SembCorp

Kim Eng on 6 Jan 2012

(SCI SP, $4.11, Hold, TP $4.23)
Sembcorp Industries (SCI) is another successful conglomerate in the Singapore corporate arena. However, its structural profile is significantly different from that of Keppel Corp. For one thing, SCI’s main asset is its 62.4% shareholding in the separately listed Sembcorp Marine (SMM) and the latter currently represents 69% of the value of its share price.

Marine now the main contributor. The emergence and strength of SMM over the past five years has resulted in its contributions surpassing those from utilities, which used to be SCI’s main earnings contributor. Management has continued to grow the utilities business at a steady pace, both organically and through acquisitions, and though it continues to be a strong part of SCI’s earnings, the returns have been overshadowed by the pure strength in the marine industry.

Our outlook for the marine sector (through SMM) remains positive as we expect the company to retain its level of profitability on the strength of its current orderbook, the lull in new orders notwithstanding. Like Keppel’s O&M division, we expect SMM to be a strong beneficiary of demand for more offshore assets to tap deepwater hydrocarbon reserves in order to fuel global growth.

Utilities set for growth. SCI’s utilities operations in Singapore have been a steady contributor through its established integrated business on Jurong Island. Its ongoing projects in the Middle East, China, India and Vietnam will also drive earnings growth over the next five years, although the gestation periods for these projects are somewhat longer, at between three and seven years. SCI has always been able to leverage off its utilities capabilities to offer large-scale integrated projects such as industrial parks. It will be expanding the  scope of its industrial park business in order to provide integrated residential solutions. This is currently being done in Vietnam and China, and SCI has the potential to expand this to other projects overseas.

SCI has also improved its geographic spread and capabilities in its water solutions through its US$200m acquisition of Cascal in 2010. Cascal is a provider of water and wastewater services globally. It operates in 21 locations across eight countries (the UK, South Africa, Indonesia, China, Chile, Panama, Antigua and the Philippines) with a customer base of homes and businesses. Cascal offers SCI additional experience in the municipal water segment and its market knowledge from its international operations provides Sembcorp with additional competencies which complement SCI’s expertise in industrial water and wastewater, water reclamation and large-scale desalination plants.

Significant history of acquisitions and divestments. If one were to look at the history of SCI, it has been full of mergers and acquisitions. The group itself is the product of a merger between Sembawang Corporation and Singapore Technologies Industrial Corporation (STIC), while also integrating Sembawang Shipyard and Jurong Shipyard into SMM. Along the way, it has divested companies like Singapore Food Industries, Sembcorp Logistics and SembCorp Engineers and Constructors, while picking up the aforementioned Cascal. Internally, it has restructured and realigned marine fabricators SMOE, as well as its industrial parks and environmental engineering business.

More acquisitions and divestments possible. Going forward, we see a potential divestment of its 24% stake in SGX-listed Gallant Venture, worth some $135m in the current market. Gallant is a separately run company and is non-core to SCI’s operations. Further strategic acquisitions to boost its competencies, in the vein of the Cascal acquisition, may also lie ahead. As well, SCI may choose to develop its own business trust to emulate the capital recycling model of selling its utilities assets when they reach maturity in order to fund new projects.

Divestment is possible but status quo for now. Given that SMM is a successful standalone listed entity in its own right, we see some sense in SCI divesting its stake, which we reckon could be worth $4.4b. The capital raised could be used to grow its utilities business or returned to the shareholders. But we see several obstacles to divestment. Firstly, SCI will not want to sell SMM in current market conditions, as the price of SMM will not reflect its full potential. Indeed, our target price for SMM is $4.95 versus its current price of $3.93, a 21% discount.

Secondly, we expect the Singapore government, through Temasek Holdings, to want to continue to have a controlling or significant stake in SMM, which it considers a strategic investment. This is currently achieved via its controlling 49% holding of SCI, which is the majority shareholder of SMM. Temasek may not be willing to undertake complicated asset swaps and purchases in order to retain its controlling stake in SMM in the case of a divestment, and is probably comfortable with the existing holding structure. Given these factors, we do not see much impetus for significant corporate actions in the near future.

We prefer direct exposure to SMM. At any rate, we see SCI’s current shareholding of SMM as advantageous to the minority shareholders of SMM. SMM has consistently paid out good annual dividends, as well as special dividends in certain years when its cash pile has built up. These dividend payments are a way for SCI to monetise its stake in SMM and use the cash received to fund the expansion of its utilities and other businesses. We expect this feature to continue, which is also beneficial to the minority shareholders.

SCI’s own dividend policy over the years has been comparatively less generous than SMM’s. Therefore, we still prefer a direct exposure through SMM in order to benefit from this dividend payout. SMM is also a purer play in the offshore market, where it may be a major beneficiary of global offshore oil and gas capital expenditure in the coming years.