Maybank Securities analyst Kelvin Tan has initiated coverage on Sembcorp Industries with a “buy” call and a target price of $3.40.
Tan’s target price represents a 14% upside to Sembcorp’s price of $2.95 as at Aug 2.
“We derive our valuation from a sum of the parts (SOTP) method, based on FY2023 forecasts. We value Sembcorp’s utilities business with an implied FY2023 P/E of 12.2x, which is +1 standard deviation above the five-year average of 10.8x. This is still below regional peers of 15.7x,” he says.
“We have chosen this target price methodology as we believe it will more fairly and accurately reflect the company’s forward valuation as we have [moved] past the peak of the pandemic,” he adds.
In his report, Tan was very positive on the SGX-listed conglomerate, citing several reasons behind his buoyant outlook.
First, the analyst sees “substantial additional earnings potential” from Sembcorp’s plan to boost its renewable energy (RE) capacity to 10GW by the FY2025.
See also: Sembcorp's financial results for 1HFY2022 expected to be 'materially higher'
“According to the International Energy Agency (IEA), global energy demand is poised to surge 47% by 2050 as electrification increases and living standards improve,” he notes in his Aug 2 report.
“RE would be the fastest growing energy source, increasing from 2% in 2020 to 18% of total energy in FY2030. RE is Sembcorp’s fastest-growing segment in our forecasts, potentially boosting earnings by 22%-25% y-o-y per annum (p.a.) until FY2024,” he adds.
One of the key metrics to monitor RE is renewable return on equity (ROE) growth, which the analyst projects Sembcorp’s to rise to 10% (from 4.6% in the FY2021).
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Sembcorp’s RE ROE growth is expected to head further north to around 20% as its assets mature, cashflow contribution rises and project debt repaid.
Second, the continued high tariffs in India and Singapore are expected to drive earnings higher for the group. On the back of the elevated electricity prices, Tan has forecasted Sembcorp’s conventional energy to surge by 3 percentage points y-o-y. The analyst also sees the group to enjoy a full-year contribution of exceptional profits from Cogen in the FY2022 to FY2023, up by 6% y-o-y.
“Of note, 85% of Sembcorp Energy India Limited’s (SEIL) plant 1 and plant 2 are underpinned by long-term and mid-term power purchase agreements (PPAs), putting Sembcorp’s India business in a stronger position financially in FY2022,” Tan writes.
“The Indian tariff hikes coupled with stable plant load factor of above 70% since February for plant 2 may continue to boost Patmi (+23% y-o-y) in FY2022,” he adds.
Third, Sembcorp’s resilience to the ongoing rapid inflation and high interest rates also puts it in a good position.
“We believe tariffs will continue to increase as interest rates rise and shortage of fuel supply. Ensuring electricity security requires large scale investment, Sembcorp is highly leveraged so higher interest rates will increase financial expense for bond issuance and vice versa. We expect Singapore’s interest rates to increase further with rising concern over mounting inflationary pressures,” says Tan.
Fourth, the group stands out for its unique proposition amid a lack of solid environmental, social and governance (ESG) companies in Singapore.
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Finally, at its share price levels as at Aug 2, Tan believes Sembcorp is trading at an attractive valuation as the group consistently generates higher ROE than its peers. It is also trading at a discount to its Asian utilities peers.
“It maintains a high return on sustainable equity ratio compared with top Asian utilities and Singapore industrial peers,” the analyst writes.
“At 10.3x FY2022 P/E, Sembcorp is undervalued compared to regional utilities peers ([with an average of] 20.7x) and Singapore industrial peers ([of around] 17.8x),” he adds.
Ahead of its results, Tan is forecasting Sembcorp’s FY2022 core income to grow by 30%, surpassing consensus’ estimates. This is due to higher revenue contributions from RE projects that should become operational within the FY, he says. That said, the analyst acknowledges that his profit forecast for the full year may be “conservative” as he assumes 2HFY2022 spot electricity prices to be sequentially lower.
“In our bull case, if current dynamics (IEX at INR6.5 (11 cents)/kWh and USEP at SGD325/MWh) continue to drive spot electricity prices higher, our fair value could rise to as much $3.66, based on 12.14x FY2022 PER, by simply factoring in higher earnings forecast,” he says.
IEX refers to the Indian Energy Exchange while USEP refers to the uniform Singapore energy price.
The analyst has also pegged FY2022-FY2024 ROE for the overall business to increase from 7.9% to 12.5%-13.1%. “Overseas projects, when fully ramped up, may help to expand ROE,” he says.
To this end, Tan views any pullback in Sembcorp’s share price as an opportunity to buy.
“We think consistent delivery of earnings is the key catalyst to maintaining investors’ confidence. We also think the catalyst beyond FY2022 could be decarbonisation of its thermal power plant in India, whose profits can be replaced by earnings from capacity expansion in RE,” Tan writes.
Key risks, on the other hand, include unplanned shutdowns, unexpected impairments and decline in spot electricity prices in Singapore or India.
Shares in Sembcorp closed 7 cents higher or 2.37% up at $3.02 on Aug 3.
