Sembcorp would do well to learn from costly errors in energy forays as it embarks on a green journey
SINGAPORE conglomerate Sembcorp Industries has made impairments to the tune of over half a billion dollars for energy investments in recent years. As the company works towards a greener business portfolio, those impairments should serve as a reminder that the energy business is full of risks.
From 2019 to the first half of 2021, Sembcorp's impairments relating to its energy (formerly called utilities) investments amounted to at least S$514 million. And this was after offsets from exceptional gains.
A reader of The Business Timesrecently noted that Sembcorp had even written off its entire investment for at least one project.
In its H1 2021 financials, there had been a S$212 million impairment for a 49 per cent-owned joint venture called Chongqing Songzao Sembcorp Electric Power. The carrying value of Sembcorp's equity interest in this project was fully wiped out.
Chongqing Songzao operates a coal-fired power plant, and it has been severely impacted by significantly higher coal costs.
Sembcorp explained in a regulatory filing that the plan was also affected by the closure of its partner's Chongqing-based coal mines.
Sembcorp also made sizeable impairments to its investment in the United Kingdom's largest flexible distributed energy generator, UK Power Reserve (UKPR), which it acquired for £216 million (then S$385 million) in May 2018.
The impairments were made shortly after the asset was purchased - S$158 million at end-2019 and S$60 million in 2020 - wiping out over half of its investment.
Energy capacity, and a reduction in demand as a result of energy efficiency and reduced industrial production, were some factors cited by Sembcorp for the underperformance.
UKPR has also been activated less frequently to balance the energy system, following improved forecasting by the National Grid Electricity System Operator.
In 2020, Sembcorp booked an impairment of S$81 million for its investment in Oman-based Sembcorp Salalah Power and Water Company. This was attributed to the decline in oil prices and the downgrading of credit ratings of the government of Oman. Sembcorp Salalah supplies power and water to a government-owned company.
Escalating costs
When Sembcorp exited the Chilean market, there was an impairment of S$64 million booked in 2019 due to the difference between the sale value and the net asset value of the business.
Also, it recognised S$27 million in the income statement as net currency translation loss upon completion of divestment in 2020.
The impairment of the business, Sembcorp said, was a result of the realisable value for the assets having been impacted by escalating operational and regulatory costs as well as the deterioration of Chile's economic, social and regulatory environment.
But Sembcorp also noted the sale, together with the returns from the rest of the portfolio acquired in 2010, had produced cash receipts in excess of the original investment and delivered an annualised return of about 10 per cent.
A Sembcorp spokesperson told BT: "In accordance with accounting standards, the company periodically reviews the carrying value of its assets and investments. The company then makes impairment decisions based on established accounting standards and practices, supported by rigorous financial assessments together with our auditors, and have disclosed the outcomes in a timely and transparent manner.
"Despite the impairments, the Sembcorp portfolio of assets, taken as a whole, has continued to deliver resilient underlying performance and strong cash flow as seen in its recent first-half 2021 results."
Sembcorp's impairments should not be trivialised. Over the same period, Sembcorp reported revenue of roughly S$15.5 billion and profits of S$508 million. The company has a market capitalisation of S$3.4 billion and an almost equivalent book value.
But how concerned should investors be?
The Securities Investors Association (Singapore) had recently quizzed Sembcorp over its total shareholder return, which has largely been in the red since 2014 - ranging from a negative 28.8 per cent (as at end FY15) to a gain of 51 per cent (as at end FY20). A Sembcorp shareholder would have lost 25.6 per cent of his or her investment from 2014 to 2020, based on the reported total shareholder return, the investor watchdog noted.
Challenging environment
Most of the negative sentiment is likely attributable to offshore and marine unit Sembcorp Marine, which is no longer owned by Sembcorp. But the impairments would have weighed on Sembcorp's financial return too.
It could be unfair to cite the various impairments as an indictment of Sembcorp's strategy. Undoubtedly, the company operates in a challenging environment. The energy business is fraught with business and regulatory risks.
CGS-CIMB analyst Lim Siew Khee said the impairments of both Chongqing Songzao and UKPR were mainly due to regulatory changes, but added that these investments were "good" when Sembcorp undertook them.
She added that unfavourable regulatory changes have always been a key risk for the company.
Sembcorp had said in its response to shareholders' queries in 2020: "We believe that appropriate due diligence was conducted for the (UKPR) acquisition... We have since strengthened our in-house domain expertise in the area of the UK electricity market trading and grid services to sharpen our forecasting abilities, especially for merchant markets in disruption."
As Sembcorp embarks on a journey to green its business portfolio, it will also need to strengthen its domain expertise in some still-developing areas.
The company plans to focus on renewable energy and sustainable urban solutions. These are attractive sectors given how much investor demand there is for sustainable investments. But investors should be mindful of the risks that come with such new territory.
Here's hoping Sembcorp's decision-making process is rigorous and robust, and the school fees it paid in terms of impairments were worth it.
