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2 Big Risks With Sembcorp Industries Limited That Investors Have To Note

Utilities, marine engineering, and urban development conglomerate Sembcorp Industries Limited (SGX: U96) may be an attractive stock for bargain-loving investors at the moment.

At its current share price of S$2.71, the company has low price-to-book and price-to-earnings ratios of 0.75 and 8.8 respectively. Furthermore, the two ratios are near five-year lows, as you can see below.

Sembcorp Industries' price-to-book (PB) and price-to-earnings (PE) ratio over past five years
Source: S&P Global Market Intelligence (click chart for larger image)

But as enticing as those valuations are, there are two big risks with Sembcorp Industries that prospective as well as current investors in the company may want to note.

The first is the potential for more headaches in the future for Sembcorp Industries’ marine engineering arm. This business is represented by Sembcorp Industries’ 61% ownership of the listed Sembcorp Marine Ltd (SGX: S51).

In a previous article, I had mentioned that Sembcorp Marine’s growing receivables in the absence of revenue growth in the fourth-quarter of 2015 (revenue had dropped by over 8% whereas total receivables had jumped by 26%) may be forming a toxic combination with its deteriorating balance sheet.

To the point about Sembcorp Marine’s balance sheet, I had produced the following chart in my previously mentioned article to show how the company’s net debt to equity ratio had climbed to 103%, the highest it’s ever been over the past decade:

Sembcorp Marine's quarterly net-debt to equity ratio since last-quarter of 2005
Source: S&P Global Market Intelligence; author’s calculations

The second big risk about Sembcorp Industries is with its utilities business. More specifically, it’s about an absence of growth in the business segment. From 2011 to 2015, here’s how the Utilities segment’s revenue and profit (before exceptional/significant items) had changed:

Sembcorp Industries' Utilites segment financial results table
Source: Sembcorp Industries’ earnings releases

Over the four year period from 2011 to 2015, we can see that the Utilities segment’s revenue had shrank. Meanwhile, its profit, after stripping off one-off items, had barely grown. Now, what’s interesting is that Sembcorp Industries had increased the segment’s power production and water treatment capacities substantially in that timeframe.

Sembcorp Industries' Utilites segment capacity table
Source: Sembcorp Industries’ earnings release

The table just above shows the segment’s growth in total capacities that are in operation as well as under development. It’s unclear just exactly how much power and water capacity were actually in operation as of 2011 and 2015.

So, it’s highly possible that the bulk of the increase in the figures seen in the table are only for capacities that are under development. If that’s the case, then there may be a big jump in the Utilities segment’s revenue and profit in the future. But if it isn’t, then the lack of economic growth in Sembcorp Industries’ Utilities business segment is a risk that investors may want to be wary of.

Sembcorp Industries has pumped in serious amounts of money into its Utilities business segment from 2011 to 2015 judging by how the segment’s equity had expanded from S$1.69 billion to S$4.25 billion in that period. If all that investment can’t produce any meaningful growth in revenue and profit, then that is money that hasn’t been well spent at all, in my opinion.

A Fool’s take

Sembcorp Industries has attractive valuations at the moment. But, there are important risks to note with the firm – in both its Marine and Utilities business segments – as I have pointed out and they are things investors may want to consider when looking at the company before making any 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 doesn't own shares in any companies mentioned.