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Morningstar | Keppel Reports 4Q Earnings; Shares Undervalued

No-moat Keppel’s 2018 net profit of SGD 944 million was largely within our expectations after stripping out net provisions made in the fourth quarter of 2018, notably for a SGD 167 million provision for expected losses on Sete Brasil’s contracts. Excluding the one-off financial penalty and related costs in 2017, earnings were up 16% year over year. We increase our fair value estimate marginally to SGD 8.30 from SGD 8.20 after rolling forward our earnings model. We think the firm remains attractive given its diversified business and healthy balance sheet, with an improving outlook in the offshore and marine, or O&M, sector.

The property segment remains the key earnings pillar, with net profit of SGD 938 million, largely underpinned by the en-bloc sales of development projects and gains from the divestment of a stake in a Beijing commercial project. We think earnings from this segment will be supported by landbank of about 50,000 homes across key Asian cities. In particular, 19,000 homes will be launch-ready from 2019-21, while earnings from the sale of 8,410 units of overseas homes will be recognized upon completion over the same period. In addition, the firm also has about 1.5 million square meters of gross floor area in its commercial portfolio, of which about 60% is under development. Management aims to increase its asset turns to enhance returns, and we remain comfortable with the firm’s strategy given its track record in capital recycling. Although there are concerns with Keppel’s large exposure in China (about 44% of total landbank), we think the firm is selective in its investment and focuses only in markets with favorable demand conditions. For example, in Keppel’s key markets such as Nanjing and Chengdu, the supply of homes with presale permits is expected to be absorbed in less than six months.

On the other hand, Keppel’s O&M segment reported a net loss of SGD 109 million, largely due to provisions made and other asset impairments. Following provisions of SGD 230 million in 2015 and SGD 81 million in 2017, management made a further provision of SGD 167 million for expected losses on Sete Brasil’s contracts taking into account current market conditions such as the day rates for rigs. We think this will likely mark the last provision for Sete Brasil, and the O&M segment is poised to return to profit in 2019. Excluding provisions and write-backs, the division actually recorded a net profit of SGD 6 million in 2018, and we expect better performance ahead given the new contracts secured. Management sounded more optimistic in the results briefing, citing declining rig supply overhang and increased tendering activity but they also emphasized that a V-shape recovery is not likely. The firm has won new orders worth SGD 1.7 billion in 2018, and we forecast new contracts win of SGD 2.5 billion in 2019.

Earnings from the infrastructure division rose 26% year over year to SGD 169 million, mainly attributable to gains related to Keppel DC REIT and higher contribution from environmental infrastructure and infrastructure services. With more contracts being won and the addition of more data centre assets, we expect earnings from this segment to remain stable.

The investment segment recorded a net loss of SGD 54 million, largely due to lower contribution from asset management business and Tianjin Eco-City, impairment of investment in an associated company, and share of losses from KrisEnergy. We think the contribution from the asset management business will recover as some investments delayed in 2018 will materialize in 2019. Meanwhile, the segment should also see more stable earnings with the pending exercise that will lead to a majority control of M1.