KepCorp

Kim Eng on 6 Jan 2012

(KEP SP, $9.44, Buy, TP $12.60)
Keppel Corp remains the most diversified of all the conglomerates under our coverage, with interests in shipyards, property development, telecommunications, logistics and business trusts. These are held either within unlisted subsidiaries or by separately listed subsidiaries and associates.

O&M the main pillar, can stand on its own. The stalwart in the Keppel Group remains its offshore and marine (O&M) division, which accounts for 57% of its revenue and 64% of its operating profit. O&M has been a strong outperformer over the past decade, buoyed by its niche in offshore, where it has seen strong order flows for drilling rigs, production vessels and support vessels.

Our positive view on Keppel Corp is based on the strength of the O&M division, where all of its businesses and geographies are held under a single holding company. The prospects look bright, as we anticipate Keppel O&M to be a strong beneficiary of demand for more offshore assets to tap deepwater hydrocarbon reserves in order to fuel global growth. We envisage that the O&M division can easily stand alone as a listed entity, given that its business is concentrated on one area.

Property division: Keppel Land and K-REIT leverage off each other. Another key division within Keppel Corp is the property-related businesses. In the near-to-medium term, we are less sanguine about its prospects for this business segment due to slowing demand for its projects both in Singapore and overseas. Its significant office exposure is also a liability in an environment of declining rents. Property makes up about 30% of Keppel Corp’s earnings and 19% of its net assets.

Key holdings in its portfolio of property assets include Keppel Land (53% stake) and both direct and indirect holdings of K-REIT (76.3% cumulative stake). Both Keppel Land and K-REIT have the opportunity to leverage off each other in what has commonly been termed “capital recycling”. Keppel Land, whose task is to develop properties, can hive off its commercial rental properties to K-REIT when its rental yields are mature and stabilised. K-REIT therefore has a stable income source to furnish the returns to its unitholders, while the cash generated from the sale of assets from Keppel Land to K-REIT is used to fund subsequent development projects for Keppel Land.

The most recent occurrence of this was the divestment of Keppel Land’s 87.5% stake in Ocean Financial Centre to K-REIT for $2.01b in October last year. K-REIT funded the acquisition with $603m of debt and $976.3m of equity raised via a 17-for-20 rights issue. Both Keppel Land and Keppel Corp, which together own 76.3% of K-REIT units, subscribed for their pro-rata entitlement of the rights units amounting to $457m and $294m, respectively. Keppel Land will book in a hefty net divestment gain of $492.7m, and both Keppel Land and Keppel Corp shareholders can look forward to a special dividend payout when both
companies announce their full-year results.

Keppel Corp itself also has several property joint ventures, especially on its development of the various Keppel Bay residential and commercial plots. However, these are one-offs from the redevelopment of its former shipyard and should be converted to cash earnings over the next 10 years.

Infrastructure could do with some tweaking. Keppel Corp holds an 80% stake in listed Keppel Telecommunications and Transportation (KTT). KTT’s business units comprise logistics, data centre and networks, and investments. While KTT is expanding its core businesses, the main asset in its investment portfolio is its associate 20% stake in MobileOne (M1). Though this Singapore cellular network operator lacks growth opportunities despite a strong dividend record, high profitability and solid balance sheet, it remains extremely profitable.

M1 could be an attractive acquisition target for foreign telecom operators interested in diversifying out of their home markets and looking for a financially strong player in a stable market. The stock currently at a PER of 13.4x and a P/BV of 6.8x. Our fair value target of $2.96 for M1 is based on an undemanding valuation of 15x FY12F PER. A re-rating of M1’s share price to $2.96 will value Keppel Corp’s 16.1% deemed interest at $434m. Selling M1 would therefore create a surplus of $400m if the stake is held at book value in Keppel’s books, which we estimate to be just $35.1m.

K-Green Trust – capital recycling redux. In 2010, Keppel Corp established K-Green Trust which essentially replicates the capital recycling model, but using its infrastructure assets instead. Its seed assets were the existing Senoko Waste-to-Energy plant, Ulu Pandan NEWater plant and Tuas Waste-to-Energy plant, which were all transferred from Keppel Corp’s infrastructure division to the newly established trust. As a dividend in specie, Keppel shareholders received one K-Green Trust (KGT) unit for every five Keppel shares held. K-Green has been relatively quiet in expanding its portfolio and its share price has languished as a result. However, the possibility remains for it to monetise its other ongoing infrastructure projects and to return capital to its shareholders.

Opportunities from Keppel’s cross-competencies. Insofar as Keppel is concerned, there is a further case to be made for the conglomerate model, especially when it comes to a cross-selling of solutions. The clearest example of this is the Keppel Group’s involvement in the Tianjin Eco-City project in China. The Tianjin Eco-City is planned as a landmark bilateral project between China and Singapore with private sector investment and development. It is located in the Tianjin Binhai New Area, which is around 40km away from Tianjin city centre. The 30- sq-km Tianjin Eco-City is envisioned to create a “harmonious and sustainable” community, built on ecological principles, that is supposed to meet the needs of an urbanising China and will be a modern township where 350,000 residents can live, work and play.

As the lead manager of several consortia to undertake the project, Keppel Corp can leverage off Keppel Land’s property development expertise (both for residential and commercial), while Keppel’s infrastructure division can facilitate town planning, utilities, waste management and green solutions. Keppel T&T’s logistics capabilities also have a role to play. Further down the road, there will be opportunities for K-REIT and K-Green Trust as these projects mature.

Therefore, if it ain’t broke... In summary, we regard Keppel Corp as a well-run conglomerate which can derive cross-benefits from its various divisions. The corporate culture of the group is also an asset to the broader company. In short, Keppel’s conglomerate structure serves the group very well.

However, we do see opportunities for Keppel to realign its operations from time to time, but these are usually opportunistic disposals. Such was the case when Keppel Corp sold its 45.5% stake in SPC in June 2009 to Petrochina for $1.47b. Keppel Corp generated a surplus of $420m from the sale.

As mentioned, M1 may be a candidate for divestment, with a potential surplus of around $400m. Another is its 36% stake in K1 Ventures worth some $60m, where it has been a relatively passive shareholder.