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Morningstar | Slow Recovery of Keppel Corp’s Offshore and Marine Segment; Shares Remain Undervalued. See Updated Analyst Note from 18 Jul 2019

Keppel’s first-half 2019 net profit of SGD 356 million, down 39% year over year, is below our expectation. While the fall in earnings is mainly due to lower gains from en-bloc sales of property projects, the recovery in the offshore and marine, or O&M, segment also trails our projection. That said, we think these are short-term hiccups and activity level is improving. We maintain our fair value estimate of SGD 8.30. We think Keppel remains undervalued at the current share price and this presents an opportunity for long-term investors to accumulate the stock.

Keppel’s O&M segment reported a net profit of SGD 10 million, a huge improvement from the net loss of SGD 40 million, a year ago. Nonetheless, operating margin for this segment remains low at below 3% as the market remains challenging. However, we believe margins will improve with the firm’s growing orderbook and better project mix. The firm is cautiously optimistic and has started to grow its headcount to cope with the increased workload. Year to date, the firm has won new orders worth SGD 1.9 billion (SGD 1.7 billion in full-year 2018). We increase our new contract wins forecast to SGD 3.0 billion from SGD 2.5 billion for full-year 2019. More importantly, close to 60% of the new orders are for LNG and renewables-related projects, indicating effective diversification away from highly competitive rig building.

Although net profit fell 57% year over year to SGD 262 million due to lower gains from en-bloc sales, the property segment remains the largest earnings contributor. The firm has decided to revalue its investment properties at midyear instead of year-end, which makes no difference to us. The division sold 2,100 homes, significantly higher than the 1,385 units in the same period last year. In particular, despite cooling measures in China, recent project launches in China (Nanjing and Tianjin Eco-City) were well received and sold out.

The firm is also growing its Vietnam business with a pipeline of more than 15,000 homes. While earnings for this segment will remain lumpy, we expect it 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.
Earnings from the infrastructure division were down 11% year over year to SGD 59 million, largely attributable to the absence of dilution gain from Keppel DC REIT’s private placement exercise. Operationally, energy infrastructure, environmental infrastructure, and infrastructure services have all reported stronger performance. We note that Keppel Marina East Desalination Plant, or MEDP, and the Hong Kong Integrated Waste Management Facility, or IWMF, continue to contribute positively to earnings. Upon completion, the MEDP and IWMF will also start contributing recurring income to the group from 2020 and 2024, respectively, with the commencement of the long-term operations and maintenance contracts.
On the other hand, the investment division reported a net profit of SGD 25 million from a net loss of SGD 46 million, a year ago, underpinned by fair value gain from M1, consolidation of M1’s results, and higher contributions from Keppel Capital. Going forward, we expect earnings from this segment to be more stable with M1 being a subsidiary of the firm. Furthermore, the firm expects to continue land sales of Tianjin Eco-City project in the second half and this should help to boost earnings for the division.