Sembcorp Industries (SCI SP) - Utilities Segment Remains Under-appreciated Despite Share Price Run-up
- SCI is expected to deliver 12% earnings growth in 2017, led by strong earnings in India. This is likely to help offset the earnings decline from China as JV contribution from Yangcheng Coal PP expires. However, the recent share price run-up was driven more by SMM, than an appreciation of utilities’ earnings potential.
- We lower our earnings forecasts by 1.5-2.0% for 2017-18 on the larger-than-expected absence of earnings from Yangcheng Coal PP.
- Maintain BUY with an unchanged target price of S$3.20.
On the cusp of a 28% yoy rise in effective power capacity in 2017.
- Sembcorp Industries’ (SCI) utilities earnings are expected to shine in 2017, led by its power business. On an effective capacity basis (gross capacity x equity stake), we expect capacity growth of 28% yoy for 2017, higher than the 3% yoy growth expected for 2016.
- Our assumption based on effective capacity offers a better gauge of SCI’s capacity growth and earnings compared with using gross capacity alone for estimates. Had we used gross capacity, a decline in 2016 would have been seen, owing to the expiry of the JV's 25% stake in Yangcheng Coal Power Plant (PP).
Utilities earnings to grow by 12% yoy in 2017, led by India.
- Group utilities earnings growth is largely to be driven by better earnings from India (+267%) in 2017. Central to this earnings growth is Thermal Powertech Corporation India’s (TPCIL) Unit #2 which will move beyond its first year of teething issues and enter a phase of steady operations.
- Offsetting this growth is an estimated 14% decline in earnings from China as the JV's 25% stake in Yangcheng Coal PP expires.
TPCIL expected to deliver stellar earnings in 2017.
- TPCIL is expected to deliver a good set of core earnings in 4Q16 which is the maiden quarter that would see the plant operate above a plant load factor (PLF) of 85%. With teething issues likely behind it after 4Q16, earnings are expected to more than double in 2017. Higher electricity prices could provide a boost, having risen from Rp2.4/kWh in end-Sep 16 to Rp3.1/kWh in December.
- Whether higher prices will stay remains to be seen, as we note a sharp weekly drop to Rp2.5/kWh this week. We give the caveat that a one-off S$25m refinancing charge for TPCIL will be made in 4Q16. Depending on accounting treatment, this may be booked directly into TPCIL’s bottom line, resulting in a loss.
- Yangcheng Coal PP earnings absence to be offset by new plant start-ups in 2017.
China made up 33% of 9M16 utilities net profit (S$85.9m).
- SCI’s 25% JV-owned Yangcheng Coal PP (2,100 MW) expired in Oct 16, which means that ~S$40m of earnings will fall off in 2017. Despite the Oct 16 expiry, Yangcheng Coal PP is expected to recognise some residual earnings in 4Q16, resulting in higher 2016 earnings from China.
- We expect the earnings absence to be partly offset by earnings from the 49%- owned Chongqing Coal PP (1,320MW, start-up early-17) as well as several Chinese water treatment plants.
Utilities to remain under-appreciated.
- SCI’s non-marine segment currently trades at an implied 9.3x 2017F PE, a 23% discount to the sector mean. The current share price was driven more by the rise in SMM’s share price, rather than better appreciation of the Utilities’ earnings potential.
- We think hesitation stems from the uncertainty surrounding its India operations. As SCI delivers on earnings, we expect the discount to narrow. Prior to the start-up issues currently plaguing SCI, this discount had narrowed to as much as ~10% on anticipation of earnings from India.
Tactical top slice after 22% share price increase.
- We expect a pull-back on SCI’s share price owing to SMM’s fundamental earnings weakness. Given the 22% share price run-up, we recommend investors to top slice and buy back at lower levels.
Lower earnings by 1.5-2.0% for 2017-18.
- We make no changes to our earnings forecast for 2016.
- We have however, tweaked our 2017-18 earnings forecasts by -2.0% and -1.5% respectively to account for timing issues relating to TPCIL and a greater-than-expected earnings absence at Yangcheng Coal PP.
Maintain BUY, target price unchanged at S$3.20.
- Our target price is based on SOTP, with the utilities segment priced at a blended 9.8x 2017F PE, based on the respective countries’ sector mean. SMM is valued at its fair value of S$1.40 per share.
- Despite the 7.4% upside to our fair value, we maintain our BUY rating as SCI’s share price likely rose due to volatility in SMM’s share price than a fundamental appreciation of the utilities business’ earnings potential.
- As India’s earnings and ROE improve, a re-rating to higher multiples from the current forward PE of 9.4x is possible. Our list of peers show that peers with ROE above 10% can command a PE multiple as high as 12x.
- Maintain BUY.