Sembcorp Industries – Renewable energy to drive earnings and valuation

 

Highlights

 

Maintain BUY and raised TP to S$5.06

We maintain our BUY call and raise TP to S$5.06, based on 11x PE for FY24e.

Sembcorp Industries – Equity fundraising ruled out

 

The news

SCI announced the acquisition of 830MW of renewable assets in China through a joint venture with SPIC. Xingling New Energy owns a portfolio of wind and solar assets.

 

SCI has signed definitive agreements with Wuling Power, an affiliated company of SPIC, to acquire a 43.5% interest in Hunan Xingling New Energy for a total equity consideration of ~RMB1,058mn (~S$204mn).

 

Wuling Power holds the remaining 54.7% interest in Xingling New Energy.

 

The Positives

+ Acquisition of Xingling New Energy will be accretive to earnings. The valuation was not disclosed, but management guided that similar to its acquisition of BEI Energy and other acquisitions, this was done at low double-digit P/E. SCI will fund the acquisition through internal cash resources and external borrowings. Completion is expected in 1H23 and the acquisition is expected to be accretive to earnings. Financials however, were not provided.

 

+ Acquisition diversifies Group’s presence from north western China. The acquisition of Wuling Power will solidify the Group’s presence in central China, Hunan. According to management, Hunan is currently importing 90% of coal outside with reserve margin at less than 20%. As such, this makes power generation in Hunan a valuable prospect. The assets are also relatively new at 4.9 years, we estimate that IRR of the project is ~11-12%.

 

Importantly, the acquisition of a 54.7% stake in Xingling New Energy also allow the Group to broaden its partnership with SPIC in renewables and green energy.

 

+ The acquisition of Xingling New Energy will bring the Group’s gross renewable energy capacity to 9.4GW. With the Group within touching distance of its 10GW target ahead of its 2025 target (Figure 1). We believe the Group will provide an update to its target in its FY22 results.

 

+ Management ruled out equity funding to finance spate of acquisitions. Amid concerns over funding requirements following the Group’s spate of renewable energy acquisitions, management has affirmed its intention to stick to its previously stated guidance of ensuring that there will be no equity fundraising to hit its 10GW target. While net debt/equity will go towards 1-2x post-acquisition, we believe the Group will use the cash flows from these newly acquired assets to pay down the debt to reach its optimal gearing target of 1.3x. We believe the latest clarification will allay concerns of an equity call.

 

Outlook

Shareholders have approved the sale of Sembcorp Energy India Limited (SEIL) to Tanweer Infra fund. We believe management will further deploy the proceeds to grow its renewables portfolio to beyond its 10GW target.

 

For FY22e, we expect continued high electricity prices in Singapore and India to lift earnings. We expect SCI to pay out 16 cents of dividends (split between final and special due to the special circumstances for FY22) for FY22e, translating to a ~5.3% dividend yield.

Sembcorp Industries – Acquisition of another 1.38GW of renewable assets

 

The news

SCI announced acquisition of 795MW of solar assets in China and 583MW of renewable assets in India.

 

SCI’s 49%-owned JV Beijing Energy Sembcorp (Hainan) International has entered into share purchase agreements with BEI Energy Development (Beijing) Co., Ltd. to acquire three solar projects, for an initial equity consideration of ~RMB15mn (approximately S$3mn) and future capital injection of up to RMB1,148mn (approximately S$222mn).

 

SCI will also acquire 100% of Vector Green Energy for a base equity consideration of ~INR27.8bn (~S$474mn).

 

The Positives

+ Acquisition of BEI Energy and Vector Green will be accretive to earnings. The valuation was not disclosed, but management guided that this was done at low double digit P/E. SCI will fund the acquisition through internal cash resources and external borrowings. Completion is expected in 1Q23 and both acquisitions are expected to be accretive to earnings, financials however, were not provided.

 

+ China and Indian assets supported by mid- to long- term PPAs. The assets in China have PPAs ranging from three to five years. As the power market in China is regulated, this provides greater stability to tariff rates. Management is confident of renewing the PPAs when they become due as the solar assets are located in the south of Hebei Province, one of China’s main energy demand centres. The assets are contracted to the State Grid Corporation of China, a Chinese state-owned electric utility and grid operator.

 

The Indian assets, which comprise mainly solar assets, are covered by long-term PPAs averaging 19 years. With recent changes to the regulation on the payment of receivables in India, credit quality has improved and the receivables issue has been mostly resolved.

 

+ The two acquisitions will bring the Group’s gross renewable energy capacity to 8.5GW. This will bring it closer to its 2025 target of 10GW of gross installed renewable capacity (Figure 1). Its acquisition of Vector Green will also bring significant utility-scale solar capacity to its India business.

 

Outlook

Shareholders have approved the sale of Sembcorp Energy India Limited (SEIL) to Tanweer Infra fund. We believe management will further deploy the proceeds to grow its renewables portfolio to beyond its 10GW target.

 

For FY22e, we expect continued high electricity prices in Singapore and India to lift over earnings. We expect SCI to pay out 16 cents of dividends (split between final and special due to the special circumstances for FY22) for FY22e, translating to a ~5.3% dividend yield.

Sembcorp Industries – Energy bill cap expected to have subdued impact

 

The news

The UK’s new leader, Liz Truss, has capped consumer energy bills at £2,500 (S$4,081) for two years to cushion rising energy prices. For businesses and public sector bodies, a sixth-month scheme will offer equivalent support to that for households, with a review in three months about how it could be better targeted.

 

SCI has 1.3GW of energy assets in the UK, consisting of energy generation and battery storage. The UK is not a significant contributor to its overall portfolio of energy assets, which are concentrated in South-east Asia, China and India.

 

The Positives

+ Impact on SCI expected to be subdued as cap will be funded by UK government. SCI’s contract with the national grid of the UK means that it generates electricity through a portfolio of diesel and gas generators. The price cap imposed, limits the amount that it can charge for its tariffs. The difference between the power in the wholesale markets, and the capped consumer price, however, is expected to be borne by the UK government.

 

+ Energy bill cap will not be financed by energy suppliers. Despite calls by the opposition Labour Party to partly fund the scheme by a windfall tax on energy suppliers, PM Liz Truss has ruled this out, favouring the entire bailout to be funded through more government borrowings instead.

 

The Negatives

- Review of the UK’s net zero strategy underway; could slow move to renewables. Liz Truss has announced a review of the government’s net zero strategy, which she argued is necessary under the current landscape. The review could potentially impact demand for energy storage, though this is still uncertain at this stage. Liz Truss has announced schemes she said would increase energy resilience, including launching about 100 new oil and gas licenses along with dozens of new North Sea licenses in an effort to boost domestic oil and gas production.

 

In the last 10 years, the UK has made significant progress to decarbonise its power sector (Figure 1). It has grown its renewable share of electricity generation from 7% to 43%. This has led to increased demand for energy storage, in which SCI is operating one of the largest energy storage portfolios in the UK at 120MWh.

 

Outlook

The impact of UK PM Liz Truss’ moves on the energy sector are still uncertain at the moment as the finer details are lacking. The impact on SCI is expected to be subdued as the contribution from UK is not large. That said, we are monitoring the developments, and will provide an update when more details are available.

 

SCI is currently in the midst of building a 360MW energy storage system at Wilton International on Teesside, which will help the UK achieve its net zero target.

Sembcorp Industries – Strategically important sale of SEIL

 

Terms and conditions of proposed sale

SCI announced the proposed sale of SEIL for the equivalent of $2.059bn, or 1x NAV. The purchaser is the Tanweer Consortium led by Oman Investment Corporation S.A.O.C (OIC), the Ministry of Defence Pension Fund, Oman (MODPF) and Dar Investment SPC (Dar Investment).

 

On completion, Tanweer Consortium will settle the entire final purchase price through the DPN via a facility provided by SCI under the DPN. The DPN will bear interest at 9% interest (1.8% spread + 7.2% benchmark), minus a greenhouse gas (GHG) emissions intensity reduction incentive rate. This GHG reduction incentive rate is subject to a cap of 180 basis points if these emission targets are met. In other words, the current spread over the benchmark rate will be removed or reduced any time within the 15-year period if the Tanweer Consortium can meet the GHG emissions target. Such adjustments will affect the final purchase price. All outstanding payment under the DPN should be payable in full on the 15th anniversary date of the completion, which is also the maturity date. The yearly payments will be recorded under the Group’s EBITDA section. Should the outstanding payment obligations not be met, the maturity date will be extended for two years, and for every two years till the monies are paid. The maturity date will not be extended beyond the 24th anniversary date of completion.

 

Shareholders approval is required for the transaction, which is expected in November this year, and the expected completion is six months after EGM.

 

The Positives

+ Acquisition consideration implies S$0.8bn/GW of gross installed capacity, higher than average comparable transactions of S$0.5-1bn/GW. The acquisition price implies 1x of NTA, which we view as fair given the weak market environment around coal-related assets. SCI will recognise ~S$11mn in gains from the sale.

 

+ Debt-capitalisation ratio improve to 62% from 66% for pro-forma 1H22. We believe the Group will leverage its stronger balance sheet to further its transition to green energy. On a pro forma basis, SCI’s total debt as at 30 June 2022 will decrease to $7.1bn from $8.7bn due to the deconsolidation of SEIL in SCI’s balance sheet. SCI’s interest paying capacity will also improve with interest coverage rising to 6.3x in the same period from 5.1x. SCI still has ~$5bn of borrowing facilities to tap on, which will accelerate the transformation of its portfolio from brown to green.

+ $700mn in receivables from SEIL expected to be repaid within the next 24-48 months. The Indian Ministry of Power has recently directed Telangana and Andhra Pradesh to settle the overdue receivables within 20-48 months. Should this be adhered to, the Group is expected to receive ~$700mn in receivables in the next 1-2 years, which will lower the credit risk of SEIL, and by extension the risk for the DPN.

 

The Negatives

- SCI will still be exposed to operational risks of SEIL for at least 15 years after sale. Even though SEIL will be deconsolidated from SCI’s books after the sale, the DPN, which is a form of vendor financing means that SCI will still be exposed to the operational risks of SEIL for at least 15 years after the sale. Should the outstanding payment obligations not be met, the maturity date will be extended for two years, and for every two years till the monies are paid. The maturity date will not be extended beyond the 24th anniversary date of completion.

 

However, we believe this risk is mitigated by both mid- and long- term contracts for SEIL, totalling 85% of SEIL’s thermal plant capacity. SEIL will have 570MW up for renewal in 2024 (22% of the power purchase agreement). That said, we view the risk of non-renewal as low given the strong current energy environment. IEX prices remain elevated at ~7,500 Rupees/hr in September vs. an average ~7,600 Rupees/hr in 1H22.

 

Outlook

Shareholders approval is required for the transaction, which is expected in November this year, and the expected completion is six months after EGM.

 

For dividends, we model a ~30% payout ratio, in line with FY21’s payout. We expect SCI to pay out 16 cents of dividends (split between final and special due to the special circumstances for FY22) for FY22e, translating to a ~4.9% dividend yield

Sembcorp Industries – Conventional and Renewable Energy lift 1H22 profits

 

 

 

 

The Positives

+ 1H22 profit ahead of our expectations, at 99% of FY22e as Conventional Energy and Renewable Energy beat. The surge in power prices and margins in Singapore and India drove Conventional Energy beat for the period (+115% YoY). Average USEP prices for 1H22 surged to S$324/MWh, higher than the S$295/MWh average in 2H21 and spark spreads have increased to $6.30/MWh YTD (Figure 1) as average USEP prices have moved ahead of HSFO in the last nine months. A one-off hedging gain of $92mn from gas hedges during the period also lifted profits, but we do not expect this to recur in 2H22. Contributions from newly acquired projects in 1H22, SDIC New Energy and Shenzhen Huiyang in China lifted Renewables profit.

 

+ Battery segment as key growth driver in medium- to long-term. The management re-affirmed its battery business as a key growth driver for the company, in line with its strategic plan announced at its Analyst Day in 2021. It currently has 120MW of energy storage in the UK which holds an important role in helping to stabilise the grid as the UK continues its pivot towards renewables.

SCI is currently in the process of building a 360MW battery facility at Teesside, UK. When completed, it will boost the Group’s capacity to take advantage of more volatile, uncertain markets with the rise of intermittent renewables.

 

+ Renewables profit at 74% of FY22e, lifted by better performance in key markets. Better wind resources in India and higher spot prices for its solar business in Singapore lifted profits (+217% YoY). SCI’s gross renewables capacity in operation and under development globally now stands at 7.1GW in 1H22 from 6.1GW as at end-2021. Its acquisition of a 98% stake in HYNE assets will contribute ~S$50mn per year to its profits.

 

The Negatives

- Lower land sales dragged Integrated Urban Solutions business, offset by higher ASPs. Higher contribution from Wilton 11 in the UK was offset by higher operating costs for the waste business in Singapore. Despite lower land sales, the Group remain confident of hitting its target of 500ha of land sales by FY25 as it plans the development of the 481-hectare Quang Tri Industrial Park in Vietnam and the 1,000ha of VSIP Binh Duong III.

 

Outlook

Management continued to guide for the Conventional Energy segment to perform well in the second half of this year as global energy markets remain firm. Despite this, we expect energy markets to moderate slightly in 2H22. USEP prices in July were ~9% lower than 1H22’s average. We expect some normalisation in FY23e.

 

Planned maintenance shutdowns for Sembcorp Biomass Power Station in the UK (~6 weeks) and India SEIL Project 2 (~45 days) in 2H22 will also put a drag on Conventional Energy earnings in 2H22.

 

We also modelled in a full half-year contribution from the newly acquired SDIC New Energy and Shenzhen Huiyang in China for its Renewables segment.

 

For dividends, we model a ~30% payout ratio, in line with FY21’s payout. We expect SCI to pay out 16 cents of dividends for FY22e, translating to a ~4.9% dividend yield.

 

 

Sembcorp Industries – Conventional Energy to lift 1H22 profits

 

 

The news

SCI financial results are expected to be materially higher for 1H22 vs. last year, driven by the Conventional Energy segment.

Contrary to a report that Myanmar’s central bank has ordered a halt on repayment of foreign loans, its subsidiary in Myanmar has not received such a directive. It has also received prompt payment from its offtaker and continues to operate its Myanmar power plant.

 

The Positives

+ Average USEP prices up 239% YoY or 9.8% HoH to lift SCI’s 1H22 Conventional Energy. The global energy crunch since September 2021 lifted SCI’s Conventional Energy segment in 2H21. The conflict in Ukraine at the beginning of the year has further exacerbated the risk of disruptions in oil and gas. As a result, average USEP prices for 1H22 surged to S$324/MWh, higher than the S$295/MWh average in 2H21 and spark spreads have increased to 6.3 YTD (Figure 1) as average USEP prices have moved ahead of HSFO in the last nine months.

 

+ Tariffs for power in India’s Tamil Nadu and Gujarat rose ~88% YoY in 1H22. Based on data from IEX, tariffs for power at Tamil Nadu and Gujarat rose to ~6.36Rs/kWh from ~3.39Rs/kWh from the same period last year. The higher tariff was driven by high global oil prices and higher temperatures in the country. The International Energy Agency (IEA) recently revised upward India’s electricity demand to 7% from negative previously in light of the intense heatwave in the country.

 

On the back of this, we revise FY22e Conventional Energy revenue up marginally from $8.6bn to $8.8bn to account for better spark spreads for Sembcorp Cogen and India (Figure 3).

 

+ On track to building up its green energy portfolio. SCI’s gross renewables capacity in operation and under development globally now stands at 6.8GW in 1H22 from 6.1GW as at end-2021 (Figure 2). This is ahead of our FY22e target of 7.3GW, accordingly, we revise our FY22e gross renewables capacity to 7.6GW on account of the Group’s aggressive build up of its renewables portfolio. We believe the company is on track to achieve its plans of increasing its renewable capacity to 10GW by 2025. We see the company’s transition toward green energy as an important driver of its re-rating.

 

The Negatives

- Headwinds in China property market to put a drag on Group’s Urban development business. China’s property market has weakened sharply in the past year as a result of a government clampdown on excessive borrowings by developers, and a Covid-19 induced economic slowdown (Figure 4). We believe this will hurt the Group’s land sales in China, though the impact is not expected to be significant as China account for just 6% of the Group’s total saleable land.

 

 

Outlook

We expect the group to continue with its transition to sustainable solutions and sustainable development. Despite its ambitious growth plans, it will not require any equity fund-raising, relying entirely on internal sources.

The Conventional Energy segment continued to perform well in the first half of this year as global energy markets rose in tandem with commodity prices. For the rest of 2022, we expect this segment to be supported by energy markets and the continued uncertainty brought about by the Ukraine conflict.

However, we expect the slowdown in the Chinese property market to offset some of the growth from the Conventional Energy and Renewable Energy segment.

The Group continues to actively seek deals in India, China and the UK by leveraging its partnerships and platforms for their acquisitions.

Sembcorp Industries – Conventional Energy drive improved operational performance

The Positives

+ FY21 net profit of $300mn was above our estimates, at 146% of FY21e. The beat came from higher revenue from Conventional Energy, which surpassed our expectations on the back of better spark and dark spreads particularly in 4Q21. The better spreads arose from stronger commodity price and better demand-supply dynamics. Net profit before exceptional items was 69% higher YoY, lifted by higher contributions from all key revenue segments: Renewables, Integrated Urban Solutions and Conventional Energy. Its coal business in India - Thermal Power Project I (P1) and Thermal Power Project II (P2) - also performed better than expected with higher demand lifting turnover. This segment remained the key contributor to turnover, accounting for 84% of overall revenue.

+ 85% of SEIL’s thermal plant capacity now mid- and long- term PPA. SCI’s subsidiary, SEIL, recently signed two long-term PPAs, bringing 85% of SEIL’s thermal plant capacity (previously 50%) to be secured by mid- and long- term PPA. The first PPA is to supply 625MW of power to Andhra Pradesh state power distribution companies for 12 years. The contract is expected to commence by FY23e. The second PPA is to supply 200MW of power to Bangladesh till May 2033. The contract is expected to commence in 1H22.

We view these developments positively for SCI’s India operations. SEIL has two projects in India, SEIL 1 and SEIL 2, with total gross installed capacities of 1.32GW each. Historically, SEIL 2 has been recording losses since FY16 due mainly to the absence of long-term PPA’s. We believe these contracts will reverse the losses from SEIL 2 from FY23e onwards.

+ Net gearing declined by more than 20% of our FY21e forecast. Free cash flow rose 71% YoY as better operating performance drove higher net cash from operating activities. The repayment of its project finance debt for Sembcorp Energy India and Sembcorp Green Infra drove net gearing lower to 160.8% from 199.8% in the same period last year. This compares favourably with the 184% we initially pencilled in.  

The Negatives

- Major maintenance shutdowns in 2022 for Phu My 3 to impact revenue. The tariffs from the maintenance of its Vietnam power plant will be further reduced as its PPA approaches expiry in 2024.

- FY21 land sales slightly below our forecasts. The Group achieved total land sales of 168 hectares in 2021, below our 180 hectares forecast. Nonetheless, SCI still saw better contribution from the urban business on higher prices achieved for land sales and contribution from the waste and waste-to-resource businesses. Despite the miss, management remains confident in achieving its 2025 target of 500 hectares land sales. 

Outlook

We expect the group to continue with its transition to sustainable solutions and sustainable development. Despite its ambitious growth plans, it will not require any equity fund-raising, relying entirely on internal sources.

The Conventional Energy segment continued to perform well in January this year as global energy markets rose in tandem with commodity prices. For FY22e, we expect this segment to be supported by firmer commodity prices and energy markets.

The Group is on track to achieve 10GW gross installed renewables capacity by 2025. The Group secured 2.9GW of new renewable energy projects across key markets in 2021. Upon completion of the 658MW portfolio acquisition in China in 1H22, the gross renewables capacity installed and under development will reach 6.1GW. The Group is actively seeking deals in India, China and the UK by leveraging on its partnerships and platforms for their acquisitions.

Upgrade to ACCUMULATE from NEUTRAL with higher target price of $2.94

We raise FY22e PATMI by 6.8% as we bake in higher profits from Conventional Energy for FY22. Our target price is raised to $2.94 as we roll forward our valuation to 1.2x FY22e P/BV, the average of its peers (Figure 2).

Sembcorp Industries – Completes demerger of Sembcorp Marine

 

Update

Following the issue of 10,462,690,870 SCM rights shares to entitled SCI shareholders on 11 September, the proposed distribution and demerger has been completed. Entitled SCI shareholders will have received their entitlement of 4.911 SCM shares for every 1 SCI share held, amounting to approximately S$0.89 (4.911 x S$0.182). We arrived at this by taking the number of SCM shares distributed for every 1 SCI shares held and multiplied this by the closing price of the SCM shares as at 10 September 2020 of S$0.182, which is the date before the distribution to SCI holders.

This means that the ex-distribution price of SCI following the distribution is approximately S$1.02 (S$1.91 - $0.89). This is arrived at by subtracting the total value of SCM shares received by SCI shareholders with the closing price of SCI on the 10 September, the date before the distribution.

In total, SCI shareholders could realise a total of $2.64/share (S$1.75 + (4.911 x S$0.182)).

 

Outlook

We are positive on the Group’s outlook. Following the deconsolidation of SCM, we think SCI will see a potential positive re-rating as the Group’s operating metrics improve in Fy21e from improving energy demand.

 

Maintain BUY with an unchanged target price of S$1.75

We maintained our BUY recommendation on SCI following the distribution-in-specie of the capital of SCM to entitled SCI shareholders. Our target price of S$1.75 for standalone SCI (ex. SCM) is pegged to a P/BV of 0.7x FY21e, which is a slight discount to their 10-year historical average equity value (ex. SCM). We expect SCI to see improved operating metrics with the Group expected to generate positive operating CF of $854mn for FY21e and return on equity of 7.6% for FY21e.

Sembcorp Industries (Initiation)- Charting a new course

 

Company Background

Sembcorp Industries (SCI) is a leading energy and urban development group, operating across multiple markets worldwide. As an integrated energy player, SCI is uniquely positioned to support the global energy transition. SCI’s urban arm is a recognised Asian developer, and has saleable land of 2,600 hectares of saleable industrial, business, commercial and residential land.

 

Investment Merits

  1. SCI shareholders could receive a total of $2.72 per share. Following the completion of the rights issue by SCM, we believe the market could assign a 0.7x FY21e P/BV for SCI (ex. SCM), a slight discount to their 10 year historical average of SCI (ex. SCM), which will give us $1.75/share. SCI shareholders will also receive 4.911 of SCM shares for every 1 share held. Based on SCM’s last closing price of $0.199 on the 7 September, SCI shareholders could receive a total of $2.72/share ($1.75 + (4.911 x $0.199)).
  2. IPO of SEIL to crystalise value of SCI’s India business unit. While the timing of SEIL’s listing remains uncertain, we believe this will happen sooner rather than later. SCI had intended to re-file their prospectus on SEIL in 2019, but postponed this to have full control in December last year. As sole owner now, we believe SCI will have full flexibility to evaluate a full range of growth opportunities in the renewables segment, while at the same time evaluate the right equity window to list their India business more expediently, which we estimate to have a value of about INR98bn or S$1.8bn.
  3. Potential positive re-rating of SCI following the demerger. The deconsolidation of SCM will transform SCI into a Energy and Urban business. SCI will now be able to focus their resources on capturing growth opportunities in two of their key segments independently of SCM. Even though the conglomerate discount attached to SCI should narrow, we think this might take time as investor’s confidence in the management could take time to rebuild. For FY21e and FY22e, we expect SCI to see ROE improve to 7.6% and 9.6% respectively from 2.7% in FY19, potentially leading to a positive re-rating of SCI.

 

Outlook

We are positive on the Group’s outlook. We believe the deconsolidation of a SCM will unlock value for SCI shareholders through disciplined capital allocation and systematic capital recycling, and allow both companies to drive long-term value creation in their respective fields.

 

Initiating coverage with a BUY rating and target price of $2.72

We initiate coverage on SCI with a BUY recommendation and a target price of $2.72. We peg SCI to a P/BV of 0.7x FY21e, which is a slight discount to their 10 year historical average equity value (ex. SCM). SCI shareholders will also receive 4.911 of SCM shares for every 1 share held. Based on SCM’s last closing price of $0.199 on the 7 September, SCI shareholders could realise a total of $2.72/share ($1.75 + (4.911 x $0.199). We expect SCI to see improved profitability and generate positive operating CF of $854mn and $1.2bn for FY21e and FY22e respectively, which will strengthen their balance sheet and puts them in a good stead to ride out the current crisis.

 

Background

Sembcorp Industries is a leading energy and urban development group, operating across multiple markets worldwide. They have three main business arms, energy, marine and urban.

On the 8 June 2020, SCI and Sembcorp Marine (SCM) (Not rated) announced the deconsolidation of their respective businesses. SCM provides innovative engineering solutions in the global offshore, marine and energy industries. Headquartered in Singapore, the SCM Group has close to 60 years of track record in the design and construction of rigs, floaters, offshore platforms and specialised vessels, as well as in the repair, upgrading and conversion of different ship types. Its solutions focus on the following areas: Gas value chain, renewable energy, process, advance drilling rigs, ocean living and maritime security.

As a diversified energy and urban player, SCI is uniquely positioned to provide integrated solutions to meet their stakeholders’ needs. Leveraging technology and digital innovation, the draw on their deep understanding across their business and global track record to provide a suite of integrated energy and urban solutions that support the energy transition and sustainable development.

 

Key Business Segments

The Energy segment’s activities are in the provision of power and water to industrial, commercial and municipal customers. Key activities in the power sector include power generation, process steam production, as well as natural gas importation. In the water sector, the business offers wastewater treatment as well as the production of reclaimed, desalinated and potable water for industrial use. In addition, the business also provides on-site logistics, solid waste management and specialised project management, engineering and procurement services

The Marine segment focuses on providing integrated solutions for the offshore and marine industry. Key capabilities include rigs & floaters, repairs & upgrades; offshore platforms and specialised shipbuilding. From the fourth quarter of FY20e, this will be deconsolidated from SCI.

The Urban segment owns, develops, markets and manages integrated urban developments comprising industrial parks as well as business, commercial and residential space in Asia.

The Others/Corporate segment comprises businesses mainly relating to minting, design and construction activities, offshore engineering and others.

 

 

Investment Merits 

  1. SCI shareholders could receive a total of $2.72 per share. Following the completion of the rights issue by SCM, we believe the market could assign a 0.7x FY21e P/BV for SCI (ex. SCM), a slight discount to their 10 year historical average of SCI (ex. SCM), which will give us $1.75/share. SCI shareholders will also receive 4.911 of SCM shares for every 1 share held. Based on SCM’s last closing price of $0.199 on the 7 September, SCI shareholders could receive a total of $2.72/share ($1.75 + (4.911 x $0.199)).

 

  1. IPO of SEIL to crystalise value of SCI’s India business unit. While the timing of SEIL’s listing remains uncertain, we believe this will happen sooner rather than later. SCI had intended to re-file their prospectus on SEIL in 2019 (having first withdrawn this in 2018), but postponed this to inject additional equity into the business to have full control in December last year. As sole owner now, we believe SCI will have full flexibility to evaluate a full range of growth opportunities in the renewables segment, while at the same time evaluate the right equity window to list their India business more expediently, which we estimate to have a value of about INR98bn or S$1.8bn.

 

  1. Potential positive re-rating of SCI following the demerger. The deconsolidation of SCM will transform SCI into a focused Energy and Urban business. SCI will now be able to focus their resources on capturing growth opportunities in two of their key segments independently of SCM. Even though the conglomerate discount attached to SCI should narrow, we think this might take time as investor’s confidence in the management could take time to rebuild. For FY21e and FY22e, we expect SCI to see ROE improve to 7.6% and 9.6% respectively, potentially leading to a positive re-rating of SCI.

 

Initiating coverage with BUY rating and target price of $2.72.

We initiate coverage on SCI with a BUY recommendation and a target price of $2.72. We peg SCI to a P/BV of 0.7x FY21e, which is a slight discount to their 10 year historical average equity value (ex. SCM). SCI shareholders will also receive 4.911 of SCM shares for every 1 share held. Based on SCM’s last closing price of $0.199 on the 7 September, SCI shareholders could realise a total of $2.72 per share ($1.75 + (4.911 x $0.199). Following the deconsolidation of SCM, we expect SCI to see improved profitability and generate positive operating cash flow of $854mn and $1.2bn for FY21e and FY22e respectively, which will strengthen their balance sheet going forward.

 

The Transaction: Enhancing shareholder value and increased strategic focus

Recapitalised rights in SCM. SCM raised S$2.1bn in equity via a 5-for-1 renounceable rights issue of 10,463,723,020 new ordinary shares at S$0.20 per rights share. SCI undertook to subscribe for up to S$1.5b of SCM rights shares by setting off the outstanding principal of S$1.5bn under the subordinated loan facility extended to SCM, while Temasek Holdings has sub-underwritten the remaining S$0.6bn. With the proceeds, SCM has repaid SCI’s S$1.5bn subordinated loan facility, improving their overall net gearing for proforma FY19 to 0.45x from 1.82x.

 

Following the completion of SCM’s rights issue, and SCI’s subscription of 7,500,000,000 rights shares, representing approximately 72% of the 10,462,690,870 rights share available under the rights issue, SCI will distribute 4.911 SCM shares per every 100 SCI shares held by shareholders on the last date of “cum-distribution” trading of SCI shares. (see Figure 6 for pre-transaction and Figure 7 for post distribution). No payment is required from SCI shareholders to receive shares in SCM. SCI shareholders will have direct shareholdings in two focused companies, with Temasek alongside as a direct and significant shareholder. Importantly in our view, SCI shareholders now gain the flexibility to calibrate their holdings in the two companies based on their own investment objectives and strategy.

 

The Transaction: Enhancing shareholder value and increased strategic focus

The key terms of SCM’s rights issue are summarised below.

On the 7 September, SCM announced the successful completion of the rights issue. The company announced that valid acceptances and excess applications were received for 9,434,192,612 rights shares, representing approximately 90.2% of the 10,462,690,870 rights shares available under the rights issue.

 

The Transaction: Enhancing shareholder value and increased strategic focus

Details of the valid acceptances and excess applications received for the rights shares are shown below (Figure 10):

Pursuant to the sub-underwriting agreement, Startree, a wholly-owned subsidiary of Temasek, has subscribed for the balance of 1,028,498,258 unsubscribed rights shares.

With the proceeds, SCM has repaid SCI’s S$1.5bn subordinated loan facility, improving their overall net gearing for proforma FY19 to 0.45x from 1.82x and net tangible asset from S$1.9bn to S$4.0bn.

 

The Transaction: Enhancing shareholder value and increased strategic focus

Following SCI’s subscription of 7,500,000,000 rights shares, representing approximately 72% of the 10,462,690,870 rights share available under the rights issue, SCI will distribute 4.91 SCM shares per every 100 SCI shares held by shareholders on the last date of “cum-distribution” trading of SCI shares. We have also detailed the financial metrics of SCI post-transaction in Figure 12 below.

We see a number of positives in the move to separate SCI’s core business from their marine interest in SCM. The primary benefit we believe is that the move will unlock value for SCI shareholders by creating two focused companies. New demand patterns emerging in the energy sector require SCI to be focused on competing effectively, and focused on their core businesses (Energy and Urban). However, SCI’s future growth may be constrained by the SCI Group balance sheet which consolidates SCM’s debt.

 

The settlement of SCM’s subordinated loan with SCI and the proposed distribution delivered a clean demerger with an immediate deleveraging of SCM, which will benefit shareholders of SCM. SCI shareholders will receive SCM shares, with no cash outlay, in a recapitalised SCM with a significantly reduced net gearing from 1.82x to 0.45x due to the settlement of the subordinated loan with SCI and the improved cash position arising from the rights issue. SCI’s profitability and returns profile will also improve going forward. We expect SCI to see an improvement in their profit from a loss of $147m in FY20e to $326m and $449m for FY21e and FY22e respectively.

Lastly, the demerger will create two focused companies, allowing SCI to focus on their core competency. The demerger also delivers a clear investment proposition and makes SCI more comparable to their peers, and also reduce the conglomerate discount attached to SCI. This is expected to lead to a potential positive re-rating of SCI.

 

Revenue

Energy comprises 64% of FY19 revenue. SCI’s energy business continues to undergo business transformation, as energy production continues to shift away from a reliance on fossil fuels to renewable energy. Over the years, SCI has been reshaping their energy portfolio mix into one that has a greater focus in renewable energy. Since 2016, net profit from their renewable business has increased nearly five-fold to S$80 million.

In their recent 1H20 results, turnover from this segment declined 19% compared to last year. The lower turnover was mainly due to the decrease in energy demand and prices from the reduction in economic activity and lockdowns arising from COVID-19. This adverse impact was mitigated by plants with long-term contracts where revenue is based on plant availability. For FY20e, we expect SCI to report S$5.3bn (-13% y-y) in revenue from this segment as the impact of COVID-19 and the reduction in economic activity as a result of lockdowns in multiple markets led to a decrease in energy demand and prices.

Going forward, Energy is expected to make up 97% of SCI’s revenue from FY21e following the deconsolidation of SCM. We expect the recovery in this segment to be driven by a recovery in economic activity in Singapore, India and the UK as lockdowns in these markets ease resulting in a recovery in energy demand.

 

Marine comprises 30% of FY19 revenue. 2019 continued to be a challenging year for the Marine business with intense competition and continued low work volume adversely impacting overall performance. In their latest 1H20 results, turnover decreased 41% y-y while SCI’s share of Marine net loss (before exceptional items) came in at S$117mn vs. the loss of S$6mn from the same period last year. Even though there has been no cancellation of any existing projects to date, there has also been no significant new orders this year. We expect SCM to continue reporting losses in FY20e and FY21e as intense competition and continued low work volume continue to weigh on their operations.

Following the deconsolidation of SCM, this segment will no longer contribute to the financial performance of SCI from FY21e.

Urban comprises 3% of FY19 revenue. SCI’s urban businesses comprise mainly associates or joint ventures which are accounted for under the equity method, turnover of the business is therefore not material. In their latest 1H20 results, net profit of S$38mn was S$20 mn higher than the corresponding period last year. The improvement was largely due to the higher contribution from Nanjing’s residential land sale and Kendal Industrial Park. Total land sales in 1H20 was 85 hectares, slightly lower than 1H19, and this is mainly due to lower land sales in Vietnam, offset by higher land sales in China and Indonesia.

For FY20e, we expect the profitability of the urban business to be lower vs. FY19 due to lower contribution from projects in China and Vietnam. COVID-19 has resulted in land property sales to be impacted, the uncertain economic outlook has led to lower take-up and demand, as well as delayed launches for some of the business’ integrated developments and properties. We expect land and property sales to recover in FY21e as regulatory and other approvals resume following delays earlier in the year.

The Urban business still has a significant landbank of 2,600 hectares of saleable industrial, business, commercial and residential land. The integrated urban developments in Vietnam, China, and Indonesia, and that will underpin its future performance. The stabilisation of the economic outlook is expected to improve take-up for the business’ integrated developments and properties.

 

Balance Sheet

Based on their 1H20 results, SCI has a gross gearing and net gearing of 1.9x and 1.6x respectively. More than half (52%) of this is in bank loans, another 22% of this is in bonds while the remaining 26% is in project finance loans. SCI borrowings have a weighted average debt cost of 3.5%, of which 64% is fixed.

Following the rights issue by SCM, SCI’s obligation to pay the SCM rights subscription amount has been offset against an equivalent amount of the principal amount outstanding and due and owing to SCI by SCM under the subordinated credit facility. We have detailed SCI’s debt maturity profile after the transaction below.

We estimate the proforma book value of SCI for FY20e to be S$4.1bn, or S$2.30 per share following the rights issue from SCM. We believe the market could ascribe a 0.7x P/Bv for SCI (ex.SCM) to account for its energy and urban development business. Even though our estimates suggest the forward ROE for FY21e and FY22e to be 7.6% and 9.6% respectively, we think confidence in the management’s ability to execute will take time to realise, resulting in a discount in their overall net asset value.

While we acknowledge that the overall net gearing level will increase from 120.6% in FY19 to 187.1% for FY20e due to the lower equity base and the distribution-in-specie to SCI shareholders. We argue that the demerger will actually result in lower capital requirements gong forward as SCI will be able to focus on their core businesses without having capital tied up in SCM. Moreover, SCI’s debt servicing ability will also improve post de-merger, and we expect that SCI will be able to reduce the debt load going forward. For FY21e and FY22e, we expect SCI’s net gearing to be reduced to 176% and 155% respectively.

 

Cash Flow

Full year FY20e loss expected, but operating cash flow to remain positive. We expect SCI to report a loss of S$92mn for FY20e due to the expected continuing losses at SCM and the exceptional items amounting to S$191mn (Figure 20) recorded in 1H20. That said, we still expect SCI to report positive operating cash flow for FY20e.

Moving forward, we expect SCI to generate positive operating cash flow of S$853mn and S$1.2bn for FY21e – FY22e. Without the drag of SCM’s negative cash flow, we expect a substantial improvement of SCI’s operating cash flow from FY21e. The Energy and Urban businesses generate relatively stable long-term cash flow streams and the demerger with SCM will allow SCI to allocate capital solely to its core businesses.

While SCI has no fixed dividend policy in place, they have paid out dividends of between 4 and 5 Singapore cents for FY17- FY19, representing 24 – 42% dividend payout ratio. The Group’s decision to suspend the interim dividend for 1H20 and to defer this to the full year reflects the challenging environment the Group is facing. With the demerger of SCM now completed and our expectation for the Group to report a positive operating cash flow for FY20e, we think the Group could pay out a dividend in for the full year FY20e. In our forecasts though, we have forecasted zero payout for FY20e to be prudent.

Notwithstanding the economic outlook beyond FY20e, we think the demerger of SCM will reduce the capital requirement of SCI as they focus capital on their respective businesses. For FY21e and FY22e, we expect SCI to report free cash flow of S$53mn and S$377mn respectively, which should support the resumption of their dividend payout.

 

IPO of Sembcorp Energy India Ltd to crystalise value of India business

SCI could crystalise the value of their India business by listing their energy unit in India, Sembcorp Energy India Limited. SCI first filed its draft red herring prospectus lodged into the Securities Board of India in 2018, but subsequently withdrew this as it was injecting new equity into the business. SEIL further announced that it intends to refile a revised prospectus at “an appropriate time.., taking into consideration market conditions.”

SCI first entered the India market in 2010, establishing itself as a reliable independent power producer in the country focused on growing a clean energy portfolio. With a presence across nine states, SEIL owns and operates 35 assets, adding up to a total power capacity of 4,370MW including 1,730MW of renewable energy. The outlook for the India market remains positive, energy consumption is expected to see an increase of over 100% from 2015 to 2035.

SEIL owns and operates 2,640MW of thermal power projects consisting of Project 1 and Project 2. SEIL’s bank facilities have a AA- rating, with a stable outlook awarded by India Ratings (a wholly-owned subsidiary of the Fitch Group).

Going forward, we believe SEIL will pursue longer-term power purchase agreements (PPAs) as these guarantee a stable tariff higher than the spot rate and also gives them access to domestic coal supply where prices are lower and more stable than imported ones. Unlike the short-term PPAs which suffer from thin or even negative spark spread, long-term PPAs provide more profit visibility for plants. For FY19, India posted a net profit of S$100mn (accounting for 48% of their FY19 profit) vs. S$47mn in 2018 mainly due to the higher contribution from its thermal power plants as well as improved operating performance by its renewable energy assets on better wind resources and new capacity addition.

 

IPO of Sembcorp Energy India Ltd to crystalise value of India business

Renewable energy companies in India trade at about 1.7x of their book value, based on SEIL’s FY19 book value of INR65.4bn, this implies a market capitalisation of about INR111.2bn (or about S$2.1bn). We impute a slight discount to the sector average P/BV to account for SEIL’s lack of a listing track record to arrive at a valuation of INR98.1bn or S$1.8bn (~1.5x FY19 P/BV).

While the timing of SCI’s India Energy IPO remains uncertain, we believe SCI’s acquisition of the remaining 5.95% stake in SEIL for INR4.6bn (approximately ~S$77mn) in December last year (implying a 1.2x FY19 P/BV or a market capitalisation of INR77.3bn or S$1.5mn) will allow SCI to have the flexibility as sole owner to evaluate and pursue a full range of growth opportunities in the renewables segment, while at the same time seeking the right equity  window to list its India business or to pursue other capital-recycling options.

 

Future plans

Going forward, we think SCI’s future focus will centre around the following themes set out below:

  1. Drive long-term value creation and performance through disciplined capital allocation and systematic capital recycling;
  2. Unlock value with targeted utilities divestments of up to S$0.5 billion and proposed IPO of India energy business; and
  3. Strengthen commitment to sustainability with targets for doubling of renewables portfolio to approximately 4,000 megawatts by 2022 and a 25% reduction in carbon emission intensity.

 

SCI transformed into a focused Energy and Urban business. SCI’s move to deconsolidate SCM will allow SCI to focus their resources and efforts on repositioning its Energy and Urban business, and capturing growth opportunities to provide solutions that support the energy transition and sustainable development. To that end, we believe SCI will focus on growing their renewables capacity, and reach approximately 4,000 megawatts by 2022.

Net profit from SCI’s renewable energy portfolio has increased by a CAGR of 67.6% per year from FY16 – FY19. As a proportion of total net profit from Energy, this has increased from just over 2% to 8.4% in FY19. Going forward, we expect SCI to grow their renewables energy footprint in key markets in Singapore, China, India and the UK. In Singapore, construction of the 60 MWp floating solar photovoltaic system on Tengeh Reservoir (see Figure 27) commenced last month. The project is expected to begin full commercial operations next year with a 25-year power purchase agreement signed with PUB, Singapore’s National Water Agency.

The Energy and Urban business has historically generated relatively stable long-term cash flow streams, even with the Energy market exposed to the merchant market. We think the demerger will allow SCI to allocate capital solely to its core businesses. We expect their balance sheet and cash flows to improve post deconsolidation from SCM as the capital requirement falls. We expect net gearing to be reduced from 187% in FY20e to 177% and 155% for FY21e and FY22e respectively.

For their Urban business, SCI still has remaining saleable land of 2,600 hectares of saleable industrial, business, commercial and residential land (see Figure 28). In our view, SCI is positioned in key growth areas in Vietnam, China and Indonesia. In Vietnam, they have nine projects strategically located in the southern, central and northern economic zones. In China, they are situated in key growth regions, and are well placed to benefit from the shift towards central-western China development. In Indonesia, central Java is expected to benefit from spillover investments from Jakarta.

We see a number of synergies in SCI’s Energy and Urban business, and we believe SCI will focus on capturing trends like urbanisation, electrification and decarbonisation.

 

The listing of SEIL will recycle capital and crystalise value on SCI’s India Energy portfolio. While the timing of SEIL’s listing remains uncertain, we think this will happen sooner rather than later.

SCI’s move to acquire the remaining 5.95% stake in SEIL last December (implying a 1.2x FY19 P/BV or a market capitalisation of INR77.3bn or S$1.5mn)  will give the company more flexibility as sole owner to evaluate and pursue a full range of growth opportunities in the renewables segment, while at the same time seeking the right equity window to list its India business or to pursue other capital-recycling options.

 

Valuation

We initiate coverage on Sembcorp Industries with a BUY recommendation and a target price of $2.72. We peg SCI (ex. SCM) to a P/Bv of 0.7x FY21e, and 4.911 distributed shares in SCM to calculate the SCM shares to be distributed to SCI shareholders. In total, we expect that SCI shareholder could get $2.72 based on our assumptions below.

We believe the market could assign a 0.7x P/BV for SCI (ex. SCM), a slight discount to the 10 year historical average of the implied SCI (ex. SCM) P/BV to account for their Energy and Urban business to S$1.75 a share. Based on the 7,500,000,000 rights shares which SCI had subscribed for in accordance with the SCI undertaking agreement, this means that 4.911 of SCM shares will be distributed to SCI shareholders. Based on SCM’s last closing price of S$0.199 on the 7 September, SCI shareholders could receive a total of S$2.72 (Figure 29). Our forecast of SCI does not include a valuation on SCM.

The recapitalisation of SCM, followed by a demerger to create two focused companies will allow SCI to focus on their core competency. The demerger also delivers a clear investment proposition and makes SCI more comparable to their peers. The deconsolidation of SCM will transform SCI into a focused Energy and Urban business. SCI will now be able to focus their resources on capturing growth opportunities in two of their key segments independently of SCM. Even though the conglomerate discount attached to SCI should narrow or disappear, we think this might take time as investor’s confidence in the management could take time to rebuild. For FY21e and FY22e, we expect SCI to see ROE improve to 7.6% and 9.6% respectively, potentially leading to a positive re-rating of SCI.

 

Risks

Continued lockdowns in SCI’s key markets like Singapore, China, India and UK due to COVID-19 resulting in decrease in energy, demand and prices. With little signs of COVID-19 cases worldwide abating, any lockdowns or extensions in lockdowns in SCI’s key markets like Singapore, China, India and UK will result in a reduction in economic activity, resulting in a decrease in energy, demand and prices. In 2Q20, energy demand in Singapore, India and the UK have all declined by approximately 5% to 20%, compared to the same period last year.

 

Uncertain economic outlook could affect take-up and demand for SCI’s integrated developments and properties. Measures undertaken by various governments to contain the COVID-19 pandemic can result in delays in regulatory and other approvals required for the Urban business’ projects. These delays in approvals accompanied with the uncertain economic outlook will have a negative impact on the overall take-up and demand for the Group’s integrated developments and properties.

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