Sembmarine carve-out should make Sembcorp attractive versus peers

Singapore

SHARES of Sembcorp Industries (SCI) begin trading excluding their entitlements on Wednesday. As Sembcorp Marine (SMM) shares had closed at S$0.193 on Tuesday, SCI's stock could reasonably be expected to fall from their close at S$1.91 the same day.

In a Monday announcement, SCI had announced that shareholders would receive 4.911 SMM shares for each SCI share held.

But SCI also now looks more attractive without SMM weighing it down, especially when evaluated against some of its peers.

SCI's shares have gained 3.24 per cent since shareholders approved a demerger from SMM on Aug 11. And analysts are expecting more gains over the next 12 months.

According to Bloomberg data, nine of the 11 calls for SCI are "buy" calls. As of Tuesday, analysts had an average target price of S$2.24. There is also one "hold" and one "sell" call.

RHB said in a note in July that it sees "underlying strength from the energy business", as SCI continues to strengthen its renewables portfolio.

Additionally, CGS-CIMB analyst Lim Siew Khee told The Business Times that without SMM, "SCI can focus on growing their energy and urban development business and (have a) lighter balance sheet".

SCI has three energy business lines: gas and power, renewables and environment, and merchant and retail. Its portfolio stretches across China, India and the United Kingdom, and its facilities generate over 12,600 megawatts (MW) of power and treat more than 8.6 million cubic metres of water and wastewater per day.

It also has an urban development business, which engages in land and property development, and provides utilities and services ranging from thermal and renewable energy to solid waste management for large-scale urban developments.

With a total of 13 projects as at end-2019 in Vietnam, China and Indonesia, the business has attracted US$34.2 billion in direct investments to its projects over the past 30 years.

As a conglomerate, SCI has historically been valued at a discount to the sum of its businesses. That conglomerate discount will remain even after the demerger, given the company's wide range of businesses.

But in June, RHB analyst Leng Seng Choon had lowered his applied conglomerate discount on his target for SCI to 20 per cent from 25 per cent previously.

Over the past five years, SCI has consistently been profitable on a full-year basis. But its bottom line has been weighed down by SMM, which has logged losses since 2018.

In its latest set of financial results, for the half-year ended June 30, SCI's energy business recorded a net loss of S$5 million while its urban segment reported S$38 million in net profit. Its marine segment, however, chalked up a net loss of S$117 million.

Without SMM, SCI can be expected to do better and some of its metrics should turn more favourable. Although the nature of the company's businesses makes it difficult to compare SCI with other regional companies, SCI could become more appealing.

CGS-CIMB's Ms Lim said: "Relative to pure play power names, SCI is more diversified and also operates in different markets in addition to a variety of products.

"It is not easy to compare them with regional peers but given that they are now considered as a purer play in the market, investors could start to give them that credit."

Regional players with energy portfolios similar to that of SCI are Tenaga Nasional in Malaysia and AGL Energy in Australia.

Tenaga Nasional has 47 wholly-owned power plants in peninsular Malaysia with a total domestic generating capacity of 10,618 MW, based on its 2019 annual report.

AGL, which operates Australia's largest electricity generation portfolio and accounts for some 20 per cent of the total generation capacity within the country's national electricity market, has an operated generation capacity of 11,208 MW.

On price-to-book multiples, SCI is cheaper than both Tenaga Nasional and AGL.

The lower valuation awarded to SCI by the market may have something to do with its negative return on equity (ROE).

In fact, while most of its major peers in the utilities space do not have particularly high ROEs, only SCI's ROE is currently negative.

In the past 20 years, SCI's ROE peaked at 42.8 per cent in 2006. However, this was after exceptional items (EI). Before EI, its ROE that year was at 18.2 per cent. The company's second-highest ROE was in 2009 at 23.1 per cent.

What would it take for SCI to return to such levels of profitability? The exclusion of SMM would certainly help.

In FY2019, SCI had reported an ROE of 3.5 per cent. But excluding its marine unit and before EI, its ROE stood at 9.4 per cent.

SCI's energy portfolio can be expected to grow, especially in the renewables sector.

In July, SCI announced that it now has an operational renewable energy capacity of 1,730MW in India. Last month, SCI started construction on a 60MW-peak floating solar photovoltaic system on Tengeh Reservoir.

"A deconsolidation of SMM reduces SCI's debt levels, improves leverage metrics and allows SCI to be more resilient," SCI had said in response to queries from the Securities Investors Association (Singapore) ahead of the recent shareholder vote on the SMM demerger. "The improved debt position would open opportunities for more debt financing, thereby strengthening our ability to execute our strategies to drive profitability and growth. These are tangible benefits, not just accounting treatment."

Relative to its peers, SCI also has a very high gearing ratio. Without the burden of SMM, perhaps the company will also be able to reduce its indebtedness and attract more investors.