SembCorp Industries : Earnings growth propelled by marine contribution

1H09 net profit up 5% yoy on higher marine earnings which accounted for 58% of group earnings. Environment Engineering (EE) and Industrial Parks posted better-than-expected performance.

Marine’s net profit up 18% on higher rig building turnover. Utilities’ net profit in 2Q09 rose 11% yoy. Operations in the UK, Vietnam and the UAE performed well. However, 1H09 net profit declined 5% yoy mainly due to lower contribution from the UK as the UK business was affected by the expiry of certain favourable supply contracts as well as the depreciation of the pound sterling.

EE posted higher 1H09 net profit on lower operational costs. Industrial Park’s reduced net profit for both 2Q09 and 1H09 was due to lower land sales from its Vietnam industrial parks and reduced earnings from Gallant Venture. This was mitigated by better performance from the China industrial park. Lower earnings for Others/Corporate was due to write-back of tax provisions made in 2Q08 and 1H08.

With close to 60% of its earnings and valuation derived from SembCorp Marine (SMM), SembCorp Industries’ (SCI) share price performance is significantly dependent on SMM. We are neutral on SMM. While its new contract wins of S$1.1b ytd is on track to meet our S$2b estimate for 2009, our valuation of the stock factors in a longer-term higher annual contract win level of S$3b. As a result of the downturn in the petrochemical and chemical sectors, three UK customers, who contributed to about 30% of UK operations’ 2008 turnover, have announced closures of their on-site facilities. SCI said it will continue to focus on reconfiguring its assets to improve revenue and on reducing costs.

Earnings forecasts and target price raised marginally. We raise our net profit forecasts marginally by 2-3% and our fair price from S$3.20 to S$3.30, premised on our revised sum-of-the parts (SOTP) valuation of S$3.29/share. Maintain HOLD.

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Sembcorp Industries: Price upside remains attractive

Upgrade target price for SCI to S$4.09. The higher target price for SCI is due to the higher values of its listed associates in our SOTP valuation metrics. This includes the increase in target price for Sembcorp Marine (SMM) to S$3.70, and the 43% jump in Gallant Venture's share price to S$0.315. Maintain BUY on SCI.

Cheaper and indirect investment into Sembcorp Marine. At SCI's last closing share price, the implied value of SMM in our SOTP valuation metrics for SCI is S$2.59, vs. SMM's last closing share price of S$3.30.

2Q09 results were above-expectation. SCI's net profit increased 2.7% y-o-y to S$142m in 2Q09, vs. our forecast of S$132m. This was due to its Marine business' stronger-than-expected EBIT margin, at 11.1%, vs. the 9.9% in 1Q09 and our forecast of 9.8%.

Utilities business' performance is in line. SCI's Utilities business delivered S$47.9m (+11% y-o-y) net profit in 2Q09, and S$99.0m (-5%) in 1H09. This was due to higher contributions from its less established markets in Vietnam, China and Middle East, which mitigated the absence of strategic fuel sale in Singapore and the expiry of certain favorable contract in the UK.

Raises profit estimates in FY09-11. We have raised recurring net profit forecast to S$549m (+5.1%) in FY09 and S$574m (+5.6%) in FY10, mainly due to stronger-than-expected profit margins from the Marine business.

SembCorp Ind - Earnings sensitivity from possible Salalah contract

In a recent BT article, it was mentioned that SCI is discussing with banks about closing the financing for the US$1bn-plus Salalah independent water and power project (IWPP) in Oman, suggesting that the group is likely to complete the deal to build, own and operate the IWPP by year-end. This runs counter to earlier reports which suggested that Oman would call for project re-bids. The article also indicated that the group had recently signed a letter with the Omanis which guarantees they would not engage any other party during a 'standstill' period. The Omanis are looking for early completion of the Salalah IWPP, which comprises a 400 MW power station and a de-salination plant to produce 15m gallons of water a day, as demand for resources in the sultanate is growing fast. While our discussion with SCI did not yield much new information as the potential contract is currently in a sensitive stage, a simple analysis suggests that depending on the level of financing obtained, earnings accretion required by the group in four years time (i.e. FY2013) could range between S$29m and S$58m in order to achieve an assumed equity IRR (EIRR) of 13% which is similar to the Fujairah project. These, we think, may be factored into their analyses as SCI works to determine the adjusted tariffs with the Omani government. Our study assumes two years of construction time for this US$1bn greenfield project, one year to ramp up operations, and 23 years for the O&M contract. If an 8.3% cost of equity (rf 2.6%, rp 4.8%, and beta 1.192) is used, the NPV for the potential stream of earnings could range between S$127m and S$255m (or S$0.07/sh and S$0.14/sh, respectively).

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.

SembCorp - concerns remain for the decline in UK utilities operations

We have fine-tuned our FY09-11F earnings forecasts to account for lower utilities revenue primarily from the group’s UK operations on the closure of a number of key customers. We have summarised below our earnings changes.

With the downward earnings revision, our price target for SCI is now S$3.38 (S$3.65 previously), still based on a 5% discount to our SOTP valuation (method unchanged). For the other listed entities, we use Gallant Venture’s market price. We value the utilities business on DCF (WACC of 6.5%, growth of 2%), and its industrial parks and environmental engineering on an FY09F P/E of 8x, in line with peers.

SCI now trades at FY10/11F P/E of 10.5x and 10.6x, which remains at the lower end of its historical trading band of 6-21x, and compares with its eight-year average P/E of 14.6x. The dividend yield at 3.6% is relatively attractive, in our view. Given the less than 15% potential upside to our price target, our stock rating is now a NEUTRAL. SCI share price has performed well in the past three to six months. Our concerns are that weaker-than-expected UK utilities’ performance could pose an earnings drag in the short to medium term. We would recommend a switch to Keppel for higher potential upside.

With the extensive restructuring and timely asset divestments over the previous years, SCI as a group, as of 1Q09, held a net cash position of S$1.54bn. Excluding project finance loans of S$346mn, the group’s net cash stood at S$1.71bn. While the bulk of the cash is held at its marine subsidiary (S$1.8bn, or S$1bn excluding advance payments), the utilities and other divisions have a low net debt of just S$244mn.

According to management, the group’s non-recourse project finance loans continue to be funded by project cashflows, with an outstanding S$332mn in corporate debt to be paid within one year. The group also recently raised S$200mn of five-year notes under an existing MTN programme.

Sembcorp Industries: Utilities business to normalize

Normalizing of Utilities business to give better visibility to investors. Earnings of Sembcorp Industries' (SCI) Utilities business are expected to normalize from 2Q09 onwards, since certain of its favorable supply contracts in the UK have already ended in 1Q08. While SCI's utilities business may still suffer revenue decline due to possible rebates given to clients in view of weak economic environment, we expect the group's austere cost measures to result in stable recurring profits in 2Q09. As a recap, SCI's recurring net profit for both its Singapore and UK Utilities operations were estimated to be relatively stable q-o-q at about S$21m in 1Q09 (vs. S$22m in 4Q08) and about S$9m (vs. S$10m), respectively.

Potential upside from removal of order cancellation assumption for SMM by end 2009. We see the on-schedule cash payments for Petroprod's jackup rig (before mid-July 2009), and Seadrill's semi-submersible rig (estimated by end 3Q09) as catalysts for the eventual removal of our S$1.1b order cancellation assumption for SCI's listed subsidiary, Sembcorp Marine. This could potentially add >3% to our fair value for SCI.

Maintain BUY on SCI. We have upgraded our fair value to S$3.63 for SCI, in line with the higher fair value for Sembcorp Marine. Maintain BUY on SCI.

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).

Semb Corp Industry - Healthy 1Q09 results; target price raised on SMM upgrade

Revenues in 1Q09 were flat at S$2,147m, while net income grew 9% yoy to S$133.6m (c. 26.4% of our FY09E). Earnings growth was mainly driven by strength from its Marine division, where PATMI rose 32% yoy to S$74m. Utilities PATMI was down 16% yoy to S$51m. Together, these two divisions accounted for about 94% of the group’s 1Q09 PATMI. We view the group's long-term prospects as healthy as SCI provides a combination of stability and visibility through its utilities arm, with upside and growth through the marine division. Buy.

We have incorporated our latest forecasts and target price for SMM, which largely account for SCI’s target price increase. For Utilities, we have trimmed our estimates as FY09 could see a four-quarter impact due to the expiration of its favourable supply contracts in the UK (versus three quarters in FY08), and as the GBP continues to remain weak, which will impact earnings from its Teeside unit.

The expiration of favourable supply contracts in the UK and GBP depreciation are out of SCI’s control, and arguably, should not be the reasons for being negative on operations. The group’s core utilities business remains generally steady and its newer operations, such as Fujairah, are contributing healthily, which is reflected in the group’s 122% surge in 1Q09 PATMI (other countries) to S$10m.

The group remains in a strong position and may look at opportunities to boost its capabilities if bank funding is available and economically viable. Our SOTP yields a TP of S$4.20. Downside risks relate to the execution of its projects, unforeseen market risks in the countries in which it has invested and sustained credit problems or contract execution failures for SMM.

SembCorp Industry - 1Q09 Results In-Line

1Q09 results — Forex gain of S$18m (vs. S$7m loss in 1Q08) and S$8.7m tax writeback of provision for deferred tax helped boost 1Q09 profit to S$134m (9% yoy), accounting for 29% of our full-year profit estimate. During the quarter, O&M was the key profit driver (55% of PATMI vs. 45% in 1Q08) while Utilities was largely in-line (after adjusting for one-off items), with weaker performance from UK with beneficial feedstock pricing contract expired since 1Q08.

Utilities — Total Utilities PATMI reached S$51mn (-16% yoy) on back of S$696m revenue (-38% yoy; due to lower HFSO prices). Sale of fuel amounting to $5m and tax writeback of $5.7m boosted Singapore Utilities PATMI by 13% to $32m and helped partially offset weakness from UK ($9m, -73% yoy). Both China and Vietnam operations are progressing well and current profitability levels should see sustained improvements as more greenfield projects kick in.

Enviro/Parks — Lower operational costs for Enviro biz helped boost profit by 79% to $1.5m despite lower revenue (-10% yoy). Industrial Park reported $4m (-40% yoy) profit due to lower land sales from Vietnam Park and lower share of results from Gallant Venture; Chinese Parks performance remains unchanged yoy. Both segments are not expected to have material impact for 2009-10 since we forecast marginal EPS contribution from Enviro/Parks.

Hold ---- SCI’s strong balance sheet (both at group and divisional level) should enable the group to weather the economic and financial crisis. After the recent sharp rally, Utilities is now trading at 9x 10E P/E (vs 12.7x for industry). The stock will likely trade range-bound given limited catalysts in the near term.

SembCorp - Marine the largest contributor

Sembcorp Industries achieved another steady quarter that were in line with our expectations, with net profit rising 8.6% to S$133.6m versus 1Q08 on the back of flat turnover at S$2.1bn. The strength at Sembcorp Marine (SMM) offset the anticipated weakness in utilities, with marine now accounting for 55% of group earnings.

Utilities turnover dropped by 38% to S$696m, mainly due to lower fuel prices, which are a pass-through item. Utilities PATMI fell by 16%. The UK business was down 73% with the expiry of a contract on more favourable terms, and the depreciation of the GBP. Singapore utilities earnings grew 13%, with a tax writeback of S$5.7m and a one-off fuel sale offsetting a provision made for upcoming unscheduled maintenance.

With regards to its bid for the US$1bn Salalah independent water & power project (IWPP) project in Oman, management said that it is still in the process of locking down financing. With tighter credit markets, it now has to rope in more banks as individual banks have overall reduced their allocation in order to reduce its risk exposure. However, SCI still seemed optimistic on securing the project.

We are leaving our FY09 forecasts unchanged, where we expect SCI to post 9.8% growth to S$557.0m. We are forecasting steady earnings CAGR of 9% p.a. over the next three years, with earnings expected to decelerate in FY11 due to the marine business. Utilities are expected to perform in line with muted GDP growth, while we are not factoring any significant project wins at this point.

We are adjusting our SOTP price target upwards from $2.70 to $3.03, in line with SMM and Gallant Ventures’ price rises. However, we are reducing our recommendation to a Hold, as SCI’s share price is currently in line with this. We do not expect any significant near term catalysts, with a potential win at Salalah possibly to come at the expense of margins.

SembCorp Industries - Opportunities created via strong balance sheet

Visibility of earnings from utilities business: SCI has established a strong global presence in utilities, which currently accounts for ~40% of the profits for the group with the two largest contributions coming from the Singapore and UK operations. We expect SCI's utilities earnings to continue to be defensive in nature, supported by long-term contracts (average of 15 years across its portfolio) and established customers.

Attractive yield with a comfortable 50% payout ratio. Since 2002, SCI has paid out 35-55% of its earnings as dividends. Management has guided for payout ratio in line with 2007 (50%), translating into DPS of 14.6cps for 2008. Supported by stable earnings, dividend yield for 2009E is at an attractive level of 5%.

Opportunities created via strong balance sheet. SCI was able to take advantage of market opportunities to grow its existing business in previous downcycles, for example, when it purchased its UK operations from Enron in 2003. We believe SCI is well positioned to take advantage of distressed assets and/or companies that are likely to emerge over the course of the next two years given its net cash position.

Risks from O&M sector underperformance. With depressed oil price, E&P capex and constrained yard capacity, we expect limited positive news on order wins in the next two years. Heightened concerns over potential order cancellations and/or deferment of payment for existing orders will also continue to overhang the O&M sector.

Foreign currency risks. SCI has operations across various countries, in particular the UK and China. Depreciation of the sterling pound or Renminbi could negatively impact profit from its overseas operations.

Sembcorp Industries – Target price raised to S$2.70, with upside potential

We are raising Sembcorp Industries (SCI) to a Buy. The stock primarily offers a good earnings mix that is underpinned by the defensive Singapore infrastructure businesses, which represents a third of overall earnings. We also believe there is significant upside to SCI’s prospects with an easing in the credit markets. Our revised SOTP valuation at S$2.70 also looks compelling.

We anticipate an imminent easing in the credit markets as the US and other government’s efforts to clean up bank’s books gather momentum. We believe that state-sponsored infrastructure projects put in limbo by the current credit crunch will be the first line of borrowers that can tap into this, due to a lower default risk and pump priming. SCI can benefit from this, particularly from utilities projects in the Middle East and China.

Recent media reports suggest that SCI is on the cusp of securing its second independent water and power project (IWPP) in the Middle East, after securing financing from China Exim Bank forthe US$1bn Salalah project in Oman. This could also pave the way for other mega-projects in Saudi Arabia, and another project in Fujairah, UAE.

However, we believe that it is too early for a recovery in Sembcorp Marine’s (SMM) offshore business, despite oil currently trading above offshore production breakeven of about US$50 per barrel. Energy demand is expected to remain weak, and financing will still not be so freely available for these riskier projects in the near term.

With a recovery in SMM’s share price, our SOTP fair value is raised to S$2.70, implying 19% upside to SCI’s share price, with a potential further revaluation of its utilities earnings multiples (currently at just 7x FY09 PER). Our net profit forecast remains unchanged, where we project a 10% rise in earnings in the current year, driven by its ongoing projects in Singapore, China and Fujairah ramp up.

SembCorp - Unwarranted cash call jittery

SembCorp Industries (SCI) has officially clarified (in response to a Dow Jones report this morning) that the Company’s request for rights issue at its upcoming Annual General Meeting (AGM) should not be seen as a disclosure that it is currently embarking on a rights issue.

1) A standard request at AGM was misconstrued as immediate fund raising request. SCI clarified that its request to seek mandate from shareholders at its AGM on 20 April 2009 is part of its annual exercise to gain flexibility on fund raising should the needs arise. This is a standard request that is present in all SCI’s AGMs since listing, and is in line with market practice. Indeed, this mandate has been adopted and approved by SCI’s shareholders at all previous AGMs.

2) SCI has room to gear up for its utilities business' acquisitions. We believe that SCI's need for an immediate cash call is low, given that SCI's biggest purchase to-date for its utilities business is UK-based subsidiary, Wilton International. The purchase price for Wilton was 100m British pound, or about S$300m at the point of purchase a few years back.

SCI's net debt (ex-SMM's net cash of S$1.8b) is S$0.2b. SCI's total equity (ex-SMM) is S$1.9b, and assuming that it gears up to a comfortable net gearing of 1x, SCI can theoretically make 5-6 acquisitions equivalent in size to Wilton International. While we can never rule out a pre-emptive cash call entirely in the future should a mammoth acquisition target appears, the chances are low for now.

3) SembCorp Marine's (SMM) now faces lower cash payment re-negotiation risk. The risk of a cash call by SCI's listed marine subsidiary, SMM, is also now lower vs. earlier in the year. As shown in our last two reports on SMM, we have argued for lower cash payment re- negotiation risk on the group’s existing order book, vs. our initial expectation. As the possibility of SMM needing external funds to bolster its already strong balance sheet gets lower, this implies that SCI’s need to raise cash to protect its 61% stake in SMM has also reduced.

SMM updates that its work progress for all rigs is on-schedule, with high cash payment collected to date. The two jackup rigs payment rescheduling with Seadrill should be seen as a one-off event, due to unusually lower cash payment collected, vs. corresponding work-in-progress.

While we believe that immediate cash call risk is lower than earlier in the year, and the price has corrected 4% this morning to S$2.14 (before trading halt), it is still higher than our unchanged fair value of S$2.00 for SCI. Maintain HOLD.

SembCorp Industries: Goldilocks report card

SembCorp Industries’ (SCI) revenue was up 15.2% y-o-y to S$9.9b in FY08, but its recurring net profit was down 4.2% y-o-y to S$534m, lower than our estimate of S$539m. We believe that SCI’s supposedly resilient Utilities business may be at risk of customers shutting down operations or asking for more rebates, should the economic downturn and credit crunch persist. We have cut net profit estimate by 7.7% to S$509m in FY09, and fair value to S$2.00. SCI has cut its dividend payout ratio from 50% to 39%, DPS at 11cts for FY08 translating into dividend yield of 5.1%.

Net profit is below expectation. SCI had S$9.9b revenue (+15.2% y-o-y) and S$507m headline net profit (-3.6%) in FY08. SCI’s earnings were held up by higher net profits from its Marine business (+32% y-o-y), which mitigated the weaker results from Utilities (-13%), Environment (-84%), and Industrial Parks (-7%) businesses. SCI’s recurring net profit was down 4.2% y-o-y to S$534m in FY08, vs. our estimate of S$539m.

Utilities business’ outlook to remain soft in 2009. We believe that SCI’s supposedly resilient Utilities business may be at risk of customers shutting down operations or asking for more rebates, should the economic downturn persist. Indeed, SCI highlights that one customer in the UK is now considering cessation of production. While SCI would mitigate the risks through realigning of resources to meet customers’ needs under its centralized utilities model, we project 10% y-o-y dip in Utilities’ net profit to S$181m for FY09, on the back of S$4.2b (-6% y-o-y) revenue projection.

SCI declares 11 Scents dividend per share. We have cut net profit estimate by 7.7% to S$509m in FY09, and fair value to S$2.00 (vs. S$2.39 previously). The lower fair value is largely due to the use of market value (vs. target price previously) for listed subsidiary, SembCorp Marine, in our SOTP methodology. SCI declares 27% y-o-y lower dividend per share of 11 Scents for FY08, implying 39% dividend payout ratio (vs. 50% in FY07).