Why Investors Should Not Be Too Excited About Keppel Telecom & Transport Ltd’s 290% Earnings Growth

Logistics and data centre outfit Keppel Telecom & Transport Ltd. (SGX: K11) announced its full-year results for 2014 yesterday evening.

On first glance, there is much to celebrate. Revenue for the year grew by 34.6% to S$224.6 million; operating profit made a remarkable multi-fold jump from S$33.3 million in 2013 to S$278.9 million; net profit also achieved a sizeable increase of 290% by spiking from S$63.2 million a year ago to S$246.6 million.

For a company with a sizeable market capitalisation of S$800 million, Keppel T&T is now trading at an eye-popping price to earnings (PE) ratio of just 3.3. For some context on how low that is, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market barometer the Straits Times Index (SGX: ^STI), is valued at around 13 times earnings.

Yet, investors should not be overly excited about the company’s latest results.

Stagnant operating results

Let’s start with the reasons for the firm’s big profit jump first. In 2014, Keppel T&T earned S$245.5 million in “other income,” with the bulk of that income coming from the one-time sale of two data centres and the firm’s stakes in some of its subsidiaries and associated companies. According to the company’s announcement:

“Excluding the one-off gains, operating results for the full year would be 21% higher than last year due largely to sundry income and distributions from other investments during the year.”

Although Keppel T&T’s operating profit seemed to have still grown by a respectable 21% even after backing off all the one-time gains from the divestments, there was no elaboration from the company on how sustainable the sundry income and distributions from other investments are like going into the future.

If we adopt a more conservative mindset and exclude “other income” entirely, Keppel T&T would have recorded an operating profit of S$83.1 million for 2014, which is basically unchanged from where it was in 2013.

Other sources of worry

Now, let’s move on to other pressing concerns other than the flat operating profit.

The company had recently spun-off its data centre businesses into Keppel DC REIT (SGX: AJBU) (that’s the reason for Keppel T&T’s sale of the data centres and its stakes in the subsidiaries and associated companies). Now, Keppel T&T owns a 30% stake in the REIT and is also the REIT’s manager.

The REIT will continue to be “a platform for the company to develop and grow its pipeline of data centre assets.” What this means is that Keppel T&T would be developing or acquiring data centre assets in the hope of selling them to Keppel DC REIT at a later date.

Therefore, the company’s data centre business would become a construction-like business, with no recurring or stable earnings stream except for management fees and distributions from Keppel DC REIT.

So, Keppel T&T’s logistics business will be its main operating business in the future and it would make sense for investors to focus more on that.

Unfortunately, the logistics segment is a problematic area. For 2014, Keppel T&T saw revenue from the logistics segment grow by 30.7% to S$148.7 million. But, net profit from the segment actually shrank by 38.7% to S$9.85 million mainly as a result of impairment losses and lower profit from associated companies. This is not a good sign.

What does the future hold

In my view, Keppel T&T is now essentially an investment holding company. Here’s why.

In 2013, Keppel T&T’s main source of profit had been its 19% stake in telecommunications outfit M1 Ltd (SGX: B2F); but given that M1 contributed slightly less than half of Keppel T&T’s total profit, the latter could still be said to be an operating company.

But in 2014, with the divestment of Keppel T&T’s data centre businesses into Keppel DC REIT, the company’s sole remaining operating business – the logistics segment – is now just a tiny part of its overall profit picture. It thus stands to reason that Keppel T&T looks more like an investment holding company than an operating firm.

This brings us to the possibility of Keppel T&T’s shares being tagged with a “conglomerate discount” – I had shared more on that topic recently, so check it out here.

With so much uncertainty facing the company in the future (for instance, there’s the potential conglomerate discount, as well as the shrinking earnings at the logistics side), investors should look beyond the 290% boost in profit in 2014 and ask: “What’s next?”

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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 Stanley Lim does not own any company mentioned