Sembcorp Industries, the best performer of the Straits Times Index (STI) so far this year, has reported earnings for 1HFY2022 ended June that blew past expectations. Going by analysts’ revised target prices of their already bullish calls, there is further upside for the stock.
For years after the oil market slumped, Sembcorp’s earnings were weighed down by the losses incurred by Sembcorp Marine, its then 61%-held subsidiary. The “demerger”, which was completed in September 2020, in a way removed the millstone so that Sembcorp could focus on growing its utilities business and increase investments in its renewable energy portfolio. Sembcorp Marine, on the other hand, has moved on to join forces with the offshore and marine unit of Keppel Corp in a deal that is pending.
When global energy prices began on a broad-based surge early this year, Sembcorp found itself in a favourable spot, capturing the upside from its mainly traditional conventional energy portfolio and to a smaller extent, its relatively new renewable energy assets.
On Aug 5, the company reported revenue of $4.8 billion for 1HFY2022, up 45% y-o-y. Earnings in the same period were at $490 million, up 94% y-o-y. It has declared an interim dividend of four cents per share, double the two cents paid this time last year. As a mark of its confidence that full-year earnings will be “significantly higher” versus FY2021, group president and CEO Wong Kim Yin is not ruling out a special dividend when FY2022 numbers are reported.
For 1HFY2022, the bulk of Sembcorp’s earnings came from its conventional energy segment, which was up 115% y-o-y to $397 million. This same segment was $27 million in the red for 1HFY2021 after an exceptional impairment of $212 million was included. The company attributes the better showing to higher electricity prices in its assets in Singapore and India, further lifted by favourable gas hedges entered in 2021.
Sembcorp’s renewables segment did well too, albeit still at a smaller scale relative to its conventional segment. For 1HFY2022, this segment contributed earnings of $76 million, versus $24 million from the year earlier. Its sustainable solutions segment, made up of the renewables and integrated urban solutions segments, occupied just over a quarter of its total profit, but is expected to continue to grow, given Sembcorp’s recent investments in this space.
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CEO Wong says the renewables segment has gained “good traction” since the company’s transformation strategy of turning from “brown to green” was announced last May. Under this plan, Sembcorp is targeting 10 gigawatts (GW) of renewable energy and 500ha of sustainable urban developments, lowering its carbon emission intensity to a factor of 0.4 by 2025, as well as increasing its sustainable solutions to make up a 70% share of its net profit.
To this end, the company has chalked up a growing list of activities recently. For example, it was appointed by the Energy Market Authority to build energy storage systems totalling 200 megawatts (MW) on Jurong Island; it won 44MW peak in contracted capacity from JTC for solar rooftops. In China, the company completed the acquisitions of SDIC New Energy and Shenzhen Huiyang New Energy in 1H2022, increasing its operational portfolio to 3.3GW from 725MW. In India, the company secured 115MW of renewables projects during the year.
The company’s gross renewables capacity installed and under development globally now stands at 7.1GW, bringing the company closer to the 10GW by 2025 target.
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According to Wong, as Sembcorp is “ahead” of this 2025 target, he can afford to be more selective in the coming six to 12 months in acquiring renewable energy assets. He stresses that Sembcorp will remain “disciplined” as it steps up its investments in these areas, as he expects “speed bumps” in the near future with geopolitical uncertainty and rising interest rates.
“We can’t get to certain targets without making acquisitions, but we are also making organic increments,” Wong says, adding that Sembcorp is headed in a “sound” direction. “If we are disciplined, then the next 6 to 12 months actually presents even more opportunities that will come up for us to think about in terms of inorganic growth, but it is not a given,” he adds.
China slowdown?
Sembcorp’s growing presence in China comes at a time when the country’s economy is slowing down because of extended pandemic-related lockdowns. Traditionally, energy consumption growth has a clear correlation with economic activity, especially in developing economies.
From Wong’s perspective, slowing energy demand from extended lockdowns in China is not a concern as yet. “Energy, especially power, is a basic necessity compared to other sectors. In [the event of] a recession, energy will be affected relatively less,” he says.
Wong says that despite the widely reported manufacturing slowdowns in China due to stringent Covid measures, Sembcorp’s operational wind and solar assets owned by its Shanghai subsidiary have not “really been affected” from a sales perspective.
Wong believes that the energy and power sector, although not impervious to a recession or slowdowns, remains relatively resilient compared to “consumer-type businesses” such as hospitality or travel. He adds that the
company will continue “actively hunting” in the wind and solar energy sectors to meet its 10GW objective.
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Separately, Wong also identified the battery business as an important sub-segment of its renewables and energy storage portfolio to pay attention to, as a key growth driver for the company in the medium to long term.
For example, in the UK, a further 50 megawatt hours (Mwh) of battery storage was commissioned, bringing total operational battery fee to 120Mwh. Sembcorp has also secured a 15-year capacity market contract that will contribute to the 300Mwh of battery storage projects. The company’s total battery storage portfolio in Singapore and the UK now stands at 624Mwh, making Sembcorp one of Asia’s largest battery operators.
Wong explains that the battery business is seen as an increasingly “integral and necessary” part of any renewables portfolio and that Sembcorp’s battery operating capability in the UK is commercially “viable and attractive”. This has
also put Sembcorp in a “good lead” in Asia to incorporate battery storage into its renewables processes regionally, underscoring the company’s long-term commitment to the green transformation of its global energy portfolio.
‘Upward re-rating’
Analysts note that Sembcorp’s 1HFY2022 earnings beat their expectations — thanks in part to one-off earnings — but still see further upside for Sembcorp’s share price, although there are some potential risks of earnings slowing down.
UOB Kay Hian’s Adrian Loh has raised his price target from $3.59 to $4.10; DBS Group Research’s Ho Pei Hwa raised hers from $3.70 to $3.80; and CGS-CIMB’s Lim Siew Khee now sees Sembcorp worth $3.80, up from $3.66 previously. Maybank Securities’ Kelvin Tan raised his target price to $4.50 on Aug 8, having just initiated coverage of the stock with a call of $3.40 on Aug 2. “We anticipate earnings outperformance to accelerate in 2HFY2022,” writes Tan.
CGS-CIMB’s Lim says that while Sembcorp’s conventional energy earnings will remain strong, the second half’s will be as much as 43% lower than the first half’s. The combination of reasons includes the company’s scheduled maintenance shutdowns for Sembcorp Biomass Power Station in the UK for five to six weeks, and Plant 2 in India for about 45 days in the second half of 2022.
In addition, citing oil prices that are already more than a quarter off their recent peak, Lim is assuming a “conservative” 20% drop in Singapore energy prices. She estimates that the Singapore conventional energy plants contribute around 60% of Sembcorp’s total earnings for this segment.
Conventional energy aside, Ho of DBS likes Sembcorp’s big moves into the renewable space. “The good progress of its renewable strategy warrants further re-rating (for its share price),” she says. Nevertheless, she notes that Sembcorp’s earnings saw a $91 million boost mainly from the unwinding of gas hedges, due to the cancellation of cargo expected in 1HFY2022.
Eugene Cheng, Sembcorp’s group CFO, explains: “For this particular year, gas positions in terms of cargo scheduled to come in were contracted last year and we would have had to put in our hedges then. Right now, we are reviewing gas positions in relation to our needs next year.”
Cheng adds that Sembcorp has already put in “meaningful” hedges for 2023, but will continue to assess gas positions to put in hedges through the second half of this year.
UOB Kay Hian’s Loh similarly notes that gains from the hedging are “unlikely to be repeated”. Nonetheless, he has significantly revised his earnings estimates for FY2022 to FY2024 upwards, as he acknowledges that his initial forecasts have been too conservative in trying to account for higher operating expenses and interest income after the inclusion of Sembcorp’s recent renewables acquisitions in China.
Loh’s higher target price of $4.10 is based on an unchanged price-earnings multiple of 13.6x. “This target P/E multiple is one standard deviation above the company’s past five-year average P/E of 10.1x, excluding 2020 where the company reported impairment-related losses, and is applied to our 2023 EPS estimate which we believe is a better reflection of the company’s ‘normalised’ earnings compared to 2022’s earnings,” he says.
Loh points out that on both P/E and P/B bases, Sembcorp trades at a discount to its peers within the utilities sector of developed economies of Asia.
Similar to DBS’ Ho, he expects an “upward re-rating” of Sembcorp’s valuation multiples, as there is a lack of “solid ESG companies” in Singapore for investors to bet on. “Sembcorp remains one of our top picks in Singapore for the quality of its earnings as well as its growth prospects in the near to medium term,” says Loh.
Sembcorp shares closed at $3.22 on Aug 10, up 60.2% year-to-date and valuing the company at $5.76 billion. In contrast, the STI was up 0.47%.
