Sembcorp Industries is doubling its utilities capacity over the next five years, but its offshore and marine business still casts a long shadow over the group. Would spinning off SembMarine help it achieve its true worth?
Tang Kin Fei sidesteps the throng of analysts that swiftly surrounds his chief financial officer, Koh Chiap Khiong, during Sembcorp Industriesâ 1H2011 results briefing recently, moving instead to greet fund managers and members of the media eager to congratulate him for delivering an impressive set of results for the period.
Although revenue for the six months to June 30, 2011 fell 8% to $4.2 billion from a year ago, Sembcorp managed to report a 5% rise in earnings to $335 million, thanks to improved performance by the utilities division. â We have made good progress in the development of our major utilities growth projects, especially in Singapore but also in China and the Middle East,â Tang, group president and CEO, says of the typically staid division at the briefing.
Sembcorpâ s utilities business registered a 17% y-o-y rise in 1H2011 earnings to $137.4 million â " representing about 40% of the companyâ s total bottom line â " on the back of a 22% increase to $2.4 billion in revenues, owing to higher electricity prices from its growing energy operations in Singapore. It also received a boost to earnings from the successful integration of US water company Cascal NV, acquired by Sembcorp in July last year to extend its capabilities in municipal water production and venture into markets such as Chile, South Africa and Panama.
Yet, Tang believes shares of his company are not trading at the valuations they deserve. â Our value proposition lies in our ability to develop and complete greenfield power plants on time and over a [relatively] short period of 16 years to generate a steady stream of growing income over the years, which is not easy in this industry,â Tang tells The Edge Singapore after the briefing. Reaching into his pocket for his iPhone, Tang accesses an application that allows him to monitor share price information of Sembcorp and points out that his company now trades below 10 times its current earnings, â which is undervalued for this industryâ .
One reason for this could be that Sembcorpâ s earnings are still more than 50%-dominated by its 60.7%-owned subsidiary Sembcorp Marine, one of the worldâ s largest rig builders and shipyard operators. With the boom in the offshore energy sector, SembMarine has seen orders for rigs and other offshore vessels soar in recent years, boosting its revenue and earnings. The result is that Sembcorp has come to be viewed as just an indirect play on SembMarine.
In fact, Sembcorpâ s share price trajectory has mostly mirrored that of its offshore and marine unit over the past few years. Indeed, after hitting 52-week highs of $5.84 and $5.80 on April 28 respectively, both SembMarine and Sembcorp have since fallen about 26% each. Yet, because it is viewed as a less direct play on the booming offshore sector, shares in Sembcorp are not as highly valued as SembMarineâ s. At current levels, SembMarine trades at 10.3 times earnings versus nine times for Sembcorp.
Now, the outlook for SembMarineâ s earnings over the next three years appears to be plateauing. Thatâ s partly because of greater uncertainty in the offshore market, given that, recently, rig orders have not been backed by charters, Kay Lim of DnB NOR points out in an Aug 3 report. In addition, yard slots have been tightening, suggesting that there is limited capacity for growth even if orders do continue to roll in.
Indeed, SembMarineâ s earnings for the six months to June 30, 2011 fell short of analystsâ estimates, owing to a delay in revenue recognition on a semi-submersible rig, the Songa Eclipse. As a result, several analysts have downgraded their earnings forecasts for both SembMarine and Sembcorp.
Will the emerging value of Sembcorpâ s utilities business now be further obscured by flagging earnings at its shipyard unit? Or, will it finally enable Sembcorp to emerge from the shadow of SembMarine? Would a split-up between the two companies help Sembcorp achieve its true worth in the market?
Leaning on SembMarine
CEO Tang agrees that Sembcorp might receive higher valuations as a standalone utilities provider. Yet, for now, it is still better off with SembÂMarine in its fold as it continues to build up its utilities business. â Without SembMarine, which is 45 years old compared with our 16 years, we would not be where we are today,â says Tang. â The utilities business takes a long time to generate income, while marine is more cyclical and can generate the cash we need to fund our growth and pay dividends at the same time.â
Sembcorp will need to continue to lean on SembMarineâ s financial heft to achieve its target of competing on a global scale. The company has a market capitalisation of $7.3 billion, which is â nothing compared to the US$50 billion utilities companies out thereâ , Tang adds.
â Without scale, we will not be able to weather bigger storms. We need to look beyond getting a higher valuation today, as our strategy is to grow the utilities income steadily so that, in five to 10 years, we will have two strong legs â " marine and utilities â " to stand on,â he says.
Indeed, the upbeat performance of 1H2011 heralds the beginning of many more profitable quarters ahead for Sembcorp as its investments in the sector push past their initial gestation periods and begin to generate cash. New facilities typically take three to seven years before debts are pared down and economies of scale are reached. By ramping up production at existing facilities and through some $4 billion in acquisitions lined up over the next five years, Tang aims to double Sembcorpâ s power and water generation capacities to 10,000mw annually and 10 million cu m a day, respectively, to establish itself as a global utilities provider.
Sembcorp owns and operates businesses involved in power generation, electricity retail, process steam production, and distribution and natural gas supply and retail, including compressed natural gas facilities both locally as well as overseas in the UK, China, Vietnam and the Middle East. It is in the process of constructing a second cogeneration plant on Jurong Island, where it already operates a similar plant â " Singaporeâ s first. It recently announced the construction of a $40 million industrial wastewater treatment plant on the island, which is expected to commence operations in 2H2012 and serve industrial customers such as German rubber company Lanxess and Jurong Aromatics Corp.
In addition, Sembcorp will be raising its supply of natural gas to Singapore by 26% to 90 billion British thermal units, following an expected increase in the flow of gas to Singapore in 4Q2011, which will contribute to profits. The company imports natural gas into the country from West Natuna, Indonesia and is the first commercial importer and retailer of natural gas in Singapore. It has already secured $466 million in new contracts for the supply of gas and other services.
Sembcorp also owns and operates a US$1 billion ($1.2 billion) 893mw power and desaliÂnation facility in Fujairah, one of the largest of its kind in the world. Tang is expecting a contract award from the Fujairah authorities in 1Q2012 to expand capacity of potable water to 130 million gallons per day from 100MGD currently. In Salalah, Oman, it recently completed Phase 1 construction of another US$1 billion power and water generation plant, which should begin generating income when completed next year. Civil
work has also commenced on a $2 billion coal-fired power plant in Andhra Pradesh, India, which should be completed by 2014.
Meanwhile, Sembcorp is extending its reach in China, where it currently operates Shanghaiâ s largest cogeneration plant. On July 6, the company announced plans to expand its water business in the country, including a joint venture to build, own and operate a water reclamaÂtion plant capable of generating 12,000 cu m of water a day in the Tianjin Lingang Industrial Area.
It is also exploring the option to acquire a municipal wastewater treatment plant and water reclamation plant in Qitaihe, Heilongjiang province. The water reclamation plant will supply water to a power plant owned by China Datang Corp Renewable Power Co â " one of the largest power producers in China. The move will allow Sembcorp â " which has a municipal water treatment plant capable of generating 100,000 cu m a day in Qitaihe â " to expand its product offerings in the city to wastewater treatment and water reclamation.
Separately, Sembcorp will also explore acquiring a municipal wastewater treatment plant, with a capacity of 50,000 cu m a day, in the Yanjiao National High Tech Industrial Development Area in Hebei province, where it already owns and operates a similar facility with a capacity of 70,000 cu m a day.
Utilities unit adds value
Despite all these moves in the utilities sector, anaÂlysts say Sembcorpâ s fortunes will be anchored to the offshore and marine sector for years to come. That could see it play second fiddle to SembMarine as far as investors are concerned. â We prefer an immediate exposure to SembMarine, as Sembcorpâ s utilities earnings will accelerate only from 2013,â writes Kim Engâ s Rohan Suppiah. He figures shares in Sembcorp would be fairly valued at $5.40 apiece, based on a sum-of-the-parts calculation. Kim Eng has a â holdâ recommendation on the stock.
Yet, analysts are beginning to take greater account of the emerging strength of SembÂcorpâ s utilities business. Lim Siew Khee, an analyst at CIMB Research, says Sembcorp is her â top pick among Singapore conglomerates as a cheaper alternative to the offshore and marine sector, with close to 60% of its earnings coming from SembMarineâ . After taking into account the additional utilities earnings over the next few years, Lim believes the company is worth $6.92 a share. CIMB has an â outperformâ call on the stock.
Meanwhile, Jason Saw, an analyst at DMG & Partners, has cut his earnings forecasts for Sembcorp to account for the lower marine earnings for the period. Yet, he still expects a stronger earnings outlook for its utilities division to help support the value of its shares. He has a â buyâ call on the stock, with a lowered price target of $6.25, down from $6.40 before.
It appears that Sembcorpâ s Tang is already making headway in getting the market to recogÂnise the growing value of the companyâ s utilities business.