Tug-Of-Fools: Keppel Corporation – The Bear Argument

I am Shane Goh. Here is my bear case for Keppel Corporation (SGX: BN4).

Keppel Corp is a home-grown conglomerate that derives its income from three core business segments: Offshore & Marine (O&M), Infrastructure and Property. The O&M unit builds jackup rig, semisubmersible drilling rig and drill ships.

Keppel Corp’s infrastructure unit was formed with the reorganisation of Keppel Energy and Keppel Integrated Engineering in 2013. It operates power plants, engages in waste-to-energy (WTE) projects, provides data centre space and logistics and distribution services.

Through Keppel Land (SGX: K17), Keppel Corp develops, sells and manages residential and commercial properties such as Marina Bay Financial Centre Tower 3. Its key markets are Singapore, China, Indonesia and Vietnam.

Weak infrastructure margin

For the past five years, Keppel Corp’s infrastructure unit generated about 20 percent to 28 percent of the firm’s turnover. However, the highest net profit margin it has enjoyed was 0.6 percent. That means for every dollar in revenue obtained, Keppel Corp earned 0.6 cents.

Source: Company Financial Reports

The segment has met challenges with engineering, procurement and construction contracts related to its WTE business in Doha, Qatar and Greater Manchester, UK. This resulted in additional provisions taken at the end of its financial year 2013 (FY13).

Although the segment’s net profit margin has turned black from a negative position during 2009 to 2011, profitability remains razor-thin.

This suggests Keppel Corp would rely on its other two core business units to drive its bottom line.

Soft oil price forecast

Despite O&M’s falling turnover from 2009 to 2013, it remains Keppel Corp’s primary revenue contributor. In FY13, the O&M unit delivered 57.6% of the firm’s turnover. As at end December 2013, the segment’s net order book stood at approximately S$14.2 billion with works stretching to 2019.

The type of products the O&M business manufactures is targeted at oil drilling companies. Their incentive to drill more would be linked to prices they are able to sell the oil for. The higher the price, the more likely they would ramp up their drilling activities.

Based on World Bank’s commodity price forecast in January 2014, the average crude oil spot price is expected to experience a steady fall from US$103.50 per barrel in 2014 to US$96.70 per barrel in 2025.

Source: World Bank

The forecast decline in oil prices suggests a potential slowdown in drilling activities. Oil drilling companies would be more cautious with their capital expenditures under such circumstances and look to prolong the lifespan of their equipment instead of buying new rigs or drill ships.

If they make fewer orders to rigbuilders such as Keppel Corp, this will have a negative impact on Keppel Corp’s revenue.

Interest rate hike

The US Federal Reserve (Fed) chair, Janet Yellen, marches on with her tapering stance on its Quantitative Easing programme. A survey conducted by Reuters in early 2014 showed that all 70 economists expect the Fed to shut down the programme by year-end.

In the latest Fed policy meeting, Yellen expects the first possible interest rate rise to come approximately six months following the end of the asset purchase programme. This will make borrowing costs more expensive and limit potential buyers’ spending power.

Since the initial signal of a tapering intent in May 2013, Singapore real estate stocks have not fared well. The FTSE ST Real Estate Index (SGX: FSTAS8600) has tumbled 22.1% at its lowest.

On top of a looming global interest rate hike, the Singapore government has introduced a slew of cooling measures in the past few years to calm an overheating property market.

Based on statistics from the Urban Redevelopment Authority, prices of private residential properties decreased by 0.9% in the fourth quarter of 2013, the first time that overall prices have dipped since the first quarter of 2012.

Faced with these two strong headwinds, the outlook for Keppel Corp’s property arm, which derives close to half of its revenue from Singapore, seems muted.

In conclusion, while Keppel Corp has shown steady net profit over the past five years (2009: S$1.6 billion, 2013:  S$1.8 billion), several obstacles stand in its way moving forward.

You can read the bull argument here.

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