Oil related companies make the headlines again as the trio of Keppel, SCI and SMM saw heavy decline with just less than a week of trading in the new year. Since this is now a hot topic and I am vested in SCI, I probably had more interest in it than the other two.
I've blogged about SCI related material a couple of times in the past and you can view them here:
Sembcorp Industries - Updates from Investor Relations
Sembcorp Industries - Segmentation Weakness in Utilities
Sembcorp Industries - Q1 FY14 Results
In this post, I will present my valuation on SCI which I have played with the template I have at hand during my lunch hour today. I wanted to split the segments using different valuation method but found that it's probably too time consuming at the moment. Furthermore, I am not too sure on how I can best value SMM mostly based on project orders and revenue recognition timeliness projection can be very tricky. Thus, I have reverted back to using the DCF methodology for all the segments.
I will divide them into two parts of the DCF methodology. The first is the EBITDA multiple and the second by using the Gordon Growth Model to value its "intrinsic value". As you probably know, there are many assumptions used in this methodology, so I will explain which number I have used my calculation.
Assumptions Overview
The goal is to come up with a final unlevered free cash flow figure for a 5 year period.
To start, I begin with the EBIT figure for 2013 which I am able to obtain via the financial statement. I assumed a forward growth rate of -1% for the first year and 5% for the next subsequent years. Q314 YTD figure is out and pro-rating them to an annualized basis would give me a rough indication of negative growth rate for 2014. Hopefully, we'll see better results in the coming years.
I come up with an estimated provision taxes of 17% corporate rate constantly throughout for the years and this figure is conservative since the company usually has deferred tax provision to offset.
I added back the depreciation which is in line with what they usually has for the normal years. This is also the biggest item that is impacting the operating cash flow other than the changes to the working capital, which can go either way.
I tried to put in more CAPEX figures which is way more than what analysts out there are predicting. The assumption is the company is still trying to grow and the growth in CAPEX is in tandem with the growth figure mentioned earlier.
With that, we have our unlevered free cash flow for the next 5 years.
1.) DCF Analysis (EBITDA Multiple Method)
The Weighted Average Cost of Capital (WACC), which is the discount factor used here is 10% and a sensitivity analysis between -1 and +1 is added for further reference.
The EBITDA multiple used is 11x and again a sensitivity analysis between -2 and +2 is added for further reference.
Based on the above assumptions, we compute the Enterprise Value using the discounted cash flow method. Next, we deduct the $4,513 debt borrowings which the company has to arrive at the Equity Value. We divide them by the outstanding shares of 1,784 million as of 17 Dec 2014 and we get an intrinsic value of $3.30.
You might wonder how could my calculated intrinsic value be so low as compared to those analysts out there and I will explain this later in my conclusion. For now, just remember that it's all assumptions.
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| DCF Analysis (2013 - 2018) - EBITDA Multiple Method |
2.) DCF Analysis (Perpetuity Gordon Growth Model)
The same assumption is used with regard to the WACC (discount factor).
The only difference here is finding the terminal growth rate which can substantiate the value of this model.
The problem with this model is that the denominator is noded as k-g, which means the growth cannot be larger than your discount factor because if it does, then this will become the best investment in the world that everyone will invest. This is akin to asking why the trees cannot be taller than the cloud.
Anyway, I've decided on my terminal growth rate at 7% with a sensitivity variation of -1 and +1.
It appears that this method isn't the best of valuing SCI because of the much lower equity value because of the increasing debt they have on their balance sheet.
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| DCF Analysis (2013 - 2018) - Perpetuity Gordon Growth Method |
Conclusion
If there is one thing I note something new about SCI, it is that their debt borrowings are increasing, almost tripling that of last year. I don't know why I did not notice this in the past. I am not too sure why they would want to start leveraging too much but my feeling is because they are ramping up their CAPEX aggressively over the coming years and they need the money to do that.
My intrinsic value also came up much shorter than most analysts' projection. This is because I have put in aggressive CAPEX over the next 5 years which brings down the FCF figure. Other analysts put in almost half the amount and as a result this boosted the intrinsic value of the company.
We already know that other risks involving higher competition for its utilities segment and the falling margin for its marine segment means that the growth we are projecting may be over optimistic. The key is probably how they fast the overseas segment can step in to cover this drop for the local market.
Companies such as SMM whose revenue depends on project order execution are hardest to value because of the irregularity of the timeliness of revenue recognition and lumpy order execution. On bad days, there could also be cancellation of such orders or over-accruing for such costs. I think this is harder than projecting property companies because for properties at least we know their schedule up to the TOP. Nevertheless, I'll see if there are better ways in valuing project order companies like SMM.
vested with 9 lots of SCI as of writing. Just playing around the spreadsheet while awaiting for a good time to average down SCI. Anyone has taken the bite for SCI in the new year already??
