Sembcorp Industries: Utilities — investing for growth

Management highlighted that the group remains focused on managing costs as well as maintaining operational excellence and good customer relations at its core business divisions in utilities and offshore & marine (through a 61% subsidiary, Sembcorp Marine). Management emphasised that the group’s multi-customer business model at its centralised utilities facilities in Singapore and the UK provides sustainable earnings, as contracts are on a relatively long-term basis. While 1Q09 had seen the UK business has been adversely affected by the expiration of previous electricity supply contracts, management assured investors that UK earnings decline has stabilised. Also, the closure of older plants at the facility has been mitigated by newer “green” investments.

The group’s 35MW Sembcorp Biomass Power Station will also see its first full year of operations this year. SCI is the leading integrated utilities and services provider to more than 45 global multinationals at the UK Teeside facility, with more than 50 years of operational experience. In Singapore, the group provides energy, water and on-site logistics and services to more than 40 multinationals at its Jurong Island facility, which it has operated for more than 11 years.

With its focus on longer-term growth, SCI remains on the lookout for growth opportunities in both the utilities and marine engineering divisions, either through organic growth or through potential M&A. As at 1Q09, the group had net cash of S$1.54bn, with Sembmarine in a net cash position of S$1.9bn, and the group’s utilities and other business in net debt of just S$341mn.

Our price target for SCI is S$3.38 (unchanged), based on a 5% discount to our SOTP valuation (method unchanged). For the other listed entities, we use Gallant Venture’s (GALV SP, not rated) market price. We value the utilities business on DCF (a WACC of 6.5%, growth of 2%), and its industrial parks and environmental engineering on an FY09F PE of 8x, in line with its peers. SCI now trades at FY10-11F PE of 9.9x and 9.9x, respectively, which remains at the lower end of its historical trading band of 6-21x, and compares to its eight-year average PE of 14.6x. The dividend yield at 3.8% is relatively attractive, in our view. Our rating is maintained at NEUTRAL. Our concerns are that weaker-than-expected UK utilities’ performance could pose an earnings drag in the short to medium term.

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