Sembcorp Industries Ltd (SGX:U96): is it a good stock to buy now?

Since the 2020 demerger of its marine sector, Sembcorp Industries has been on an upward trajectory. The stock price is up 28%, despite the fact that stock prices are falling across the board.

In this article, we will examine Sembcorp Industries’ business and evaluate if investors should consider purchasing this stock.

What does Sembcorp Industries do?

Sembcorp Industries (SGX:U96) is a leading energy and urban solutions provider with a market capitalisation of $5 billion.

Apart from operations in Singapore, Sembcorp Industries has projects spanning China, India, Bangladesh, Vietnam, Myanmar, Oman, UAE and the UK.

Its business is divided into three segments:

1. Conventional Energy,
2. Renewable Energy, and
3. Integrated Urban Solutions.

1) Conventional Energy

The bulk of Sembcorp Industries’ revenue comes from its Conventional Energy segment which contributes 45% of its net profit in FY2021.

Sembcorp is a pretty established player in this field, with over 9,400 MW of conventional power capacity in markets worldwide, generated from a diversity of fuels, including natural gas and coal.

A breakdown of this segment:

• Power & Steam plants: Present in China, India, Bangladesh, Singapore, Vietnam, Myanmar, Oman, UAE and the UK (Capacity of 9,400MW)
• Gas & Related Services: Present in Singapore (approximately 431 billion British thermal units of piped natural gas per day)

More information about its Gas service. Sembcorp Industries, as the appointed term liquefied natural gas importer for Singapore, is the largest natural gas supplier here and remains critical to the functioning of our city, where natural gas continues to be the dominant energy source.

2) Renewable Energy

Capitalising the clean energy trend, Sembcorp has been growing its renewable energy portfolio from as early as 2012. It is now one of the most prominent homegrown renewable energy players globally, with a renewable energy capacity of more than 6.8GW (That’s almost doubled from just a year ago!).

Its renewable energy portfolio comprises wind, solar and energy storage in various markets like Singapore, Vietnam, China, India and the UK.

They have grown their capacity across their energy portfolio, here’s a breakdown of this segment:

• Wind Energy: Present in China and India (Capacity of 4,904MW)
• Solar Energy: Present in Singapore, India, Vietnam and China (Capacity of 1,425MW)
• Energy Storage Systems: Present in the Singapore and UK (Capacity of 424MWh)

3) Integrated Urban Solutions

The last segment of Sembcorp Industries’ business is its integrated urban solution. The role of this business segment is to ensure the sustainable development of cities, with a focus on environmental concerns.

We can further break this segment down into three sub-segments:

• Urban
• Water
• Waste & Waste-to-Resource

Urban

This subsegment undertakes master planning, land preparation and infrastructure development to transform raw land into sustainable urban developments, which comprises of industrial parks as well as business, commercial and residential spaces.

As of today, it has over 15 private sector-led and government-supported projects over 13,000 hectares in emerging markets across Asia. They have a presence in China, Vietnam and Indonesia.

Water

Sembcorp’s water management ranges from industrial wastewater treatment to water reclamation and industrial water supply. In total, its facilities process a total of 8.3 million cubic metres per day (Equivalent to 3,320 Olympic size swimming pools)

Interestingly, Sembcorp is involved in the whole system, allowing it to close the loop and ensure the sustainability of water resources. First up, its supply-side obtains water from Water Treatment, Desalination and Water Reclamation (NEWater). The ‘used’ water is then treated in its facilities which can then be used again.

Their water segment has a presence in Singapore, China, Philippines, Oman, UAE and the UK

Waste & Waste to Resource

Have you seen these trucks driving around Singapore? This is the company that keeps our streets clean!

Sembcorp is a Singapore-based integrated environmental services company specialising in trash management, public cleaning, and recycling. Its solid waste management services include the following:

• Waste Collection (Residential, Industrial, Commercial as well as construction and demolition waste collection)
• Post-collection Treatment and Recycling
• Public Cleaning (Cleaning services which include sweeping of roads, removal of debris from major waterways and cleaning of recreational beaches and parks.)

In addition, Sembcorp has a Waste to Resource subsegment whose focus is to extract energy and biomass from the collected wastes.

This segment is present in Singapore and the UK:

• In Singapore, Sembcorp oversees the whole energy-from-waste value chain, from waste collection to steam and electricity generation and distribution.
• In the UK, Sembcorp maintains the first large-scale wood-fired biomass facility, which produces power and steam from sustainably sourced and recycled wood.

Sembcorp Industries’ Financials

Their business sounds impressive, but how did they do financially? Let’s find out.

Net Profit

Sembcorp reported a net profit of $279 million, up 78% from the previous year. This is the result of increased contributions across all categories. Despite this, the company’s pre-pandemic net profit (excluding its discontinued operations) was still slightly higher, indicating that it has yet to recover fully.

Breaking down its profits into its three categories, the conventional energy segment accounts for 45% of Sembcorp’s net profit and has witnessed the most significant rise of 54%.

Following that, we have the integrated Urban Solution segment, which accounts for 41% of total profit, and the Renewables segment, which accounts for 14%.

Overall, Sembcorp’s three main segments performed well, owing to greater margins, particularly in its conventional energy division, due to increased demand.

Five years performance

Let’s now take a look at Sembcorp Industries’ income performance across five years.

From the graph, we can see that its income performance has not been spectacular. In fact, its net profit has been consistently dropping over the past few years. Nevertheless, FY2021 has shown a significant rebound.

Yet, this may not be the end for Sembcorp Industries. While the removal of its marine segment has lowered volatility considerably, the cause for its significant improvement has been the recovery of the economy, which has resulted in increased demand for energy. Moving forward, for Sembcorp to continue to grow, we must presume that economies do not slow as some analysts is predicting.

Cash Flow and Liquidity

As of 31 December 2021, Sembcorp Industries’ cash and cash equivalents stood at $1,297 million.

• Net cash from operation came in at $1,219 million,
• net cash used in investing activities was $100 million,
• while net cash used in financing activities was S$855 million.

Sembcorp Industries is in a far better situation now than it was a year ago. Sembcorp Industries’ cash and cash equivalents have increased from $1,009 million to $1,297 million as a result of increased cash from operations and a reduction in one-time cash outflows.

With its positive cash flow, we can be at peace that its business is at least sustainable.

Balance Sheet

Sembcorp Industries’ debt level has also decreased, indicating improved financial health.

With an interest coverage ratio of 3.0 times, it is not exceptional, but it is an improvement over a year ago and a reasonable level to cover its debt interest payment.

That said, based on its debt maturity profile, it appears that a significant portion of its debt (27%) will be due soon.

While it is likely that the company will refinance it, we should consider the worst-case situation in which it must repay the debt. In this scenario, the cash from operations would be insufficient to cover the repayment. Even if this does not happen, refinancing at this time when interest rates are rising would increase the company’s cost of borrowing.

Is the Open Electricity Market a risk?

If you have held Singtel shares, you will understand that the opening of the telecommunications space has resulted in its decline over the years.

Likewise, in 2017, the Electricity Market Authority opened the electricity market to encourage competition and innovation in the power industry. Given that, how much will this impact Sembcorp Industries?

Well, first of we must understand how the electricity market in Singapore works. For a start, we have three stakeholders in the industry:

• power generation companies,
• electricity retailers, and
• consumers.

Power generation companies are power plants that generate electricity. This is where Sembcorp Industries’ main business is.

Next are the Electricity retailers who buy electricity from these power generation companies and sell it to consumers. This is where you have SP Group and also new incumbents as a result of the OEM. Unsurprisingly, Sembcorp is also a retailer and sells electricity from its power plant.

*To note, SP Group still owns and maintain Singapore’s sole power grid. Whenever you buy from a retailer, the power still comes from this grid. In return, SP group charges these retailers fees for using their infrastructures.

In my opinion, this OEM will not have a significant impact on Sembcorp energy business as they are primarily a power generation company than a retailer.

In fact, the opening of the electricity market opens up new business opportunities for Sembcorp Industries as it can now sell its electricity directly to consumers.

Future of Sembcorp Industries

Electricity demand has begun to recover in 2021 as the world learns to live with Covid-19. All of this has translated into improved operating performance for Sembcorp Industries. Nevertheless, the management believes that risk and uncertainty will persist as a result of the COVID-19 epidemic, uneven global economic recovery, and rising interest rates.

Looking ahead, Sembcorp has also unveiled strategic plans to transform its portfolio to greener energy sources. This is in line with the megatrends or decarbonisation, urbanisation and electrification of our world and

• More sustainable

It aims to have 70% of its net profit coming from its sustainable solutions portfolio, up from the current 40%.

The group also aim for its renewable energy portfolio to grow at a compounded annual growth rate (CAGR) of 30% and its integrated urban solution portfolio to grow at 10% CAGR by 2025.

• More renewables

It aims to quadruple its gross installed renewable energy capacity to 10GW, up from its current 2.6GW.

• More sustainable urban developments

It aims to triple its land sales by 2025.

• Lower carbon emissions

It aims to reduce greenhouse gas emissions intensity from 0.54 tonnes of carbon dioxide equivalent per megawatt-hour (tCO₂e/MWh) to 0.40 tCO₂e/MWh.

• Halve GHG emissions by 2030, net-zero by 2050

No new coal-fired energy asset investments.

Valuation of Sembcorp Industries: Is it a good time to buy?

Price to Book

Sembcorp Industries is currently trading with a price to earnings ratio of 19.0x.

At this level, it is no longer as undervalued as a year ago. This is especially true given the 5-year average p/e ratio stands at 20.3x. At best, the price is now close to its fair value.

Dividend yield

Considering Sembcorp Industries’ dividend is unstable, we should put more emphasis on its P/E ratio than its dividend yield. Of course, dividend investors may still want to consider Sembcorp Industries’ current dividend yield too when deciding to buy or not.

With a dividend of 5 cents at the current price of $2.80 per share, it yields around 1.8%, which is relatively low if you are looking for a dividend stock.

Author’s Opinion

Sembcorp Industries is in a harsh industry. While it has dominance in Singapore and would not likely go away due to the critical service it provides to Singaporeans, I’m not too fond of its profit margins.

Sembcorp Industries’ margin is too low for my liking. Even after the removal of its marine business, Sembcorp Industries’ net profit margin for FY2021 was 3.6%.

At the same time, while Sembcorp Industries grows its clean energy portfolio, we have to take note that its traditional energy power, which still makes up a bulk of its profit, would start to decline too. Creative destruction would likely take place where its traditional energy portfolio is replaced by cleaner energy. Rather than growth in its portfolio, we would most likely see a replacement of assets in the coming years.

Of course we should give credit where credit is due; the management has done an excellent job of navigating the company, as seen by its FY2021 financial report. Can they continue to do so in the future? What are your thoughts?