NRA Capital: Sembcorp Industries - 6 Mar 2008

Price correction presents an opportunity

· SCI announced a 49 percent drop in full-year earnings, after exceptional items, to $526m. But at the operating level, earnings were up 46 per cent to $557.2m, in line with our expectations. The group took a hit in the exceptional items section, due to its share of SembCorp Marine’s derivatives trading losses.

· Part of the reason for the strong performance was also due to a $48m tax write-back on the profits from the sale of its Pacific Internet stake. Taking this out, operating net profit would have been $509m, slightly below our forecast.

· There’s been a selldown in SCI since the results were announced and partly in line with the market fall. We think the selldown is also due to some fund redemptions, and consider the correction has brought the stock back to an attractive entry level and upgrade our recommendation to Buy.

· Our forecast for this year and FY09 remain unchanged, fair value is $5.82. At yesterday’s closing price of $4.24, there is a 37 per cent upside to our fair value. Stock is also trading cum dividend, which is 3.5 per cent for FY07 and projected to rise to 3.8 per cent for the current year.

· While the guidance for the utilities division apparently disappointed some, the slack will likely be covered by the marine division, which is seeing a record order book and likely to post improving margins for the current year.

Divisonal review

1. Utilities. Earnings growth of 19 per cent to $230m was slightly below expectations due to a weaker performance from the UK operations and also higher costs due to new ventures and potential M&A. Management guided that contribution from UK would continue to be under pressure this year due to uncertainty of the cost renewal of coal supply. Also, overseas projects such as that in Shanghai Caojing, would be subject to higher costs due to regulatory price hikes in natural gas and there will be a lag period before this can be passed on to customers. While the outlook for Singapore operations is still stable, growth will not be exciting.

2. Marine division had a good FY07 and was marred only by the forex hit of $308m, with another US$50.7m reported as a contingent liability. Despite the charge, SembCorp Marine (SCM) still managed to post earnings for 4Q:07. The group’s order book has risen to a new all-time high of $7.4bn and earnings growth is likely to continue these two years, barring any more write offs for foreign exchange losses.

3. Enviro turned around from a disappointing FY06 loss to turn on profits of $14m. This was attributed partly to a good performance from its Australian JVs. The Australian entities have also made some new waste-to-alternative energy acquisitions which should be well received. In Singapore, the solid waste treatment and recycling facility has commenced operations.

4. Parks. This is another smallish part of the group’s business that should be able to maintain its performance this year. But the group has guided that if the US does enter into a prolonged recession arising from the sub-prime crisis, it could cause a slowdown in the manufacturing sector, affecting the industrial parks business under them.

Earnings outlook

Note that the Group has cautiously guided to “maintain its FY2007 PATMI before exceptional items and the one-off tax write-back”. This would imply a flattish FY2008 performance. We expect Marine to surprise on the upside and are also optimistic that the utilities division should perform well.