Keppel buy with SPC’s divestment

We upgrade Keppel to a BUY, with a price target of S$8.57 (from S$7.92), based on our sum-of-the-parts valuation (SOTP — method unchanged). We have adjusted our FY09F earnings to account for the exceptional gain of S$660mn to be booked in 2Q09, given the deal completion timing.

Excluding the exceptional gain, FY09-11F earnings have been adjusted downward to take away SPC earnings previously incorporated into our forecasts. We also have adjusted our FY09F, FY10F and FY11F infrastructure division earnings upward significantly to S$123mn, S$134.8mn and S$147.5mn, respectively, to account for the 1Q09 earnings, where EBIT margin doubled to 6% from 3% in 1Q08. As mentioned earlier, infrastructure EBIT earnings grew 177% to S$37mn in 1Q09, on the back of improved performance and new contributions from the various units.

Our price target of S$8.57 is pegged at a 5% discount to our SOTP value of S$9.03 (method unchanged). We value the O&M division using a DCF over a 20-year period. This incorporates a cyclical downturn in earnings from FY11F, and a WACC of 7.5% (in line with our WACC valuation for Sembcorp Marine). The group’s other businesses are valued at the current market price levels. We incorporate the divestment price of S$6.25 per share for Keppel’s 45.51% stake in SPC into our SOTP valuation. As for Keppel Land, we have incorporated Keppel’s maintained stake in a larger capitalised entity (based on KepLand’s latest market price and increased share base) following the property subsidiary’s recently completed rights issue.

With our price target implying a more than 23% potential upside, we rate Keppel Corp a BUY. FY10-11F PE of 13.0x and 12.9x each have moved up substantially from the lower end of Keppel’s historical PE band range of 8x and 18x for FY10F and FY11F, respectively. But, we believe the restructuring of the group’s businesses and how the group deploys funds from the SPC sale will be a key catalyst for the stock. Potential strategic investments, either in its offshore & marine or infrastructure division, or M&A acquisition opportunities, and a recovering property market being less of a drag on valuations are also positives, in our view.

If we strip out the group’s property and infrastructure and other divisions, Keppel’s offshore & marine business is trading at FY09F PE and FY10F PE of 8.8x and 10.8x, respectively. The group ROE of 17% looks reasonably attractive for a conglomerate, although we note the downtrend. The forward dividend yield at 4.6% is attractive relative to SCI’s 3.8% yield, with the group likely to maintain its track record of paying 50-60% of earnings as dividends.

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