Sembcorp Industries - An interesting laggard play; attractive on several fronts

Over the past one, three and 12 months, SCI has lagged the market largely on fears of weakening utilities earnings which we believe have been overplayed. At the current levels, its utilities business’ implied valuation is 6.3x FY09E PER (vs. 14x average for European and Asian utility plays). The group remains in a solid net cash position and is well positioned for any potential M&A activities. Maintain Buy.

Our calculations suggest that by reversing the other components of SCI, Sembcorp Marine’s (SMM;Buy;SGD2.93) implied valuations (through SCI) are currently at 9.5x FY09E PER vs. 12.6x, the actual multiple for SMM, or about 25% less. Over time, these valuation discrepancies tend to converge, as shown in Figure 3. The recent oil price strength bodes well for SCI (through SMM) as some of the E&P plans previously delayed/shelved may get revived.

The expiry of its favourable supply contracts in the UK and GBP depreciation are out of SCI’s control and arguably, should not be reasons for being negative on operations. The group’s core utilities business remains steady and its newer operations such as Fujairah and China are beginning to contribute more. The recent strength in the GBP vs. the S$, if sustained, should be positive for Sembcorp Utilities as earnings are translated back to S$.

SCI provides a combination of stability (through its utilities business) and growth (from its Marine division), and is backed by strong fundamentals. Our SOTP yields a target price of S$4.20. Downside risks include the execution of projects, unforeseen market risks in the countries in which it has invested, and sustained credit problems or contract execution failures for SMM (see p. 6 for more detail).

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