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Is The Beaten-Down Keppel Corporation Limited A Bargain Now?

It seems that the recent fall in the price of oil has hurt Keppel Corporation Limited (SGX: BN4) badly.

Since the start of June, the offshore & marine and property conglomerate has seen its share price slide by some 22% from S$10.63 to S$8.34 currently. This has happened even as the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the market barometer the Straits Times Index (SGX: ^STI), has inched up by 0.6% to S$3.36 in the same period.

With Keppel Corp’s large price decline recently, is it a good time for investors to go bargain hunting?

A historically cheap valuation

We can turn to Keppel Corp’s valuation for some help in answering the question.

Keppel Corp PE ratio

Source: S&P Capital IQ

The chart above, which plots Keppel Corp’s PE ratio going back all the way to the start of 2005, shows that the company’s current PE of 8.1 is significantly lower than its long-term average PE (going back to the start of 2005) of 13.1.

A comparison of Keppel Corp’s valuation with that of the market average also points toward the share as being cheap; currently, the SPDR STI ETF is valued at around 13.4 times its trailing earnings.

It must be noted, though, that even a comprehensive look at Keppel Corp’s valuation can’t give us a full picture – a share with a low valuation can still turn out to be a dreadful mistake if its business crumbles over time.

With Keppel Corp though, despite short-term headwinds, there’re reasons to be optimistic.

A resilient company

I’m going to be focusing on Keppel Corp’s offshore & marine business segment, where it builds oil rigs and converts vessels to suit customers’ needs, for two main reasons.

Firstly, the offshore & marine segment has been the biggest contributor to the company’s profits over the past few years. Secondly, although the company’s main geographical markets for its property segment (namely Singapore and China) have been soft of late, it’s really the recent tumble in oil prices which has coincided with Keppel Corp’s sharp price fall; this leads me to believe that the market’s focus has really been on the company’s oil & gas-related business.

Keppel Corp price chart

Source: Yahoo finance

The chart immediately below looks back at Keppel Corp’s offshore & marine business in relation to the movement of oil prices. It shows that the segment has been remarkably resilient even to crumbling oil prices.

Keppel Corp profit versus oil price chart

Source: Company filings for net profit; Index Mundi for monthly Brent crude prices

Even as Brent crude languished at around US$40 per barrel or lower in the first quarter of 2009, dropping from a peak of around US$130 a barrel in the latter half of 2008, Keppel Corp’s offshore & marine business still managed to clock in very respectable profits of S$191 million and S$206 million in the first and second quarters of 2009, respectively. For some perspective, the first two quarters of 2014 saw the segment ship in profits of S$241 million and S$280 million.

There’s certainly some seasonality and a hint of cyclicality involved with the firm’s offshore & marine segment, but it has been able to weather past storms admirably. This is why there’s some cause for optimism even in the current pessimistic environment for the price of oil.

The cyclical nature of oil

There’s also one other point to note about the recent rout in oil prices – the danger of “extreme extrapolations” as renowned financial journalist Jason Zweig puts it. According to Zweig in a recent Wall Street Journal article, in 2008, when oil peaked at around US$145 a barrel, analysts were all rushing to peg oil at much higher prices; Goldman Sachs even had forecasts for oil to reach US$200.

But when oil crashed by almost 80% between July and December 2008 (as can be seen my chart above), analysts then “hastened to reverse their projections,” wrote Zweig, “just in time for oil prices to go right back up.” He then added (emphasis mine):

“Now that oil has fallen by 38% in five months, you should expect a rash of predictions of apocalyptically low pries… [But with] any asset, be skeptical of anyone who forecasts either an epic boom after prices have risen or an even more catastrophic collapse after they have fallen hard.”

So in other words, sentiment might often swing to extremes even when the movement of the fundamentals are often a lot more mundane.

A Fool’s take

Keppel Corp’s now trading at a low valuation likely due to fears over its offshore & marine business (and some concerns over its real estate development business too). However, there are reasons for investors to be optimistic about the company’s future given the resilient nature of its oil-related business in the past.

But that said, investors should never invest only with the rearview mirror on. Oil might still really crash hard from here (though that’s unlikely like I mentioned earlier), severely crimping the long-term demand for rigs and hurting Keppel Corp’s main profit driver badly. All told, investors would have to weigh the risks and rewards with Keppel Corp in order to make an intelligent investing decision.

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