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SCI’s recent share price performance hasn’t been great. While price movements themselves don’t change our thesis, we have been tracking the stock closely.
As we do have holdings in SCI stock, we thought it would be apt to provide a quick update ahead of the company’s 1H2020 earnings announcement on 17th July 2020 (Fri).
Do also check out our previous and subsequent articles on Sembcorp Industries (SCI).
- 11 June 2020: “SEMBCORP INDUSTRIES IS DAMN CHEAP”
- 8 September: 2020: “[Update] Sembcorp Industries shareholders are going to receive Sembcorp Marine shares – What to Expect + What to Do”
1) Redid our calculations based on current prices. Thesis still intact
2) Current Analyst Price Targets for SCI are above today’s close
3) Note! 1H20 results may be short-term headwind!
4) Biggest risk to thesis remains the same: No demerger
5) Potential improvement to investment strategy: Short SMM
The InvestQuest’s View: Our thesis remains intact. With the assumption that the demerger transaction goes through successfully, we believe that SCI provides good investment value. However, short-term performance may be especially volatile, after SMM’s poorer than expected earnings result today and SCI’s upcoming 1H20 earnings release scheduled for 17 July (Friday). We will be hoping to get more clarity behind SCI and SMM’s rationale behind the deal structure and choice of timing, as well as contingency plans should the demerger transaction fail to go through.
(OPTIONAL) Recap of Thesis
(Full details at our original article)
The implied value of Sembcorp Industries’ *demerged* business is cheap relative to peers. At the time of writing, the implied valuation was 4.5x P/E and 0.4x P/B, around one-third that of peers in the same industry.
The reason for WHY value might potentially be created post demerger with Sembcorp Marine (SMM):
- Removal of conglomerate discount
- No longer dragged by SMM’s subpar performance
- High stability of utilities business in Covid-era
1) Redid our calculations based on current SCI and SMM prices. Thesis still intact
1A) What is the implied price of the *demerged* SCI? It’s S$0.59 to S$0.74
Assuming the SCI/SMM demerger goes through and using SMM’s latest share prices of S$0.455 as of 15 July market close, the implied value of demerged SCI shares is as follows.
- Sembcorp Marine stake: S$1.04 to S$1.19.
- S$0.455 per share of SMM translates to a theoretical SMM ex-rights price of S$0.2425 (workings shown in table below).
- SCI shareholders will be entitled to receive between 4.27 to 4.91 shares of ex-rights SMM shares, which is worth S$1.04 to S$1.19.
- Demerged Sembcorp Industries: S$0.59 to S$0.74.
- SCI closed at S$1.78 on 15 July.
- If you minus the SMM stake (S$1.04 to S$1.19 as calculated earlier) from SCI’s current share price of S$1.78, this implies that the demerged SCI stub is being valued at S$0.59 to S$0.74 (workings shown in 2nd table below).
1B) At S$0.74 implied price, what’s the P/E and P/B for the demerged SCI?
4.5x P/E and 0.41x P/B for a utilities business
At S$0.74, what’s the Price-to-Earnings (P/E) of this demerged SCI? 4.5x. We had previously estimated that earnings per share of the demerged entity will be S$0.165 for FY2020. So S$0.74 divided by S$0.165 is 4.5x P/E.
Note 2: For the Forward P/E, we use a market cap determined by the implied price of the demerged SCI (S$0.74 x no. of shares). We use the future forecasted and adjusted earnings.
Source: Bloomberg and Sembcorp Industries Annual Reports. IQ Computations.
At S$0.74, what’s the Price-to-Book (P/B) of this demerged SCI? 0.41x.
Note 2: For the Forward P/B, we use a market cap determined by the implied price of the demerged SCI (S$0.74 x no. of shares). We then compare that market cap to the Demerged SCI’s book value in FY19 (which we calculated and which matches the pro forma book value in the announcements) and then minused off S$1.5bn that is lost in assets because SCI is giving out its subscribed shares. We have also accounted for the current shares that SCI owns for SMM that it is giving out.
Source: Bloomberg and Sembcorp Industries Annual Reports. IQ Computations.
1C) Demerged SCI still looks cheap against peers, so our fundamental view is the same
Valuations of the demerged SCI also looks cheap relative to peer comps (see table below).
SCI ex-EMM dividend yield assumes dividend per share of $0.05 is maintained, divided by $0.74 implied SCI (ex-SMM) market price.
SCI’s ex-SMM net debt to equity is computed using projected net cash divided by demerged entity’s NAV, extracted from https://links.sgx.com/FileOpen/SGX%20ANNOUNCEMENT%20FINAL.ashx?App=Announcement&FileID=616791
1D) Even if we use a more conservative P/B target for the demerged SCI, merged SCI still looks cheap
We were flattered to have attracted the comments of a very knowledgeable reader. You can view the reader’s feedback as well as our reply towards the bottom of the previously published article.
The reader had commented that the demerged SCI should trade at a discount to the peer median, as SCI has larger EM exposure (a sizable India Energy Business) and higher implied leverage. The reader suggested that a 0.6-0.7x P/B would be a fair multiple for the demerged SCI.
We disagreed, but in any case since demerged SCI’s implied P/B is 0.41x, a 0.6-0.7x P/B “target” would still indicate a >50% upside to the demerged SCI’s value.
If we use 0.6x fair P/B, that’s S$1.09 for the demerged SCI. If we add it to our calculated S$1.04 value of SCI’s SMM shares, that’s a total of S$2.13 for the merged SCI. Merged SCI is currently trading at S$1.78.
Using this reader’s more conservative P/B target for the *demerged* SCI (which we still find too low), it still implies a 20% upside for the current SCI.
For reasons discussed in the comment section of the previous article, we believe the fair P/B for the *demerged* SCI should be significantly closer to peers.
2) Current Analyst Price Targets for SCI are above today’s close
We have listed the latest analyst price targets for SCI in the table below. We have only included those brokers who have updated their target prices after the SCI/SMM demerger announcement in early June.
Where available, we have also included the post-demerger target price. A number of these broker reports may be accessed from this sginvestors site, if you are keen to read in more detail.
SCI’s post-demerger analyst target prices of S$1.20-S$1.30 do provide a fair bit of upside potential to demerged SCI’s current implied price of S$0.74.
3) Note! 1H20 results may be short-term headwind!
As noted previously, results releases can be a short-term risk factor.
SMM just reported interim results this evening that fell short of consensus estimates.
- Earnings: S$192mm net loss in 1H2020 (consensus est. net loss of S$84.5mm) vs net loss of S$6.8mm in 1H2019
- Revenue: S$906.2mm in 1H2020 vs S$1.54bn in 1H2019
These figures will be consolidated into SCI, which may cause SCI to miss consensus estimates as well which may feed into negative sentiment for the stock.
That said, ultimately what we care about are *demerged* SCI’s earnings. We previously noted that SCI did gave pessimistic earnings guidance in May, which analysts have already factored into their forecasts. It’s still possible for these core earnings to miss their expectations.
SCI results will be announced on 17th July (Fri).
Overall, unless the medium-term earnings outlook for SCI’s utilities business changes dramatically, we’ll still maintain our position in SCI and seek to average down tactically. One of the reasons why we bought into SCI has also to do with what we perceive to be a high margin of safety (between current price and where we see value). This gives us more buffer.
4) Biggest risk to our thesis remains the same: Demerger doesn’t happen
On that note, SIAS Research released a press statement on 14th July, directed to SCI and SMM. Questions were posed to both companies with regards to the SMM rights issue and SCI/SMM demerger, with the intention to help shareholders understand the transaction better. There are 13 questions in total and I am personally looking forward to the answers, as they cover aspects such as why the current proposed deal structure was deemed best and if there are any contingencies if the demerger transaction falls through.
5) Potential improvement to our investment strategy: Short SMM as a hedge
As we are much more optimistic in the demerged SCI business than SMM, we had initially thought of hedging the SCI stock position with short positions on SMM. However, the SMM shares for borrowing must be pretty limited as I have had no success so far. Let me know if you’ve been able to do it!
The InvestQuest’s View: Our thesis remains intact. With the assumption that the demerger transaction goes through successfully, we believe that SCI provides good investment value. However, short-term performance may be especially volatile, after SMM’s poorer than expected earnings result today and SCI’s upcoming 1H20 earnings release scheduled for 17 July (Friday). We will be hoping to get more clarity behind SCI and SMM’s rationale behind the deal structure and choice of timing, as well as contingency plans should the demerger transaction fail to go through.
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