Sembcorp Industries’ (Sembcorp) U96 post-pandemic strong business recovery and ability to hit its publicly-disclosed targets for renewables provide a bullish business outlook for FY2023 ending December and beyond, says UOB Kay Hian (UOBKH) analyst Adrian Loh.
Loh maintained a positive stance and his “buy” call on the Singapore-based industrial conglomerate with an upgrade in target price to $4.64 from $4.57 previously.
Loh’s bullish outlook can be attributed to several factors, including the likelihood of Sembcorp conducting a merger as a “likely mode of expansion” in a bid to present a higher renewables target to the market in the next few months.
The group already has 9.8GW of renewables, including both operational and projects under development, and is close to its stated target of 10GW, Loh points out.
“Investors were also keen to hear that the hurdle rate (on a local currency basis) for Sembcorp’s India projects is in the mid-teens while China’s is slightly above 10% IRR,” says Loh.
IRR stands for the internal rate of return.
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Investors also appeared to have a keen interest in Sembcorp’s hydrogen strategy despite the nascent nature of the technology. “Management highlighted that its current assets and position in the Middle East puts it in a good position to generate green hydrogen,” he adds.
Sembcorp’s hydrogen strategy has also attracted “meaningful interest” from its investors.
“Management emphasised that given its current business mix, it will focus on hydrogen production as well as downstream demand, with the key issue being the size of capital expenditures (capex) needed to get such a project off the ground,” says Loh.
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“It also highlighted that its current assets and position in the Middle East (power and water plant in Oman and desalination plant in the United Arab Emirates) puts it in a good position to generate green hydrogen,” he adds. “While management stated that it will not take part in the midstream, ie storage, and transportation, it has engaged with Chiyoda of Japan as a technology partner for its SPERA technology which enables the transportation of hydrogen via tankers at room temperature.”
Finally, Sembcorp’s 18-year power purchase agreement (PPA) which was signed with Micron on Feb 27 is also seen as another plus in Loh’s book.
“In our view, this is a landmark deal for Sembcorp given that the Singapore market has traditionally been spot or short-duration market (i.e. one to three years). With this 18-year PPA signed, 37% of Sembcorp’s Singapore generation capacity is contracted and thus should allow Sembcorp to cover the capital cost of new H-class generators and replace its current combined cycle gas turbines and earn a positive carry,” he writes.
Sembcorp’s partnership with Lego to put together a 40-hectare low-carbon facility incorporating a 50MW solar farm is also a “positive sign of things to come”.
“With this concept in place, Sembcorp will use it to advance its other expansion plans in Vietnam at its four new business parks that it secured licences for in 2022: Quang Tri Industrial Park, VSIP Binh Duong III, VSIP Can Tho and VSIP Nghe An (Park II),” the analyst writes.
Other factors of note in Loh’s report include Sembcorp’s “manageable” debt levels.
On concerns that lower gas prices may lead to lower profits, the analyst says he has already factored a normalisation in Sembcorp’s conventional energy segment in his FY2024 and FY2025 earnings estimates.
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The sale of Sembcorp’s coal-fired power plant in India in return for a deferred payment note also appears to be a “non-issue” to some of the group’s investors, according to Loh. “Given that these were young assets, Sembcorp would have needed to take a [over] US$1 billion ($1.34 billion) write-off if these two coal-fired power plants were shut down.”
“In our view, the worst-case scenario would have been the nationalisation of these assets (as they are large at 2.64GW and provide power to 2.5 million people) and Sembcorp’s position being jeopardised in the country,” he says.
To this end, Loh has upped his FY2023 to FY2025 earnings estimates by 1% to 4% to account for the higher margins from Sembcorp’s agreement with Micron. The revised estimates also factor in a slower-than-expected slowdown in profitability from Sembcorp’s conventional energy segment.
In addition, Loh highlights that Sembcorp generated a return on equity (ROE) of almost 22% in 2022 based on assets that are on average five years old, thus he believes that this level of ROE would be sustainable in the years to come.
“In our view, Sembcorp remains inexpensive as it trades at a 16%-28% discount to its global utilities peers’ average FY2023 P/E, ev/ebitda and P/B of 14.5x, 9.4x and 1.7x respectively,” he writes.
As at 2.45pm, shares in Sembcorp are trading 4 cents higher, or 1% up, at $4.04.
