Sembcorp Industries – Strategically important sale of SEIL September 7, 2022 216

PSR Recommendation: ACCUMULATE Status: Upgraded
Last Close Price: 3.08 Target Price: 3.680
  • Acquisition consideration of S$2.059bn implies S$0.8bn/GW of gross installed capacity, which is higher than average comparable transactions of S$0.5-1bn/GW. We view the transaction as fair given the weak market environment for coal assets.
  • Debt-capitalisation ratio improve to 62% from 66% for pro forma 1H22. We believe the Group will leverage its balance sheet and re-invest the proceeds into green assets.
  • Sembcorp Industries (SCI) will still be exposed to operational risks of Sembcorp Energy India Limited (SEIL) after the sale through its 15-year exposure to the Deferred Payment Note (DPN).
  • We upgrade to ACCUMULATE from NEUTRAL with higher target price of $3.68 (prev. $3.27). We lower FY23e PATMI by 11% as we strip out SEIL’s contribution and lower contribution from urban developments. Our target price is raised to $3.68, still based on 1.2x P/BV, the average of its peers as we roll forward estimates to FY23e.

 

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

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About the author

Profile photo of Terence Chua

Terence Chua
Senior Research Analyst
Phillip Securities Research

Terence specialises in the consumer, conglomerate and industrials sector. He has over five years of experience as an analyst in the buy- and sell-side. As an institutional fund management analyst, he sat on the China-Hong Kong desk. Terence was ranked top 3 for Best Analyst under the small caps and energy category in the Asia Money poll 2018.

He graduated from the Singapore Management University with a major in Finance (Honours), and is the honoured recipient of the CFA scholarship.

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