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Morningstar | Little Surprise in Keppel’s First-Quarter Results; Shares Remain Undervalued

No-moat Keppel reported first-quarter 2019 net profit of SGD 203 million, down 40% year over year, mainly attributable to smaller gains from en-bloc sales of residential projects. Although the earnings only accounted for 21% of our full-year forecast, we consider the results to be in line given that the firm’s profit is lumpy in nature. Our fair value estimate of SGD 8.30 is unchanged. While there was little surprise in the firm’s results, we think Keppel remains undervalued at current share price and we continue to see positive outlook for the offshore and marine, or O&M, sector.

The property segment was the largest earnings contributor, with net profit of SGD 132 million, largely underpinned by the divestment of a 70% interest in Dong Nai Waterfront City in Vietnam. We acknowledge investors’ concerns with Keppel’s large exposure in China (about 44% of total landbank), but we are comfortable with the firm’s strategy that focuses only in markets with favorable demand conditions. In first-quarter 2019, home sales in China rose 21% year over year to 230 units. In addition, the firm launched a 271-unit Nanjing residential project in April and it was fully sold with more than 10 times oversubscription. We also expect property earnings to be supported by the firm’s capital recycling strategy (develop profitable projects and recycle assets for higher returns) and income from the more stable commercial portfolio.

On the other hand, Keppel’s O&M segment reported a net profit of SGD 6 million, on the back of higher associates’ contribution and lower taxes. This was an improvement from a net loss of SGD 23 million, a year ago. More importantly, we think the recovery in earnings is imminent given the increased workload from new projects. After several rounds of layoffs, the firm is also planning to increase its workforce by 1,800 people in 2019, reflecting management’s confidence in its future outlook.

Year to date, the firm has won new orders worth SGD 1 billion (SGD 1.7 billion in 2018), and we forecast new contracts wins of SGD 2.5 billion for full-year 2019. Furthermore, Sete Brasil has called for a tender for the sale of four drilling units, of which two were being built by Keppel. We believe a successful resolution with Sete Brasil will be a catalyst for the firm.

Meanwhile, earnings from the infrastructure division were down 38% year over year to SGD 16 million, mainly due to a SGD 7 million share of cost for the acquisition of Ixom by Keppel Infrastructure Trust. Management is currently planning to transform its logistics business to a high performing asset-light service provider in urban logistics, and we expect this to benefit the division in the longer term.

The investment segment saw a huge improvement, recording net profit of SGD 49 million from a net loss of SGD 44 million a year ago, largely attributable to fair value gains from the remeasurement of previously held interests in M1, partly offset by a higher fair value loss on KrisEnergy warrants and an impairment provision for an associated company. Going forward, we expect earnings from this segment to be more stable with M1 being a subsidiary of the firm. In addition, the partnership with Golar LNG to venture into operation of a floating liquefied natural gas, or FLNG, facility will provide a seed asset for a new infrastructure fund to be managed by Keppel Capital, its asset management business that contributes recurring income to the firm.

The firm also announced a mid- to long-term ROE target of 15% with limited details on how this can be achieved. While the goal looks realistic taking into account the firm’s average ROE of 17.7% over the past decade (2009-18), we do not expect it to be attained in our explicit five-year forecast as we think competition will continue to pressure the firm’s returns, especially for the O&M sector. The firm’s annualized ROE in first quarter of 2019 was 7%.