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Thursday, December 3, 2015

Is Sembcorp Industries Worth A Buy At This Point?

It's been quite a while since I last updated developments on SCI. Last, I managed to divest all my holdings at $4.80 before the vicious spiral downwards to where it is today. You can view the previous post here back in April.

You might recall that I compiled 5 years of future cashflow into the DCF model to get an estimated intrinsic value. The model assumes a few things which I will recap quickly below:

  • 1% Growth for the next 2 years and 2% for the next 3 years.
  • Capex includes both maintenance and investment expansion, and the assumption takes into consideration a gradual 10% declines in capex each year by each year.
  • Discount Rate of 10%.
  • EBIT multiple long term average (2005 - 2014) of 11x.
  • Net Debt Borrowings of $4,734 millions.
The estimated intrinsic value based on the above assumption came to about $3.30.

Since then, a couple of developments have happened which is unsurprising given the recent slowdown in all segments of SCI.
9M net profit for the utilities segment have increased marginally by 3% mainly due to the overseas expansion they have invested, and we can see the margin compression for the local segment slowing down.
9M net profit for the marine segment however have plunged rather badly by 36% due to industry slowdown, despite the huge order book they have on their book. Given that this makes up a rather lower contribution now that the utilities have stepped up, SCI is somewhat fortunate that the slowdown came at a rather opportune time that the utilities expansion is growing rapidly.
SCI will also book a one-off divestment of $350M gain in Q4 which will help the bottomline. I suspect there will be more frequent divestment (similar to Keppel Corp strategies) given their core income is not doing very well. These one-off would surely come in handy.
I re-run the latest 2014 and 2015 estimates figures into the model and incorporate a 3% growth in 2015 which includes the one off divestment but input a 20% downfall in the following year and 5% in subsequent year. I predicted a 2018 turnaround and have incorporated a 5% growth and 10% in subsequent year to complete the 5 year future cashflow model.
For this model, I have also separately included the interest costs because that is something which has been getting higher now so it could end up to be material.
Do note that the capex still includes both maintenance and expansion so it does not truly represent the right picture since future return is not included in the computation from the 1st to 5th year.
The intrinsic value came up to about $2.01, which is somewhat expected given the much lower FCF due to capex which followed the year on year growth.


Overseas Expansion Taking Off

However, it is not all gloom and doom yet.
If you look at the latest 9M results, the utilities segment for the Singapore produced a 9.5% operating margin while the overseas are surging at 15.7%. This means that for as long as the expansion produces above average irr return, which is higher than the assumption of 10% WACC which we use, then the expansion are returning very good incremental difference.
Dividends Payment
In order to pay a 16 cents dividends, the company needs approximately $393M to fund the same dividends. By looking at the FCF they have produced over the years due to high capex, it seems that they will run out of cash one day. So one of these days, they will have to stop their aggressive expansion and let their existing operations take over generating the cashflow.

Rights Issue On the Cards
The worry is that SMM might have to raise funds through rights issue if things get really ugly. They have so much net gearing on their books right now that give a few more cancellation or delay they would be sucked in the vicious working capital cycle. When that happens, you can be sure its share price would plunge the way Ezra did, and probably it's much harder to get back from then on.
Final Thoughts
It's a really two way call either you should or should not buy the company at this moment.
On one hand, if you think the company has a strong balance sheet that can sustain their working capital while the cycle slowdown is taking place, and that oil price will eventually bounce back, then by all means, you can try to predict the trough at this level. However, given that this is just the start of the slowdown, I think there would be more risk than reward at the moment and you should not discount external chain impact that might happen to an O&G sector.
There are other companies which are still exhibiting strong earnings which you might want to consider if you have a weaker heart. This is certainly not one of them. Having said that, this might be a good opportunity if you look at it in hindsight maybe 5 or 10 years from now, who knows.
In any case, please do your own due diligence as you are accountable for your own investment.


  1. Hi B

    Glad that you see what I see. The risk reward ratio is not worth. I don't have a crystal ball though.

    1. Hi Frugal Daddy

      I guess only time will tell if the decision is right or wrong :)

    2. Will be better to have seen it in Sep last year!

  2. Hello B,

    I have always enjoyed the detailed analysis done by meticulous bloggers like you. Thank you for sharing your point of view.

    Coincidentally, I just nibbled some SCI shares. Will see how things go. :)

    1. Hi SS

      Many thanks for your kind words.

      Hope all went well for your investment :)

  3. Is the formula of FCFE correct? I notice FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment
    from Investopedia.

    this is different from what you worked out in the article, having said that I take no stand on SCI.

    1. Hi Bruce

      I made a purpose not to include the net working capital because this can swing one way to the other, so I'm assuming they remain the same, but yes your formula is correct to calculate the exact FCFE. It's just not that useful in this purpose for projection matters.

  4. I have 2000 shares of SCI at an average price of about 3.8. Ouch.

    If only SCI didn't have a 60% stack in SembMarine. In fact I'm starting to think of valuing SCI based just on the earnings of the Utilities business. What do you think? Good idea or no?

    1. Hi J

      To be fair, the marine segment used to help a lot for SCI when the utilities is still in the infant stage. Now they've grown to much matured and the marine is having their bad cycle so it does see like it's dragging the company down. But I think the only way out is probably to consolidate the marine together and then list the utilities portion as a trust separately later on.

  5. Hi B,

    If an analyst analyse a co and intrinsic value can drop so much within a space of less than 1 yr (ur current b previous posts!), isn't it not worth in analyzing this particular company anymore???

  6. Hi,
    Can you share the formulas you use to compute the DCF analysis? Do you add up the NPV for all cash flows from 2014-2019 and add a terminal value?
    I am learning.