• Since the demerger of Sembcorp Marine (SGX:S51) from Sembcorp Industries (SGX:U96) on 9 Sep 20, Sembcorp Industries' share price has significantly outperformed, rising by 36% from its theoretical demerged price of S$0.96/share.
• We nevertheless continue to see upside over the next 6-12 months given that the company trades at a discount to its regional utilities peers both on a P/B and PE basis.
• Maintain BUY on Sembcorp Industries with an updated target price of S$1.66 as we have extracted the book value of Sembcorp Marine from our valuation.

Outperformance of Sembcorp Industries Share Price

• Since the demerger with Sembcorp Marine, Sembcorp Industries' share price has risen by 36% over the 9 Sep to 17 Sep period while the STI has seen a 0.2% decline over the same time frame. We attribute this to the fact that the removal of Sembcorp Marine as its subsidiary has given the market greater confidence in Sembcorp Industries’ future business outlook as it will not have the millstone of having to provide financial support for Sembcorp Marine going forward.

Expanding Its Renewable-energy Presence in China

• On 11 Sep 20, Sembcorp Industries announced that it had signed an MOU with NASDAQ-listed GDS Holdings (GDS) to develop and provide renewable energy solutions for GDS’s data centres in China, as well as looking for opportunities to realise operational synergies between GDS’s data centres and Sembcorp’s renewable-power generation and water management systems.
• Sembcorp Industries has stated that it will be GDS’s strategic partner in the development of integrated green solutions to support GDS’s environmental sustainability goals.

New China Growth Angle

• While Sembcorp Industries did not provide any potential financial impact from this tie-up with GDS, we note that the latter’s 2Q20 results were extremely strong with revenue growing 36% y-o-y to US$189m while its EBITDA rose 48% y-o-y to US$90m.
• Importantly, its EBITDA margin expanded nearly 4ppt to 47.2%. Operationally it saw a 51% y-o-y increase in its total committed and pre-committed area to 333,000m³ while its area-in-service increased by 48% y-o-y to over 266,000m³. GDS’s clients include Alibaba, Amazon Web Services, Huawei, JD.com and Bytedance.

Sembcorp Industries - Valuation & Recommendation

• Reiterate BUY on Sembcorp Industries with an updated P/B-based target price of S$1.66, pegged at 0.8x P/B (previously 0.6x) to its end-1H20 book value of S$2.08/share.
• Our new target P/B multiple is a discount of 8% to its 5-year P/B average of 0.86x, which we view as reasonable, given that the market will have a much better look through to Sembcorp Industries’ earnings without the ‘fog’ of Sembcorp Marine’s losses (see net profit chart on RHS). However, we are reluctant to ascribe a higher P/B multiple to Sembcorp Industries at this stage given that:
  1. the company has businesses that are still struggling as they lack regulated earnings, notably UK Power Reserve, and
  2. the uncertain nature and trajectory of the regional and global economic recovery post-COVID-19 affects energy demand.

Regional utilities peers trade at higher P/B multiples

• We highlight that gas & thermal utilities peers in the region trade at a P/B of 1.0-2.3x, renewables peers trade at 1.3-4.7x P/B while water & waste treatment peers trade at 1.8-2.4x P/B. Unfortunately, Sembcorp Industries does not disclose the book value of its various business segments in this manner and thus we are not able to undertake a comparable-company valuation.
• Nevertheless, with Sembcorp Industries trading at 2021 P/B of 0.5x, we are confident that the valuation gap to its peers will close in the next 6- 12 months.

Meaningful upside in the medium to long term, based on earnings multiples.

• Looking at Sembcorp Industries’ utilities comparables in the region, there appears to be meaningful valuation upside in excess of S$3.70 (excluding a holding company discount) if we were to use comparable PE multiples for its three business segments.

No longer bound by Sembcorp Marine’s fortunes

• Sembcorp Industries' share price has shown a very high correlation of 94% vs Sembcorp Marine's share price over the past 10 years from 2010-2019. In our view, this was due to higher-frequency newsflow from the oil & gas industry as well as the offshore marine industry that moved Sembcorp Marine's share price, and thus also had an outsized effect on Sembcorp Industries' share price.
• With the demerger, we believe that Sembcorp Industries' share price will be less volatile, and its valuation should reflect regional utilities valuations instead.

Sembcorp Industries' share price catalyst:

• Sustained economic recovery post COVID-19 outbreak, thus leading to increased energy ilities demand.
• Given the rally in Sembcorp Industries' share price in the past week, the threat of being excluded from the Straits Times Index has dissipated in our view.

Source: UOB Kay Hian Research - 18 Sep 2020