Tuesday, April 15, 2008

Citigroup: Sembcorp Industries - 15 Apr 2008

Buy: Long-term Growth Story Stays Intact

* Headwinds in the UK — SembCorp Utilities will renegotiate its UK supply contracts that expired on 31 March 2008. Replacement contracts are likely to be signed at higher costs. Management has guided to a S$20m-30m downward impact on the FY08 bottom line, equivalent to 19-28% of FY07 Utilities PATMI contribution from the UK.

* Lower utilities margins — We have cut our margin assumptions for Utilities, and now expect the division to post a ~3% decline in PATMI as lower UK earnings are partly offset by stronger contributions from Singapore and, to a smaller extent, China and Vietnam.

* Cautious guidance — Management is cautious on FY08 and expects to “maintain” its FY07 PATMI before exceptional items excluding the one-off tax write-back, with growth in other divisions offsetting the possible underperformance in the UK. Management appears more optimistic about longer term performance, citing contributions from new markets (e.g. China, Vietnam) and new projects (e.g. Wilton 10, strong Marine order book).

* 2% FY08E PATMI growth — We incorporate our SembCorp Marine earnings estimates into our model, and together with lower Utilities contributions, revise downwards our overall net profit estimates by 5-12% over FY08-09E. Our new FY08E net profit implies about 2% FY08E PATMI growth, in line with management guidance.

* Maintain Buy/Low Risk — We incorporate our SMM target price of S$3.82 into our SOTP valuation, and incorporate a 10% discount to our utilities sector EV/EBITDA peer valuation to factor in the short-term margin headwinds faced by UK Utilities. Our new target price of S$4.85 implies a total return of 25%.

Quant view: Contrarian

SembCorp Ind lies in the contrarian quadrant of our value-momentum map, with strong relative valuation but weak momentum scores. The stock’s migration from Glamor to Contrarian could be attributable to the fall in the stock price.

On momentum, SembCorp Ind ranks higher than peers in the Singapore market but lags behind in Industrials. However, on valuation, the stock lags behind peers in the Singapore market but ranks higher in the industrials sector.

From a systematic macro exposure analysis, SembCorp Ind, being a low-beta stock, should hold its own in falling markets. It also benefits from falling yields in emerging markets.

Company description

Sembcorp Industries (SCI) is a leading utilities and marine group in Asia. It provides integrated utilities and energy to industrial customers in Singapore, the UK and the region. It is also a leading global marine and offshore engineering group. Its main businesses are: integrated Utilities and Energy, Environmental Management, and Marine Engineering. SCI is a world pioneer in providing centralized multi-utility facilities, offering a full spectrum of third-party utilities; the leading provider of integrated environmental solutions in Asia Pacific; and one of the largest ship repair and conversion operations in Asia.


Investment strategy

We have a Buy/Low Risk (1L) rating on SembCorp Industries for its attractive valuations and exposure to robust industry fundamentals. SCI is an industrial conglomerate with three businesses: Utilities, Marine Engineering, and Environmental Engineering. Its Marine activities are undertaken by listed subsidiary SembCorp Marine. One of the key earnings drivers of the group is Utilities, which should see strong contributions from its facilities on Jurong Island, Vietnam and the UK. Marine Engineering is well supported by a robust order book and healthy industry fundamentals. Environmental Engineering is still small, but the group intends to expand it.

Valuation

Our target price of S$4.85 is pegged at a 5% holding-company discount to the group's estimated break-up value of S$5.13 per share. We prefer to use RNAV as our primary valuation method for conglomerates, given the group's different business activities. Our target price equates to 15.2x 2008E P/E, which is about a 7% premium to the Singapore market multiple of 14.3x and we think justified by the stock's stronger performance vs. the market and the potential for forward valuations to improve following any possible M&A activities within the utilities business.

Risks

In accordance with our quantitative risk-rating system, which tracks 260-day historical share-price volatility, we rate SCI shares Low Risk. Downside risks that could impede the shares from reaching our target price include: provisions for divestment of non-core assets; delays in contracts; a sharp decline in oil prices, which could adversely affect demand for the group's marine engineering business; and operational risks from its exposure to diversified markets.

1 comment:

QUALITY STOCKS UNDER FOUR DOLLARS said...

I have never been a fan of large money center banks. I do not like citigroup although I do like the TARP warrants that trade on citigroup stock they do not expire until 2018.