The recent oil price rout has beaten down many stocks of oil-related companies and probably its good to have a look to see if valuations are compelling enough. Now, I usually like to buy clear-cut bargain type stocks and consequently most of my portfolio consists of small to mid cap businesses like AP Oil (see post here for full details). However, one of the rare blue chip companies that I monitor is Sembcorp Industries. Some metrics (based on 8 Dec '14) as follows:
Price = S$4.15
Shares Outstanding = 1801.4 (million)
Market Cap = S$7,565 (million)
P/E (TTM) = 9.70
P/NTA (mrq)= 1.51
ROE (ttm) = 14.91%
Price = S$4.15
Shares Outstanding = 1801.4 (million)
Market Cap = S$7,565 (million)
P/E (TTM) = 9.70
P/NTA (mrq)= 1.51
ROE (ttm) = 14.91%
SEMBCORP INDUSTRIES BUSINESS
I wouldn't go into details about the business but will probably highlight a few things so that the reader can get a general understanding about its operations. I encourage you to look at the Company's Website as it provides a comprehensive overview of its businesses here.
Sembcorp Industries is listed in the SGX and its business consists of 3 main segments:
UtilitiesDeveloper, owner and operator of energy and water assets over 6 continents with an established presence in Asia and growing presence in emerging markets. The company has established a niche as a global leader for the provision of bundled energy, water and on-site logistics to customers in energy-intensive industrial sites, and as a developer, owner and operator of large-scale combined power and water plants.
|Sembcorp Utilties Network|
As shown in the picture, the Utilties segment already has a global footprint (including emerging markets) and the guidance was that there's still potential for expansion. This segment of the company is what probably attracts many investors now due to its natural moat, source of recurring income as well as potential growth.
MarineSeparately listed in the SGX, this segment is a leading global marine and offshore engineering group specializing in a full spectrum of integrated solutions in ship repair, ship building, ship conversion, rig building and offshore engineering and construction. This segment is likely causing the steep decline as it is highly related to the oil industry.
Urban DevelopmentSembcorp owns, develops, markets and manages urban developments such as industrial parks, business, commercial and residential spaces in countries like China, Vietnam and Indonesia. The company's early involvement in the development of industrial, residential, business and commercial areas also provides potential opportunities for the provision of utilities and other solutions.This is smallest segment contributing less than 10% to bottom line.
I don't want to bore the readers with in-depth study of the business model but please do have a look at the company website and annual reports regarding its business strategies and the like.
|Sembcorp Industries 5-year Summary|
The 5-year financial summary seems to show that on aggregate, the company is performing reasonably well in terms of revenues and earnings. The free cash flow is pretty lumpy as expected due to the capex heavy nature of the marine industry as well as the growing phase of the utilities business. Something that I don't quite like is that the company is currently in net debt and with debt/equity ratio of 65% - but I argue that the overall earnings power is more than sufficient to finance this and the S$2200M cash on hand is definitely enough to pay out the S$930M borrowings due within 1-year. The company has been paying dividends as far back as more than 10 years ago and the past 5 years shows a payout ratio of about 30%-40%. Assuming dividends is maintained at S$0.17, yield is about 4.1%.
Another worrying trend is the decreasing ROE from 20.6% to 15.7% over a period of 5 years. A 15% ROE is still pretty good in general but its also good to pinpoint the reasons for the decline.
|Sembcorp Industries Segment ROE|
Obviously, we would prefer a business that is able to at least maintain its rate of return whilst employing incremental amounts of capital for expansion over an extended period of time - the Utilities segment is one good example. From 2009 - 2013, while using increasing amounts of capital, ROE for the Utilities business is relatively stable fluctuating between 15.6% to 19.6% while Marine is showing a consistent decline from 38.2% to 20.8%. Kudos to the Utilities segment in this aspect. Of course, we can't discount the fact that Marine's current rate of return is still very decent, but its inability to maintain this may be a cause for concern.
Perhaps a 10-year summary can provide a more meaningful insight of Sembcorp Industries 2 core operations:
As can be seen, both segments registered huge growth in both revenue and net profit over the past 10 years. The clear winner here is no doubt the Marine segment having registered 420% and 259% growth versus Utilities at 140% and 183% growth in revenue and net profit respectively. Are these growth sustainable enough for the analyst to make a decision with regards to its earnings power?
|10-year Revenue & Profit Chart for Utilties & Marine|
|10-year Net Profit Margin Chart for Utilities & Marine|
The 10-year period net profit margin confirms this view point. Although the Marine registered a higher average net profit margin (7%) than Utilities (6.2%) over this period, the Utilities segment's margin is more stable at between 4% to 9% versus Marine's 3.5% to 11.5%. Do note that the 9% margin achieved in 2013 includes non-recurring income which when adjusted, should bring it lower to about 7.5%.
It is not wrong to say that due to the nature of its industry, typical utilities businesses are quite stable. For Sembcorp Industries, with the support of the statistical exhibits from the revenue, earnings, ROE and Net Profit Margin, I argue that its Utilities business is inherently stable and because of this predictability and stability, the Utilities business warrants a higher valuation as compared to other businesses. For the Marine segment, because of its dependence on order book & oil prices, coupled with its statistical showing, we can't for sure say it is a stable operating business. But based on its leadership position in its industry and strong features like ROE, it is also unfair to conclude that it is a lousy business that is worth a very low valuation.
Originally, I would prefer to use cash flows to value Sembcorp. However, the free cash flows are not very consistent owing to the heavy capex required, presumably for future growth. Coupled with the lack of guidance in estimating maintenance capex, perhaps its better to value the entire business on an earnings basis.
Removing one-time items from the IPO of Sembcorp Salalah in Oman and impairment charges at Teeside in UK, the adjusted 2013 earnings would be about $$380M. As shown above (table and chart), the Utilities segment has shown sustained growth in revenue and earnings in the past decade. We know that this segment is still in the midst of expansion and track record has shown management to be prudent in this aspect.. From this, I think its fair to say that 2013 earnings for Utilities is a nice guide for future earnings. At what multiplier should be fair for this segment then?
|Sector P/E extracted from Gurufocus|
The Marine segment is in a relatively volatile business affected by things like its orderbook, oil prices and sentiments. What I am looking here is for a long-term average of what Marine can consistently earn in the future. Perhaps its better to normalize the earnings and take the average result of the past 10 years, giving us an earnings power of about S$285M. A long term P/E of about 12-13 should be decent enough for a company like Marine, considering its long operating history and track record, despite its supposedly fluctuating business environment. This means that Marine is worth around S$3550M.
Adding them together, the Valuation should be about S$9250M (or price of about $5.15) as compared to current market cap of S$7,565 implying a margin of safety of 18%. I've decided to ignore the Urban Development segment since it probably is too small (for now) to affect the overall valuation significantly (I'll consider it as an x'mas gift).
True, the business is currently priced in the market above its book value and on this basis some may feel it is liberally priced. However, accounting treatment has its own constraints and certain non-quantifiable information such as Sembcorp's strong reputation, customer relations and capacity for innovation is not captured directly in the financial statements. I believe these intangibles is definitely worth something for Sembcorp (unlike many companies out there) but I hesitate to come out with a value. Anyway, compared with many blue chip companies, a price to tangible book of 1.5 is actually quite low. As an ongoing business, it is usually the earnings power of its assets rather than balance sheet valuation that really counts and based on these considerations I'm comfortable with the above indicated valuation.
Sembcorp Industries has been buying back shares recently. However, a quick check at the total shares outstanding for the past years does not show a decreasing trend. This is likely due to the company's policy of issuing stock options. There's not much to conclude about the value of the company here.
It is worth highlighting that a director of Sembcorp Marine has bought some shares during the recent price decline, possibly indicating that Marine segment is undervalued as well.
Sembcorp Industries is an industrial conglomerate with its core operating business earning a decent return on capital. Based on the market price of Sembcorp Marine, the implied valuation of the market clearly undervalues the Utilities segment. An investor who wants to take part in the undervaluation of the Utilities segment probably could buy Sembcorp Industries and correspondingly short an equivalent proportion of Sembcorp Marine. However, I prefer not to bet against the Marine segment. Looking it at another point of view, buying shares of Sembcorp Industries could bring about a natural industrial and geographical diversification from the Utilities, Marine and Urban Development businesses.
The concern here is whether the margin of safety is enough to justify a purchase. I'm here reminded about a similar concept (we call this 'safety factor') during my university days studying Engineering. To put it very simply, we were taught that if the consequences are severe or gravely (For eg, when building a bridge for cars and which may involves lives of many people), the typical safety factor should be high. Similarly, if we were to build a chair (that probably won't kill someone if it collapse), a small safety factor should do fine.
For a company like Sembcorp Industries, I believe we don't need too high a margin of safety to justify a purchase. 20%-30% should be fair enough. However, this is not to say that a margin of safety as low as 5%-10% is sufficient. This would mean that investors who bought at about S$5.00 even though Sembcorp Industries dropped from a high of S$5.50 may not be putting their money to good use.
All in all, I believe this analysis is consistent with our stock investments philosophy (read more about it here) and should do quite okay in the long term. I'll really appreciate if you can share some insights about this company. Thank you!
Long Sembcorp Industries (U96.SI) @ S$4.15 with the hope it'll go down for further accumulation
No position in Sembcorp Marine (S51.SI)
secret investors : Another detailed analysis you have here. All the best to you.. Personally have not vested any blue chip yet... will look into them comes 19/01/2015 ;-)ReplyDelete
Richard, thanks for going through my analysis. Actually Sembcorp Industries is my one and only blue chip counter currently in my portfolio haha.. Very wise to wait till the reduction of board lot size to 100. Do share with me which blue chip you're interested in future :)Delete
Good analysis there on Sembcorp and congrats on getting them at $4.15.
I have similarly done analysis on SCI in the past so I have some comments regarding the company.
CAPEX. I actually like to see that the company is ramping up its capex purchase on its utilities segment. I think it's still on the way to gaining traction and the more they invest in capex right now on overseas operations it means that the management is confident that they are probably going to do well in the long term.
I have not been too disappointed with the RoE so far. As you can see from the breakdown, it's mostly coming from the lower profit margin from the marine business. I think those days where they ramp up 30+% margin are over with so much competition from the Chinese and Korean.
Lastly, the one thing analysts and all investors (and myself) have been saying is the low PER their utilities segment is currently valued in. We think it's cheap if we compare it against fellow peers. But the question is, it has been for many years they are trading under PER of 10x, so I'm not quite sure what would propel the shares to be trading at 15x. We may be too optimistic in that sense. We may be wrong of course but the market has proven us wrong again and again. Will we see a day where it is trading at PER of 15x? Maybe yes one day, and we can only hope.
Hi B, appreciate your positive comments. I was actually hoping for price to drop further for accumulation. I’ve read your analysis about SCI from your blog and I must say its very, very well written.Delete
Utilities CAPEX. I agree that prudent capex on the Utilities front may be a net positive for the business based on management track record and its ability in the maintenance of its returns on capital. However, considering that the future value of money is worth much less today and also expansion involves some level of uncertainty, I would very much prefer capex to be funded mostly internally and without affecting current dividend payments. If these conditions are met first, I’m fine with ramping up its capex purchase :)
MARINE. The overall lower profitability is probably affected by Marine segment but on a valuation perspective, I think we still have to factor in Marine’s business no matter what.
Regarding your last paragraph, I suspect that many investors or potential ones are still deeply fixated about Sembcorp’s Marine business and has not been aware of the success and growth of the utilities business, thereby undervaluing it. Like you, I’m also not sure what would propel the shares of the Utilities segment to 15x. But assuming we are not comparing with its peer businesses or the market's valuation, and only basing strictly on a discounted cash flow perspective, I think this valuation is fair considering the economic characteristics of Utilities segment (leading position, stability and predictability of cash flows etc). Basically on a zero-growth basis we are putting a discount rate of 6.7% for a respectable business.
Also, my hunch is that my valuation for the Marine segment is probably a tad too low (Earnings power of S285M vs TTM earnings of S$345M plus PER of 12-13X) and I have considered the Urban Development business to be worth zero which is definitely not true.
Lastly, some final considerations which I did not include in the post is that – the Marine segment is probably the one providing the cash for Utilities expansion traditionally. If Marine is unable to do well under current circumstances, the Utilities might be affected. Sembcorp claims that the small Urban Development business may be a springboard for further involvement in opportunities for Utilities side but so far I haven’t really seen any synergies in this aspect (anyone, please correct me if I’m wrong). I guess these business relations wasn’t completely factored into my analysis. The valuation might be higher or lower because of these but I must really thank the margin of safety for providing some comfort here.
What do you think?
Yes traditionally in the past the marine business is the one providing the cash for expansion for its utilities segment when they are still in the infant stage. However, for the past 3 years or so, the utilities business can sustain their expansion on themselves. I asked before during the AGM whether they would consider spinning off its utilities segment and they said they might consider it as a trust in the future but they have no intention of dropping their marine business from SCI.
The management mentioned the Urban Development will be a key pillar in the future. Maybe we are underestimating it but I think the impact will still be minor currently as compared to the other two business segment. I don't know if it will ever materialize one day where the earnings will grow substantially but I guess it will be a bonus to consider it that way. I'll just put a zero valuation on it for now for conservative purpose.
Yes agree it can sustain itself but I guess it’s always better if Marine can still provide a certain level of cash flows for Utilities to work on. If it can’t then management had better be more careful if they want to expand as quickly as before.Delete
I haven’t been to the AGM before but thanks for the insight with regards to the management’s intention of spinning off its utilities segment. This has to be a plus but it also has to depend on when they are going to do that. I’m looking forward to attend their coming AGM :-)
The Urban Development segment, other than providing additional source of revenue, may provide additional yet-to-be-seen strategic boost to the Utilities business. My feel is that the Urban Development segment will do well in time to come but like what you’ve said, better be safe and put a zero worth to it.
Thanks so much for your inputs, B. Appreciate your time on this new blog :)
Hi Secret Investors,ReplyDelete
I love/admired your in depth analysis and the amount of effort spent.
It's very logical and contain lots of balance personal views, most of which I also agree.
As an investor of SCI too, I feel pretty confident. Yet, looking at the price curve, I noted that in Oct 2011, there is a dip of prices below 3.5? And that was already way beyond post crisis low period below 2.5.
I had not followed SCI then and was curious why did that happen?
Just pondering will a repeat happen?
Thanks for going through my blog. I see that you have a blog yourself too. Perhaps we can exchange links for our bloglist?
Also, glad to see another fellow investor in SCI. Great questions posed there regarding the price chart. I think your guess is as good as mine whether a repeat of price below S$3.50 or even S$2.50 will happen. Personally, I feel there’s always a chance something like that will happen again though.
However, looking at this situation on a value standpoint may be a source of vindication. The ~S$3.40 price occurred in 2011Q4. In terms of available information then and for simplicity, we can use 2010’s financial data for reference. With earnings of S$793M (you may want to refer to the table in my post), the PER turns out to be about 7.7x which is also very attractive. Perhaps that is why over such a short period of time 3-6 months, the stock price recovered.
Alternatively, if you follow my post and using the same technique, (Here, I assume that my view of the fundamentals/stability for both Marine & Utilities is the same at that point in time as it is now (this is quite likely) & I also used latest results for Utilities but 7-years average for Marine instead of 10 years), the valuation becomes S$6650M or about $3.70/share. I ignored the other segments in both cases. It turns out that this is decidedly less attractive at that point of time compared to now on a price to value basis (Value VS Price – 2011 is S$3.70 VS S$3.40 & 2014 is S$5.15 VS S$4.15). Thus we can say that even though the price is lower at ~$3.40 in 2011, it is not necessarily more attractive when it is priced at S$4.15 in 2014. Of course there may be bias (hindsight) etc but I’ve tried to minimize them using the same method when looking at the company for both periods.
I guess the point here is that due to business developments over the years, we have better clarity in forming a rough intrinsic value estimate of the business itself which in 2014, we estimate it to be close to S$5.15 wherein we ‘wrongly’ estimate it to be at S$3.70 based on the available data in 2011. Without any doubts, we may yet again be proved wrong as the future unfolds. That's why we can't depend only on this counter in our entire portfolio.
I’m not sure if this is clear enough but I’m open to questions and/or objections :)
Hi Secret Investors,
Sure, I already added your blog to my blogroll. My honour.
Thanks for the detail explanation / analysis once more. Great effort! Whether the intrinsic value is right or wrong..it is determines by buyers and sellers, going forward.
Within ourselves, as long as we did our research and homework, and feels confident about our stock holdings, it is probably the most important.
Going through your detail analysis, I am sure you had done what is more than enough and will not stop further researching.
I am definitely not very good in number crunching. But my gut tells me it’s a good buy after my research earlier on. Along the way, if it turns out wrong, and then I will adjust/adapt accordingly.
What is critical is that my normal life cannot be affected by the price changes.
Continue to good work in analysing.
Thanks for exchanging links. Yes, I agree with you that psychologically we must feel comfortable and even confident with our stock holdings such that our normal life is not affected by the fluctuations of the market. As mentioned in my post on AP Oil , as long as we are conservative with our numbers and we allow for some spread between price and value, things should turn out fine in the long term. Sometimes I do wonder myself if too much analysis is useful – My experience was that typically 80% of the results should come out from the first 20% of the research. For me though, it’s always good to dig deeper if I have the time just to be sure.
Do visit my blog once in a while and share your views on my thoughts. Happy new year to you!
Not satisfied with the dividend yield.ReplyDelete
The dividend yield for Sembcorp Industries is not the best among many of the blue chip stocks around. However, I suggest that dividend yield is part of the overall analysis.
If after analysis, we like a stock like Sembcorp but we feel the yield is too low, I think there's 2 ways to handle this:
1. If you feel that dividends will remain constant, wait for the price to drop further to get a higher dividend yield; or
2. Ensure the current price is low enough such that there's good upside for capital appreciation. Buy at this low enough price and hope that based on the fundamentals & potential growth of the company, the earnings will increase in the long-term and maybe future dividends will increase as a result.
For me, since the current dividend yield is already good enough for me and the company has been paying dividends yearly for >10 years now, I opt for the latter point 2 which is obviously the less wiser way.
Thanks for the feedback :-)
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