Is Keppel Corp a buy now?

Shareholders of Keppel Corpation has suffered a torrid year. Year to date, Keppel’s share price has fallen from a lofty 11.00 to that of 6.80, marking a 38% decline. This is in line with the global stock market rout witnessed over the past two months.  As investors on the side line watching this carnage, it is tempting to start our nibbles into Keppel Corp; but first let us evaluate the situation.

Overview of Keppel

Keppel is a conglomerate whose business is spread across four segments: Offshore and Marine, Property, Infrastructure and Investments.

Keppel’s earnings come mainly from its offshore and marine as well as property. Keppel is the global leader in rig design and buildings as well as specialized shipbuilding. While it’s property arm consist of Keppel Land and Keppel Reit, hence giving it exposure to both Singapore and China’s property market.

Its infrastructure division has interests in Singapore’s power generation plants, NEWater plant and date centres. They are held by Keppel’s subsidiary of KIT and KC DC REIT. While its investments segment consists of stakes in M1, Keppel T&T, Kris Energy and K1 Investments.

Is the sell down justified?

Comparing its latest 1H reports against previous year’s 1H, Keppel reported an earnings growth of 2%. However, one should not be hasty to conclude Keppel is a “buy” as the sell down in share price does not mirror the fact that its earnings had grown. A deeper analysis of Keppel’s P&L is required. Upon closer examination, one will realize Keppel’s core profitability has declined year on year. What propped it up was Keppel’s reporting of a one time gain of $202 million for selling its co-gen plant. Striping this one time gain, Keppel’s 1H earnings will have fallen by 25%.

Trouble looming in its main divisions

As Keppel’s offshore & marine division specializes in oil rig design and building, its business is dependent on the Capital expenditures of oil production customers (such as Petrobras, Chevron etc.) However bad times have fallen for its customers as oil prices have fallen to record lows because of global oversupply. With that, its customers have deferred majority of their capital expenditure plan, in turn affecting Keppel offshore’s business. Revenue and profit contribution by Keppel’s offshore has decreased year on year.

With the oversupply of oil being severe, I do not think the crisis will be over in just a year. My prediction is a pro-longed crisis where we will see many small energy companies going bankrupt. We have seen how some local offshore support companies, Ezra and Swiber, raising money from shareholders to prop up their business during these hard times. This oil crisis will last for at least 2 more years, and will be a trying period for our oil related listed companies.

An Office Space market downturn?

Secondly, Keppel’s property segment is in a fix too. With the recent takeover of Keppel Land, Keppel Corp now has a greater exposure to Singapore and China’s property market. However with the slowdown in both countries, the property division is bound to be affected. Furthermore, Keppel‘s exposure to the office segment through its subsidiary of Keppel Reit will hurt it.

Keppel Reit is a highly leveraged company with a debt to assets ratio (Leverage Ratio) of 42.6% and whose portfolio exposure is mainly in the office space. With the large supply of office spaces in 2016 because of Guoco Towers and South Beach Towers, there will be a fall in office rentals due to this oversupply. This fall in rental rates and higher vacany rates due to an oversupply will cause Keppel reit's Singapore assets to be valued lower. This results in an increase of the reit's leverage ratio. With MAS’s rule that the leverage limit should not exceed 45%, Keppel reit is likely to seek money from shareholders to shore up its balance sheet.  And its majority shareholder happens to be Keppel Corp who holds a 45.39% stake.

Keppel’s Dividend

At a trailing dividend yield of 7%, Keppel appears to be a steal because one would naturally think a yield protection of 7% will be obtained for holding Keppel through this period. However, given the gloomy assessment, I do not think Keppel will sustain its 0.48 cents dividend over the next few years. A reduction of dividend is on the cards due to the poor business environment and tight cash flow.

As of end June 2015, Keppel has 2.37 Billion of cash. While it seems a lot, it is worth noting this figure has been further reduced because for this quarter, Keppel paid out its interim dividend ($215M) and cash was asked by one of its subsidiary, Kris energy ($105M). It is likely Keppel’s cash holdings is now much lower. In addition, Keppel is likely to have set aside $1.2 Billion as working capital for its offshore and property operations. Coupled with a high chance that Keppel Reit will require funding so as not to exceed MAS’s requirement on leverage ratio, it is unlikely Keppel will sustain a 48 cents dividend for next year. Such dividends will cost Keppel $870 million of cash every year. The only plausible way for Keppel to maintain dividends is to borrow more money.

Conclusion

While Keppel is likely to ride out the storm in the oil & gas and property industry in the long run, the question for us investors is if Keppel worth the purchase at $6.80 now? To me, given the outlook, I do not feel it is worth the price and is likely to decline further when it is likely to report lower earnings next year (due to lack of one-off gains) and a cut in dividend. Keppel may be worth a re look if it goes below $6.