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Sembcorp Industries is up 74% this year – Sell or Hold?

SG, Stocks

Written by:

Alex Yeo

Sembcorp Industries is the best performer amongst the 30 stocks in the Straits Times Index on a year to date (YTD), 1 year and 3 year basis, with the stock price gaining 74%, 44% and 23% respectively. As the best performer by far on both a YTD and 1 year basis, the question on whether it is time to sell or should investors continue to hold inevitably arises.

Sembcorp provided a preliminary guidance for their 1H22 financial results expecting it to be materially higher than 1H21 results. This higher-than-expected performance in 1H2022 was driven by the Conventional Energy segment as electricity price in Singapore and India continued to remain high in 1H2022.

Here we look at reasons why we think you may consider selling and why we may continue to hold.

We previously covered Sembcorp here.

Summary of Sembcorp’s financial results

P&L in S$’mFY21FY20FY19FY18FY17
EPS/Dividend (cents)/NAV in S$     
Revenue7,7955,4479,61811,6899,026
EBITDA1,2881,1841,5351,2791,523
Adjusted EBITDA1,4941,4171,7191,4531,687
Adjusted EBITDA margin (%)1926181219
Net profit/(loss)279(997)247347383
Earnings/(loss) per share15.63(56.81)11.8116.9819.06
Net asset value2.121.873.853.803.88
Dividends5.04.05.04.05.0
Key Metrics:     
Return on Equity (%)7.93.03.55.15.8
Interest cover (times)3.02.42.62.52.9
Debt to capitalisation ratio0.650.690.580.570.55
Debt to capitalisation ratio (Net)0.530.600.480.470.40
Source: Author’s compilation

3 reasons to sell

1) Uncertain global environment may impact commodity prices and demand for utilities

Both its conventional energy and renewable segments have benefited from higher oil and also natural gas prices so far. Sembcorp guided that its 1H22 profits would be materially higher due to the conventional energy segment. We also assume that the renewables segment was also a beneficiary from higher utility prices along with its conventional energy segment as higher utility prices arising from conventional energy tend to also lead to higher utility prices for the renewables segment.

Prices of fossil fuel are dependent on supply and demand factors. Many analysts have taken the view that elevated fuel prices are significantly attributed to the Russia Ukraine conflict which impacts supply. Factors that affect supply such as geopolitical events and production capacity requires a longer time to make changes. Countries have been in the process of making changes to their supply options to try and diversify away the geopolitical risk and this will keep a cap on fuel prices.

Due to the tightening monetary policy in most countries, demand has clearly fallen. Utilities, which are by nature high capital expenditure investments depend on demand as the key factor to overall profitability due to the amount of fixed costs involved.

2) Uncertain global environment may impact demand for urban solutions

Risks and uncertainties are expected to persist in 2022 with the continued impact of the COVID 19 pandemic, uneven global economic recovery, and rising interest rate environment.

Sembcorp’s urban solutions business comprises the following sub segments:

– Developing sustainable urban developments in China, Vietnam, Indonesia

– Water treatment and wastewater management services in Singapore, China, UK, Oman and UAE

– Waste to resource solutions in Singapore and the UK

Higher interest rate environment and uncertain prospects will diminish land sales and investment in urban developments. The waste treatment, management and conversion into resources are industries with robust long term tailwinds, however, in both a longer and shorter time frame, demand factors play a part. Waste volumes can be impacted where industrial productions are reduced as a consequence of a slowing economy.

3) Poor track record

A variety of impairment and exceptional items occur more frequently than expected and across various countries. Sembcorp has not done well in recent years as it was dragged down not only by its marine segment prior to its divestment but also its utilities segment. In the last 5 years, it has made a total of $831 million (approximately $0.46/share) in impairment across its various business segments globally while it has only distributed $0.24/share.

(S$ million)20212020201920182017
Impairment of investment in associate and a joint venture212113
Impairment loss in value of assets and assets written off, net1170961631
Impairment of goodwill2765126
Expected credit loss191173(16)
Intangible assets*664
Impairment on assets reclassified to held for sale1464
Total2432312962041

Examples of exceptional items in FY21 include impairment of S$212 million of Chongqing Songzao power offset by S$6 million gain from divestment of Sembcorp Jingmen Water Co and S$13 million from sales of land and connection fee income in the UK.

Chongqing Songzao was a coal fired power plant and although initially there was expectation of government support, and some support was received, it became evident that on a long-term basis, the availability and form of government support are both uncertain and insufficient. In the longer term, the asset was also expected to face competitive pressure from low carbon power sources.

Going back to 2019, it also took a $158 million impairment of UK Power Reserve in 4Q19 (with an additional $60 million impairment in 2020) just after acquiring this asset for $385 million in 2Q18 (May 2018). This was a flexible energy generation operator that was impacted by a combination of economic and industry factors such as an increase in energy capacity and a reduction in underlying demand due to reduced industrial production in that area.

Coming back to 2020, it wrote down assets such as the UK Power Reserve asset, wastewater plants and woodchip boiler facility in Jurong Island, Singapore and also a wastewater treatment plant in Nanjing, China. Other examples of exceptional items for FY20 are presented in the table below.

From a sympathetic perspective, many of these assets were in the conventional energy segments which has served its course and provided returns to Sembcorp, however there were also assets in the renewables segment that have been impaired.

There is no doubt that a broad statement can be made that renewable energy is future proof, however the reality for infrastructure assets is that the location of the asset and the regulatory environment in which it operates are more important as it affects supply, demand, and price of utilities.

2 reasons to continue to hold

1) Electricity price continues to remain elevated

Due to the Russia Ukraine conflict, oil prices have been elevated and it is likely to remain elevated. As of now, the Crude oil price curve is in backwardation, meaning that the future price is expected to decline. However, the price levels are still expect to remain elevated at above $80/barrel.

Similarly, Natural gas futures are also in backwardation but will remain elevated, with a sharp fall off only from April 2023.

While higher commodity prices do not necessarily mean higher gross profit margins for utilities as there would likely be some form of regulations limiting price increases, generating the same margins on higher revenue while maintaining the same fixed costs means there is higher profit. This is why Sembcorp is making higher profits and will continue to do so as long as the underlying commodity prices remain elevated.

Higher energy prices would be a catalyst for growth in the renewable segment. In the very short term, higher energy prices can lead to a rush to produce more oil. However, in the longer term, higher and more volatile energy prices will be a catalyst for efforts to decarbonize the energy grids, which is critical for meeting climate change goals. This will benefit Sembcorp as it is positioning itself for this transformation.

2) Focused business model with a strategic transformation plan

Sembcorp has been executing its strategic transformation plan for less than a year, yet it has achieved plenty. In 2021, Sembcorp secured 2.9GW of new renewable energy projects across key markets. Upon completion of the 658MW portfolio acquisition in China in the first half of 2022, gross renewables capacity installed and under development will reach 6.1GW. With this, Sembcorp is confident of hitting its target of 10GW of gross installed renewables capacity by 2025. 

The target is to grow the portfolio and at the same time transform its portfolio with more renewables, more sustainable urban developments and lower emissions. The ESG theme continues to hold centre in the minds of many governments and investors as these bodies are working towards achieving the carbon emissions targets that they have previously laid out.

Conclusion – its probably time to sell

Sembcorp’s share price has been lacklustre and investors who bought years ago would still be sitting on losses. Only investors who have bought in the recent three years would be sitting on a profit. Investors who bought in 10 years ago would still be sitting on a loss even after including dividends and the distribution in specie of Sembcorp Marine’s shares. However, the stock has been up 74% this year alone and way off the lows traded in September 2020 of $1.18.

Looking at the chart above, there is an indication to sell as the current P/E ratio is much higher than at any time in the last 10 years with the exception of the pandemic period where earnings plummeted across the world but stock prices remained strong due to quantitative easing.

Other reasons indicating that it is time to sell as the uncertain global environment will likely impact demand for utilities and urban solution. Although commodity prices are forecasted to still be elevated, Oil and Gas prices are both expected to be lower in the next 1 year compared to the current prices.

Sembcorp’s transformation plan is a reason to continue to hold but we think that its probably time for investors to sell given the stock price has risen 74% YTD and taking into account the reasons mentioned above.

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