Sembcorp Industries - Initiation: in weak market, seeking overseas growth

■ Expansion of overseas utilities business could disappoint

■ Singapore market likely to remain challenging

Initiate with Underperform (4) and target price of SGD2.83

Investment case:
Power generation companies in Singapore like Sembcorp Industries (SCI) are faltering amid a power capacity glut. Given the weak domestic operating environment, the company is aggressively expanding its overseas utilities business. However, we expect overseas earnings to underwhelm consensus forecasts, leading to negative earnings revisions in the quarters ahead. SCI’s exposure to subsidiary SembMarine (SMM SP, SGD1.97, Sell [5]; TP: SGD1.73) could also result in share-price weakness given the close correlation between the two stocks.

India could disappoint on start-up losses. The market expects SCI’s Indian power plants to be the quintessential assets driving earnings growth in coming quarters. However, we note that its first Indian power plant project, TPCIL, has yet to turn profitable, with YTD losses of SGD20m, according to management guidance. NCCPP, its second thermal plant project in India, is likely to incur a similar level of start-up losses in 2016, which would offset any positive contributions from TPCIL.

Singapore market remains challenging. We expect the Singapore power sector to generate losses in 2016, given a challenging operating climate with the current Uniform Singapore Energy Price (USEP) at a trough. This is contrary to market expectations for the power market to bottom in 2015. Without a strong recovery in the power sector, which accounted for 55% of Singapore utilities’ earnings in 2014 vs. 4% in 2015E on our forecast, we see potential earnings disappointment leading to share-price deterioration.

Still a high correlation with marine. The poor outlook for SCI’s marine business should be partially mitigated by its focus on growing its portfolio of utilities assets. However, given the close correlation (0.82x) between both SCI and SembMarine’s share prices, we do not think SCI’s share price can escape unscathed given the prevailing negative sentiment pertaining to SembMarine’s operations.

2016 dividend at risk. With our forecast for SembMarine to reduce its dividend by 33% in 2016 vs. 2014, in line with our lower earnings forecasts, we do expect SCI to cut its dividend, albeit on a smaller magnitude from SGD0.16 to SGD0.125 in 2016. The 2015 dividend amount will likely remain at SGD0.16 due to divestment gains from disposed assets.

Technical Analysis
Daily Chart
We have an SOTP-based 12-month target price of SGD2.83 for SCI, which implies a 2016E PER of 9.4x. Excluding its marine business, our fair value for SCI’s utilities business implies a 8.0x 2016 PER, a 32% discount to the business’s 10-year average PER of 11.8x. We initiate coverage of SCI with an Underperform (4) rating, with our target price indicating 10.4% downside from current levels.

Key risks to our Underperform (4) call would be strong overseas execution and a sustainable increase in oil prices. (Read Report)

Read Related Reports
1) Sembcorp Industries - Overseas utilities for growth‏ by OCBC Investment Research, published on 4 December 2015

2) SembCorp Industries - Buy: A better 2016 by HSBC Global Research, published on 3 December 2015

Source : Daiwa Capital Markets

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