Analysts from CGS-CIMB Research, Citi Research, CLSA, DBS Group Research and UOB Kay Hian are positive on Sembcorp Industries’ decision to divest its power plant business in India.
Sembcorp, on Sept 5, announced that it is proposing to sell Sembcorp Energy India Ltd (SEIL) for the equivalent of $2.058 billion to Tanweer Consortium.
The consortium is led by Oman Investment Corporation S.A.O.C. (OIC), the Ministry of Defence Pension Fund, Oman (MODPF) and Dar Investment SPC (Dar Investment).
CGS-CIMB lifts TP to $4.78 on ESG uplift
CGS-CIMB analysts Lim Siew Khee and Izabella Tan are reiterating their “add” call with a higher target price of $4.78 from $3.80 previously, with Sembcorp’s latest move alleviating the environmental, social and governance (ESG) concerns over its coal assets.
With the removal of SEIL, Lim and Tan now value Sembcorp based on a calendar year (CY) 2023 P/E of 12x, which is at a 10% discount to Sembcorp’s regional peers. The company’s renewable peers are currently trading at 28x.
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“In our ESG benchmarking, we had said that successful decarbonisation efforts could lead to premium valuations ascribed to Sembcorp as it is the only pure renewable energy proxy in Singapore,” the analysts write.
In their report, the analysts see that the divestment of the profit-making SEIL will not result in a “major dent” in Sembcorp’s profits.
“The absence of coal profits would be converted into a form of vendor financing, in our view,” they point out. “SEIL runs two coal power plants with a gross installed capacity of 1,320MW each. Apart from a contract with Telangana DISCOMS for 570MW expiring in 2024, contracts for the remaining 1,575MW extend to 2033-2040.”
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On this, Lim and Tan estimate that Sembcorp will receive $150 million of cashflow per year from deferred payment notes (DPN), based on an average interest rate of 8% per annum (p.a.). This is relative to the profits of $40 million p.a. from 2019- 2021 from the two coal power plants due to the lack of long-term power purchase agreements (PPAs) for its second plant, SEIL 2, they add.
The deconsolidation of SEIL would also reduce Sembcorp’s proforma net gearing to 1.37x from 1.75x as at end-1HFY2022, the analysts note.
However, Lim and Tan have pencilled in a 38% decline in Sembcorp’s net profit in the 2HFY2022 ending December to $310 million, and a 15% y-o-y decline in its net profit for the FY2023. The declines have priced in a potential reduction in energy prices if demand/supply disruption dissipates.
Year-to-date (ytd), Sembcorp has outperformed the benchmark Straits Times Index (STI) by 70%, but the analysts see further upside to the stock’s share price given its decarbonisation plans.
To them, downside risks to Sembcorp’s share price include a prolonged unplanned shutdown, as well as unfavourable regulator changes.
Citi sees opportunities for capital reallocation from divestment
Citi Research analyst Jame Osman is also keeping his “buy” recommendation on Sembcorp with an unchanged target price of $4.14 after the divestment news.
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“Overall, we view the deal positively as a balanced approach to divestment, and primarily as it marks a key step by Sembcorp toward achieving material decarbonisation of its asset portfolio,” he writes in his report dated Sept 5.
The disclosed valuation of SEIL is also higher than his previous estimate, he notes. This means that the net earnings shortfall post-divestment is effectively lower-than-expected, he adds.
“Sembcorp disclosed SEIL’s 1HFY2022 earnings contribution was $101 million ([which is around] 25% of overall 1HFY2022 patmi ex-one off gain of $92 million booked) vs. FY2021’s $57 million,” Osman notes. “However, on a pro-forma basis post-tax interest income from the DPN would have been $79 million, suggesting a potential net earnings vacuum of $22 million from the proposed divestment based on [Sembcorp’s] 1HFY2022 performance,” he adds.
During its briefing, Sembcorp’s management clarified that the DPN will be recognised as a long-term interest bearing receivable on its balance sheet, while the DPN income will be recognised as other non-operating income above the ebitda line.
“Consequently, 1HFY2022 earnings contribution from sustainable solutions would increase to 31% (from 25%) while greenhouse gas (GHG) emissions intensity would decline to 0.32 tCO2e/MWh (from 0.51) in FY2021,” Osman continues. “In terms of gearing, debt/ebitda would improve to 4.9x (from 5.0x) on a pro-forma basis for 1HFY2022. We had previously estimated a divestment of the coal plants at $1.5 billion and a potential earnings shortfall of [around] 14%-17% of our FY2023 forecasts.”
Overall, the analyst says the divestment of SEIL could raise his fair value estimate by around 15% as he factors in a $44 million (pro-rated) decline in Sembcorp’s ebitda for the FY2023 due to the absence of contributions from SEIL. The forecasts are applied to Osman’s target EV/ebitda of 8.0x for Sembcorp’s energy businesses, supported by the material reduction in net debt due to the deconsolidation of $1.5 billion relating to SEIL’s debt position as at end-1HFY2022, he notes.
To this end, the analyst sees “opportunities abound” for Sembcorp to reallocate its capital following the divestment of SEIL.
“We expect Sembcorp to redeploy capital in the near to medium-term toward earnings accretive renewable acquisitions. The company appears to be actively pursuing market opportunities,” he says. In his previous report dated Aug 30, the analyst noted that Sembcorp had been actively exploring renewables acquisition opportunities in India to recycle capital should it divest its coal assets.
Divestment of its Indian thermal plant a ‘positive surprise’: CLSA
CLSA analysts Horng Han Low and Lukman Firas are keeping their “buy” calls on Sembcorp with an unchanged target price of $3.80 as they “remain optimistic” on Sembcorp’s “green transition momentum”.
“The group’s ability to divest SEIL, despite industry-wide challenges to secure buyers for brown assets, reflects management’s commitment to its brown-to-green transformation,” they write.
Calling the divestment of its Indian thermal plant a “positive surprise”, Horng and Firas says Sembcorp’s “strong execution” could drive a further re-rating in its share price.
The deal, which values SEIL at a P/B of 1x, is “fair”, in their view.
While Sembcorp will not receive cash upfront from the divestment, the analysts note that the move will improve the company’s gearing and facilitates “additional borrowing for organic growth and mergers and acquisitions (M&As) in renewables”.
DBS sees multiple re-rating catalysts for Sembcorp
DBS analyst Ho Pei Hwa has also kept her “buy” call on Sembcorp with an unchanged target price of $3.80.
The divestment of the company’s stake in its Indian power plant at book is a “significant decarbonisation milestone”, she says.
“Sembcorp’s green transformation is advancing ahead of target since the announcement in May 2021. Gross installed renewable capacity has more than doubled to 7.1GW (5.1 GW attributable to SCI) as of end-June from 2.6GW as of end-2020 and looks set to achieve its 10GW target ahead of 2025,” she adds.
In her report, Ho sees multiple re-rating catalysts for the stock, among them the “good progress” of its renewable strategy and decarbonisation initiatives.
The analyst adds that following the completion of Sembcorp’s recently-proposed divestment of its coal-fired power plants in India by May 2023, its last coal-fired plant in China will follow suit, hopefully.
“Meanwhile, the improved supply/demand fundamentals in Singapore’s power market should boost its near-term earnings,” the analyst writes.
“We are positive on Sembcorp’s longer-term prospects as its growing renewable portfolio should continue to drive its valuation re-rating. Growth is expected to be funded by debt and internal cash flows,” she adds.
Ho’s target price is based on an FY2022 P/B of 1.6x, in line with Sembcorp’s peers’ average in China and India.
“This is fair against mid-teens normalised return on equity (ROE). Successful execution of its renewable energy plan, translating into earnings growth, would further lift valuations,” says Ho.
Divestment of plant is a ‘strategically important sale’: UOB Kay Hian
Finally, UOB Kay Hian analyst Adrian Loh is keeping his “buy” call on Sembcorp Industries with an unchanged target price of $4.10.
On the divestment, Loh notes that the acquisition price implies an annualised FY2022 P/E of 10.2x and price to net tangible assets (P/NTA) of 1.03x, which he views as “largely fair” given the current market environment around coal-related assets.
“The price also implies $0.8 billion/GW of gross installed capacity, which is towards the high end of comparable transactions of $0.5 billion to 1.0b/GW,” he adds.
As such, Loh views the sale in a “favourable light”. This given the “strategic imperative for Sembcorp to progress towards being a greener company,” he says.
The sale is also “strategically important”, in his view, as it meets Sembcorp’s previously stated objectives of decarbonising its portfolio of assets as well as deconsolidating its debt.
On this, Loh continues to see an upward re-rating of Sembcorp’s valuation multiples due to the “scarcity value of solid ESG companies in Singapore”. The company’s continuation to build out its green energy portfolio is also another contributor to the upward re-rating of its valuation.
“Sembcorp remains our top pick in Singapore for the quality of its earnings as well as its growth prospects in the near to medium term,” says Loh.
Shares in Sembcorp closed 15 cents higher or 4.5% up at a 52-week high of $3.48 on Sept 7.
