• Sembcorp Industries' energy business grew 8% q-o-q, led by strong India profits, partially offset by losses in UK.
• Trim FY19/20 earnings forecasts by 13/5% on Sembcorp Marine earnings revision.
• Interim DPS of 2 Scts declared, same as last year.
• Maintain BUY; Target Price lowered to S$3.20.

Energy Business Firing Up

• Maintain BUY; Target Price reduced to S$3.20, to reflect lower Target Price for Sembcorp Marine (SGX:S51) and reduction in valuation multiple for non-Marine business from 10x PE (-0.5SD) to 8x PE (-1SD) given the cloudy macro outlook.
• SEMBCORP INDUSTRIES (SGX:U96) offers a unique value proposition as a defensive utilities business, with a proxy to ride the cyclical O&M recovery. Its India operations have shown signs of turnaround in 1H19. This should re-rate Sembcorp Industries’ Energy business, which is undervalued at 0.6x P/BV and 6x PE against 6-7% ROE.
• India power segment on recovery path; remains long-term growth engine. Sembcorp Industries’ India operations swung from a loss of S$58m in 2017 to a 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. India remains a key growth driver, accounting for 15- 20% of earnings.

Where We Differ

• We believe in the long-term growth prospects of Sembcorp Industries’ 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’s O&M arm and Sembcorp Marine in view of keener competition in the sector.
• We believe spin-off of its marine arm could re-rate Sembcorp Industries’ undervalued utilities business that is being overshadowed by the cyclical marine business.

What's New - India Led the Pack in 2Q19

2Q19 results largely in line.

• Sembcorp Industries’ net profit grew 20% y-o-y and 5% q-o-q to S$98m in 2Q19, making up 27% of our full-year estimate. Its Energy segment performed well (+8% y-o-y and q-o-q to S$92m), with India operations turning around as expected, offsetting weakness in Marine and Urban Development.
• 1H19 net profit of S$191m made up 54% of our revised earnings (adjusted for Marine earnings downgrade), largely in line, as the Marine segment is now expected to register wider losses in 2H19.

India operation reported biggest quarterly profit of S$42m in 2Q19

• India operation reported biggest quarterly profit of S$42m in 2Q19 (vs -S$7m in 1Q19 and +S$39m in 2Q18), attributable to resumption of SEIL Project 1 Unit 1, commencement of Bangladesh PPA (~19% capacity of SEIL Project2) towards end-February and peak season effect for renewables. The results were aided by favourable coal cost but partially offset by weaker renewable profit of S$11m (vs S$17m a year ago) due to taxation.
• In Singapore, net profit in 2Q19 saw a sequential increase of 44% q-o-q to S$36m, leveraging on low LNG cost. The power market remains competitive, but the retail business is doing relatively well. On carbon tax, we estimated that the implementation could result in an additional cost of S$15- 20m, of which a big chunk should be passed on to customers.
• In UK, it reported net loss of S$18m this quarter vs net profit of S$24m a quarter ago, in the absence of recognition of 1Q19 peak winter availability payment of ~S$16m for UK Power Reserves (UKPR), which turned into a loss of S$12m in 2Q19.

Urban Development

• Urban Development segment generated profit of S$11m (- 69% y-o-y) in 2Q19, largely from Vietnam industrial land sales. Land sales tend to be lumpy and we expect momentum to pick up as the property market continues to improve in China. Healthy net orderbook of 504 ha would be recognised as land sales over next 2-3 years.
• In addition, we will also see recognition of income from the sale of Riverside Grandeur Residential development in China as progressive handover is expected in 2019.

Marine.

• Marine subsidiary – 61%-owned Sembcorp Marine reported headline net loss of S$8.5 in 2Q19, from S$1.8m profit a quarter ago. Excluding non-recurring items (accelerated depreciation, impairment and tax credit), net loss would have been ~S$2m vs profits of ~S$10m in 1Q19 and S$13m in 4Q18.
• YTD wins of S$175m lagged expectations. While overall improvement and offshore capex taking time to translate into new orders, Sembcorp Marine has been actively responding to an increasing pipeline of tenders and enquiries for production and gas-related projects. Hence, management remains hopeful on securing new orders in the foreseeable quarters.
• Meanwhile, Sembcorp Marine expects sequentially higher losses in the second half with full-year losses projected to be similar in range to last year’s losses. This is because of lower activity level due to low contract wins in the prior quarters.
• We lowered our Marine order win expectation this year from S$2.5bn to S$1.5bn given the slow order flow YTD. We have also lowered our EBIT margin assumption by 3.9ppts/1.59ppts for FY19/20. Our earnings forecasts for Sembcorp Marine are thus cut from +S$39m/+S$72m to -S$54m/+S$27m for FY19/20. Earnings growth in 2020 is predominantly lifted by the absence of a S$48m accelerated depreciation.
• As a result, our FY19/20F earnings forecasts for Sembcorp Industries are reduced by 13%/5%.

Source: DBS Research - 16 Aug 2019