March 13, 2019

 

Sembcorp Industries’s share price has slumped slightly since its 4Q18 results, as the higher gearing on SMM’s balance sheet renewed concerns on equity financing. Given the higher working capital requirements for future work and elevated capex of ~S$300m for 2019, SMM’s balance sheet is tight. Parallels are being drawn with the recent recapitalisation of its Singapore-listed peer, which saw an equity injection of S$1.5b2.0b in 2018 for its O&M business.

SCI has often re-iterated it will support SMM through the cycle. Assuming SMM undertakes equity financing of the same quantum as its Singapore-listed peer, SCI will have to raise capital to subscribe to the equity call. Such a course of action will significantly improve SMM’s financial position, while partially offsetting the valuation downside for SCI. For SMM, this comes in the formof: a) lower net gearing, b) higher working capital position, c) better profitability from lower interest expense, justifying a higher valuation multiple, and d) cleaner balance sheet to pursue new contracts that will further drive earnings growth. SCI’s valuation will suffer from dilution, but this is partially offset by the aforementioned impact for SMM. However, until the risk of an equity call dissipates,share price is likely to experience an overhang.

SEIL Project 1 PLF worsened in Feb 19 despite Unit #1 resuming operations, while SEIL Project 2 showed yoy weakness. Dark spread is narrowing as India spot electricity prices are declining more than coal prices. Earnings are lowered 1-3% as a result. At the same time, balance sheet concerns for SMM have created an overhang.

SEIL Project 1 (fka TPCIL) saw Unit #1 resume operation in end-Feb 19 as foretold by management. This improvement was however, offset by Unit #2 experiencing outages over 20-28 February, resulting in SEIL Project 1’s tentative PLF for Feb 19 (42.1%) coming in lower than that of Jan 19 (44.3%), when Unit #1 was completely down. Average PLF for SEIL Project 2 (fka SGPL) over JanFeb 19 was marginally lower at 75% (2M18: 77%).

IEX spot prices have fallen 28% qoq to Rs3.31/kWh (4Q18: Rs4.60/kWh, 1Q18: Rs3.49/kWh). Partly offsetting the decline in spot electricity prices was a corresponding decline in coal prices by 6% qoq. The net impact sees the dark spread narrow for 1Q19, which will negatively impact profitability for SEIL Project 2.

Given the overhang and underperformance from the Utilities division, we have adjusted our target price down to S$2.80. This values SMM at an unchanged S$1.83 per share, with the Utilities segment valued at an implied 7.5x 2019F PE (prev: 9.6x), reflecting -0.5SD of its long-term mean since 2001 (7.8x). Given the limited upside and uncertainty surrounding the stock, we downgrade our recommendation to HOLD. Target price: S$2.80. – UOB KayHian

Sembcorp Industries closed at: S$2.55