Is Sembcorp Industries Limited A Bargain Right Now?

Local blue chip Sembcorp Industries Limited (SGX: U96) has seen its shares punished by the market in recent years.

Since 10 October 2014, the utilities and marine engineering conglomerate has seen its share price fall by a stunning 48% to S$2.61 currently.

Shares that have fallen hard may represent good value. But, not every one of them will be a legitimate bargain. So, which group is Sembcorp Industries likely to belong to?

It’s not an easy question to answer. But, fortunately, I have some help from Peter Lynch. Lynch is the legendary fund manager of the US-based Fidelity Magellan Fund from 1977 to 1990. In those 13 years, he managed to rack up annual returns of an incredible 29% – that’s enough to turn $1,000 into $27,000!

In his classic investment book One Up On Wall Street, Lynch shared a general checklist he had used when he was researching stocks. Let’s see what the checklist can tell us about Sembcorp Industries.

1. The Price-Earnings ratio: Is it low or high for this particular company and for similar companies in the same industry (generally, low PEs are preferred).

At Sembcorp Industries’ current stock price, it is valued at 13.8 times trailing earnings. You can see in the chart below how the conglomerate’s PE ratio is near a five-year high at the moment:

Source: S&P Global Market Intelligence

Moreover, Sembcorp Industries’ PE of 13.8 is also slightly higher than the market average as represented by the SPDR STI ETF (SGX: ES3). To the point, the SPDR STI ETF – an exchange-traded fund that mimics the fundamentals of the Straits Times Index (SGX: ^STI) – has a PE of 12 right now.

It’s obvious that Sembcorp Industries has not ticked the right box here.

2. What is the percentage of institutional ownership? The lower the better.

This criterion was added by Lynch because he thought that companies that were not noticed by institutional investors (big money managers) tended to make for better bargains.

Unfortunately, Sembcorp Industries has a very high level of institutional ownership. As of 1 March 2016, Temasek Holdings has a total stake of 49.5% in the company. Temasek is one of the investment arms of the Singapore government and has assets under management of over S$240 billion.

3. Are insiders buying and whether the company itself is buying back its own shares? Both are good signs.

Lynch thinks they are good signs because they could be a signal that a company’s management sees the shares as undervalued.

In the case of Sembcorp Industries, it has bought back shares of itself sporadically in the past six months. The company has a share buyback mandate that started on 19 April 2016 – since then, it has purchased 1.05 million shares of itself, which represents merely 0.06% of its total share count as of 19 April 2016.

Given the small amount of buybacks over the past six months, I think that the scales should tip toward a ‘No’ here for this criterion for Sembcorp Industries.

4. What is the record of earnings growth and whether the earnings are sporadic or consistent?

The following chart shows Sembcorp Industries’ earnings per share from 2005 to 2015:

Source: S&P Global Market Intelligence

The conglomerate’s earnings have been consistently positive over the past decade, so that’s a plus. But, growth hasn’t been smooth. In fact, Sembcorp Industries’ earnings per share had declined by 34% in 2015. The slide has continued: In the first-half of 2016, Sembcorp Industries’ earnings per share had fallen by 51%.

Given these numbers, I think it’s fair to conclude that the company’s record of earnings growth has been poor.

5. Does the company have a strong balance sheet?

As of 30 June 2016, Sembcorp Industries has total debt of S$8.53 billion but cash of just S$1.68 billion. With shareholders’ equity of S$5.58 billion (excluding perpetual securities), this results in a net-debt to shareholders’ equity of 123%. That’s not low and does not look like a strong balance sheet to me.

Bonus criterion! Does the company have room to grow?

This criterion appeared in One Up On Wall Street in a more-specific checklist that Lynch used for fast-growing companies. But, I think it’s very appropriate for most companies since a company that can’t grow would find it very tough to build value for shareholders.

Sembcorp Industries has two main business segments: Utilities and Marine. The latter comes from the company’s majority ownership of Sembcorp Marine Ltd (SGX: S51). In its earnings release for the second-quarter of 2016, Sembcorp Marine’s outlook appeared bleak.

Sembcorp Marine’s outlook is corroborated by recent comments made by the management of property development and marine engineering conglomerate Keppel Corporation Limited (SGX: BN4). Keppel Corp’s chief executive had commented around three months ago that the oil & gas industry “must be prepared for not only a long winter, but a harsh one.”

Both Sembcorp Marine and Keppel Corp are amongst the world’s largest oil rig builders and their businesses have been hurt by the drastic fall in the price of oil over the past two years.

At the Utilities end of Sembcorp Industries’ business, I had pointed out a few months ago in an article that the segment has failed to generate any significant growth in revenue and profit between 2011 and 2015 despite seeing huge increases of at least 54% in its power and water capacity (of the in-operation and under-development varieties).

All the above we have seen in relation to the sixth criterion leads me to think that Sembcorp Industries’ room to grow appears to be crimped, at least over the medium-term.

A Fool’s take

Rounding it all up, Sembcorp Industries does not appear to be a company that would catch the eye of Lynch. It has a high PE ratio, a high level of institutional ownership, no significant insider buying, a poor record of earnings growth, a weak balance sheet, and an apparent lack of growth opportunities.

That said, as useful as Lynch’s checklist is, it should only be used as a starting point. Investors would have to dig deeper into Sembcorp Industries (such as its cash flow picture) in order to arrive at an investing conclusion.

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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.