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The Troubling State of Sembcorp Industries Limited’s Energy Business

Chong Ser Jing

Sembcorp Industries Limited’s (SGX: U96) share price of S$2.14 right now gives it a price-to-book (PB) ratio of 0.55. This looks like an attractive valuation on the surface, since the current PB ratio is near a five-year low as illustrated in the chart below. But there is an important risk with the company’s business that investors should note, and it concerns the troubling state of Sembcorp Industries’ energy business.


Source: S&P Global Market Intelligence
 

Business background

Sembcorp Industries can be seen as a bona fide conglomerate in Singapore’s stock market. The company generated S$11.7 billion in revenue in 2019, of which 56% came from the utilities segment. The segment recently changed its name to energy, and its key activities include power generation, process steam production, wastewater treatment, and production of desalinated and potable water, among others.

Another key segment is marine, which contributed 42% of Sembcorp Industries’ revenue in 2018. The segment comes from Sembcorp Industries’ ownership of around 61% of another Singapore-listed company, Sembcorp Marine Ltd (SGX: S51). Sembcorp Marine builds oil rigs and provides ship-building-and-repair services. 

Troubling state

The economics of the energy segment, Sembcorp Industries’ main revenue contributor, appears to have deteriorated significantly over time and there are two reasons why I say so.

First, over the five year period from 2013 to 2018, the energy segment’s revenue and power production and water treatment capacities all grew substantially in that timeframe. But its profit, after stripping off one-off items, had declined. These data are shown in the table just below:


Source: Sembcorp Industries earnings presentation and annual reports

Second, the energy segment’s return on equity has fallen hard from a respectable 18.6% in 2013 to a paltry 7.7% in 2018. The sharp fall in the return on equity for the energy segment, coupled with the segment’s fall in profit (excluding one-off items), suggest that the economics of Sembcorp Industries’ utilities business has worsened markedly over the past few years. 

The Foolish bottom line

It’s unclear exactly how much power and water capacity were actually in operation as of 2013 and 2018. So it’s highly possible that the bulk of the increase in the capacity-figures seen in the period are mostly for capacities that are under development. If that’s the case, then there may be a big jump in the energy segment’s profit and return on equity in the future. But if it isn’t, then the lack of profit growth in Sembcorp Industries’ energy segment, along with the falling return on equity, is a risk that prospective and current investors of the company may want to be wary of.

If the economics of the energy segment does not improve, Sembcorp Industries may not turn out to be a bargain despite its currently low PB ratio.

More reading

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore writer Chong Ser Jing does not own shares in any companies mentioned. 

Motley Fool Singapore 2019