Keppel Corp and Sembcorp Industries have been one of the main culprit highlights in the recent oil bear scenario, which brings it's share price down from the recent 5 year high of $11.57 to the low of $7.50.
Some readers have asked me whether Keppel is worth a buy at this price and I am pretty sure there are plenty who are considering to enter as well, given how "attractive" the last 5 years Keppel has bring to shareholders.
Personally speaking, I have not done an in-depth research of Keppel's core business while my previous couple of posts on Sembcorp was because I have previously been vested with them. In any case, conglomerates are a bunch of different core business integrated together which can make it very difficult to value.
For the purpose of this posting, I'll just do a simple sum of the parts method and if you are interested you can tweak from it.
Part A
The recent move to privatize Keppel Land means that Keppel Corp has now owned 95% of the properties arm.
This move has helped to mitigate the drop in earnings for its O&M segment, though the purchase would also increase its gearing from 0.11x to 0.42x.
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| Keppel Land |
For the purpose of this exercise, we'll take an easy way out by valuing the value of the properties arm based on its privatization price at $4.38. Since Keppel owned 95% of the same, the market value for SOTP purpose is $4.16.
If you take a look at the upcoming projects they have up until 2017, I think this segment will be the main driver for the company while the other segments take a beating. That's the advantage of being a conglomerates, having other segment to step up when the other is nursing its wound.
Part B
I've included both the infrastructure and investment in this segment.
This is the part most promising to the group and one of the trump card I reckon they are going to use during these recent years. For instance, they have divested a 51% stake in Keppel Cogen to its infrastructure trust while recycling its capital for other use. I'm pretty sure there will be a day when Sembcorp will follow suit with its utilities infrastructure trust but for now, they can only sit in envy.
Following the recent Q2 results, management has guided that revaluations, impairments and divestments (RID) remain a huge part of their recurring income, forming almost 21% of the annual PATMI for the past 5 years. Given the recent hit in the O&M earnings, I am pretty sure they will utilize this segment even more to sustain earnings in the future.
The SOTP for this segment is pretty straight forward by taking the market value of the individual listed entities, multiplied by the percentage holdings they owned. The market value for this segment is $2.27.
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| Infrastructure & Investments |
Part C
This is the hardest segment to value because this will be the hardest hit since they are related to the O&M.
For your information, the current EBITDA valuation based on the 2014 end year results for the O&M segment is at $5.55, based on 11x FY14 results. Obviously, you are not going to see that kind of number in the next few years as the sectors take a hit, so the million dollar question would be how much they are being valued.
I am actually taking a lazy way out by taking reference to the previous oil crisis low and replace the O&M margins to calculate my forecast PATMI for the next 5 years. Thus, for the purpose of this exercise, I have forecasted earnings for the next 5 years to drop 20%, 20%, 10%, and then stay constant for the next 2 years. The normalized PATMI for the next 5 years will go almost in half what they have in 2014. You can immediately see how bad it becomes.
Of course, I am playing only with the margins here and assuming order books remain the same. If the other variable factor of order books are also lowered, you can be sure that it will only get worse. Having said that, I've factored in quite possibly a very bad case scenario so the figures can be pretty conservative.
Other analysts are using a direct 11x EBITDA FY16 numbers, so their numbers are much higher than the one you see below because they are only accounting for the next one year forecast, and not the longer views that it may further drop.
The market value based on the below assumptions is $1.42.
Part D
This part is pretty direct and I am taking the available cash balance net the borrowings they had on their books.
The market value for this is -$2.77.
Summing up the total of (A) + (B) + (C) + (D), we get a total of $5.08.
Final Thoughts
This is just a very simple exercise to understand how much each segment are worth in the market but you can see how the group are playing out its other card when the other takes a hit.
If you believe that the O&M segment loss is temporary, then buying at current price could prove to be very worthwhile when oil price eventually recover. However, if you are those who wants further margin of safety before entering, then you can consider the impact of earnings the group can take.
Other major weight producers such as Exxonmobil and Chevron have taken a huge hit on their recent earnings and you can read their outlook for the next 5 years. The cut on jobs and capex are glaringly high so investors who want exposure to the oil industry needs to be mentally prepared that you can potentially sit on a huge paper loss for the next foreseeable years, unless some other segments can step up, like what we've seen for Keppel.
What I was trying to show here is that everyone thinks Keppel is "supposed" to be a $11 to $13 stock, but many forget that it is based on the assumptions that margins for their O&M segment are at the peak when the normalized oil price was above $100. If for the next decade, normalized oil is lowered to around $50 to $70, you can be sure that Keppel will be worth lesser than that. Suddenly, the new generation of investors will see Keppel as a $8 to $9 stock. So while the current price of $7.50 may look "cheap" to some investors out there, who thinks that mean reversion will take place in the longer term, you might want to ask if there are any margin of safety build in it.
What I was trying to show here is that everyone thinks Keppel is "supposed" to be a $11 to $13 stock, but many forget that it is based on the assumptions that margins for their O&M segment are at the peak when the normalized oil price was above $100. If for the next decade, normalized oil is lowered to around $50 to $70, you can be sure that Keppel will be worth lesser than that. Suddenly, the new generation of investors will see Keppel as a $8 to $9 stock. So while the current price of $7.50 may look "cheap" to some investors out there, who thinks that mean reversion will take place in the longer term, you might want to ask if there are any margin of safety build in it.
What do you think? Is Keppel Corporation worth the buy at current price?
