up but conglomerate discount applies: MER’s SOTP has gone up to S$13.56 but MER thinks a 20% discount would apply, thus bringing the net asset value (NAV) to S$10.85. The split – 51% offshore and marine (O&M), 34% property, 13% infra and 2% others.
 
Impact 4: Leverage goes up: MER has assumed that KEP would raise the entire S$3.23bn for the 45.4% stake from debt. This increases the net debt / equity ratio to 37% for 2015E from 7% estimated earlier.
 
Impact 5: Minority interest on the balance sheet goes down and so does the total equity value: KEP had S$3.5bn of minority interest from KPLD on its balance sheet at the end of 2014. KEP’s total equity value on its balance sheet goes down by that amount.
 
MER’s Earnings and target price revision
MER increases its earnings by 9% and 2% for the next 2 years, and raises its target price from S$10.50 to S$10.85.
 
Price catalyst
12-month price target: S$10.85 based on a Sum of Parts methodology.
Catalyst: New orders
 
MER’s action and recommendation
Short term pain for long term gain: Given the headwinds in the property market in Asia in the near term, MER thinks it is a bold move by KEP but a value accretive one with an eye on the long term fundamentals and strategy.
 
Stock becomes cheaper on P/E and inexpensive on P/B; Robust dividend yield of 6%: Given the increase in earnings, KEP is now at 8.3x 2015E P/E and 1.3x P/B with 16% ROE. Assuming a 45-50% payout ratio over the next 2 years, KEP is likely to continue paying a S$0.48 dividend in MER’s view, which makes the dividend yield very attractive.

Source: Macquarie Research - 26 Jan 2015