A major beneficiary of higher energy prices was Sembcorp Industries (SCI) U96 % , one of the better-performing component stocks of the Straits Times Index last year. The power-producing group announced a net profit of $883 million for FY2022 ended Dec 31, 2022 before exceptional items, up 87% y-o-y, and a net profit of $848 million, up 204% y-o-y after exceptional items. The exceptional item was an $8 million write-off for an investment in Vietnam because of expenses. The $848 million figure was above the average of $819 million analysts were expecting.
SCI’s earnings come from a renewable energy portfolio driven by acquisitions, conventional energy, and integrated urban solutions which include industrial parks.
The surge in group net profit was a result of higher power costs in 2022. SCI is an important supplier of power in Singapore. This is reported under its conventional energy segment which posted net profit before exceptional items of $766 million in FY2022, up from $373 million in FY2021. The doubling of net profit was due to higher energy demand and better margins in Singapore and the UK.
Net profit from the renewable energy portfolio rose by 150% y-o-y to $140 million due mainly to two acquisitions made in 2022 — a 35% stake in SDIC New Energy and 98% in Shenzhen Huiyang New Energy (HYNE) — as well as higher prices for solar energy in Singapore.
Integrated Urban Solutions reported a 5% y-o-y decline in net profit in FY2022 to $140 million due to lower land and property sales in China, offset by higher contribution from Wilton 11 in the UK.
Given the doubling of net profit and a much improved operating and free cash flow position, SCI announced a special dividend of four cents. This, coupled with an interim dividend of four cents and a final dividend of four cents, provides a total dividend payout of 12 cents.
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Can net profit levels be maintained?
What can shareholders expect in FY2023? Clearly, global gas prices remain elevated despite being a lot lower than their highs in 2022. The US Energy Information Administration (EIA) expects the Henry Hub natural gas spot price to average US$3.40 ($4.50) per million British thermal units (MMBtu) in 2023, down almost 50% from last year and about 30% from EIA’s January Short-Term Energy Outlook forecast. “We revised our outlook for Henry Hub prices as a result of significantly warmer-than-normal weather in January that led to less-than-normal consumption of natural gas for space heating and pushed inventories above the five-year average,” EIA says.
As a result of the lower natural gas consumption in January, natural gas inventories ended the month above their five-year (2018–2022) average. “We now expect inventories will close the withdrawal season at the end of March at more than 1.8 trillion cubic feet, 16% more than the five-year average,” EIA notes.
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SCI’s spread may come off, but its margins are likely to remain healthy because the cost of its gas does not depend on short-term market trends but on long-term gas contracts with its suppliers. SCI group president and CEO Wong Kim Yin says: “A good portion of our expected production is contracted. Input is a big driver of profit margins in the Singapore conventional energy business, and we expect the 2023 conventional energy business to be within our expectation. We are the largest importer of natural gas through pipeline and LNG [liquefied natural gas]. We have access to suppliers and customers and we’ve built a 20-year gas [supply] contract starting 2001. That contract continues to flow and we have entered into fresh contracts to replace what is depleting.
“Our gas position allows us to access and serve our customers with confidence for a reasonably long tenure. Because of that, I can go upstream and buy gas contracts for reasonably long tenures, and if you sign long enough, you’re given a reasonable price. We can see downstream and upstream and serve our portfolio needs and grow our position in the Singapore gas and electricity market.”
Group CFO Eugene Cheng says that in Singapore, roughly two-thirds of SCI’s assets are contracted out for one to three years, leaving one-third free as a “service back-up”.
Lim Siew Khee, analyst at CGS-CIMB, writes in a recent report that the power spread — the difference between its costs and the sale of power — at SCI is likely to stay strong. “We note that the USEP (Uniform Singapore Energy Price) has fallen by 20% h-o-h to an average of $259/kwh in 2H22, but year-to-date it is still elevated,” she says.
Higher cost of debt
Apart from lower electricity prices, SCI may have to grapple with high interest expenses. In FY2022, this was up only 5% y-o-y, but in 2HFY2022, finance costs were 19% higher y-o-y.
“Although we averaged 4.1% financing costs in 2022, we saw our weighted average cost of debt rise to 4.4% in 4Q2022,” Cheng indicates. He says that SCI has around $2 billion of refinancing to undertake in the next two years.
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While base rates have risen, longer-term debt costs less than short-term debt. “We will be looking to refinance at optimal tenors,” he says. “One of the successes in the last two years is the switch to using corporate level green [loans] where we get to average down margins and spreads, offsetting the impact on rising base rates. We expect interest cost to creep up but there are mitigating factors,” Cheng says.
Increasingly, SCI has been allowing project financing debt to fall, while raising its portion of green financing at the corporate level, which Cheng says is more efficient. “Our strategy is to reduce reliance on project finance loans and to increase green and sustainability-linked loans.”
In 2022, project finance loans accounted for 16% of debt while corporate debt was 84% of total debt. Half of the corporate debt is in sustainability-linked and green finance. “We raised $3.3 billion in [green] debt in the last 24 months,” Cheng says. SCI’s total debt stood at $7 billion while net debt was $5.8 billion as at Dec 31, 2022.
Some 66% of SCI’s debt is fixed while 34% is floating, hence leaving a smaller portion that is subject to the vagaries of interest rate trends. “In 2020, only 27% was fixed. Going forward we will still be focused on increasing the fixed rate portion with a target of 75%,” Cheng says.
He adds that SCI has cash and cash equivalents of $1.3 billion, committed revolving credit facility of $2.4 billion, uncommitted credit facilities of $2.5 billion and $912 million unutilised trade-related facilities.
Lower electricity prices, coupled with higher debt costs, have led analysts to forecast lower earnings for FY2023. CGS-CIMB is forecasting a net profit of $740 million, DBS expects a net profit of $681 million this year, while UOB Kay Hian is forecasting $658 million.
Pivoting to renewables
SCI’s stated strategy is to use its cash flow and earnings to increasingly pivot to renewables. As part of this strategy, SCI’s goal is to produce around 10 gigawatt (GW) of renewable energy by 2025. In 2022, including gross installed capacity for acquisitions announced in 2021 and 2022 pending completion, SCI can produce 8.3GW.
Cheng indicates that earnings from a full-year contribution from SDIC and HYNE would likely be $166 million. “Renewables ROE of 10.2% is on 11 months contribution by SDIC and seven months by HYNE. On a run rate they would have been 12%,” Cheng says.
Other announced acquisitions include a 49% stake in a portfolio owned by BEI Energy and a 45.3% stake in Xingling New Energy. In India, SCI completed the acquisition of Vector Green, a 583MW portfolio with predominantly solar assets, in January this year. SCI also secured 195MW of renewables projects in India in 2022.
Also in 2022, the Sembcorp Energy Storage System (ESS), Southeast Asia’s largest utility-scale ESS of 285MWh, was built across two sites in Banyan and Sakra on Jurong Island. The ESS mitigates the impact of solar intermittency and enhances grid resilience.
In the future, SCI is looking to green hydrogen as a possible growth sector. In 4Q2022, SCI entered into strategic partnerships with the Japanese government and various companies to explore hydrogen and other decarbonisation initiatives. These include a memorandum of understanding (MOU) with Japan Bank for International Cooperation (JBIC) to assist SCI in its hydrogen project; an MOU with Sojitz Corp for green hydrogen production, battery energy storage and net-zero industrial parks; and an MOU with IHI Corp to build out an integrated green ammonia supply chain.
The SEIL transaction
Another way that SCI says it will be able to increase its renewable energy portfolio is to recycle cash flows from brown projects — the so-called “brown to green” conversion. In January this year, SCI completed the divestment of Sembcorp Energy India (SEIL), the equivalent of $2.058 billion, to the Tanweer Consortium. SCI arranged vendor financing for the Tanweer Consortium via a deferred payment note (DPN) for 15 years. SCI will receive interest for the DPN at the rate of 1.8% plus the Indian government 10-year bond yield spot rate. For FY2021, this would have worked out to $157 million.
However, Anthropocene Fixed Income Institute, a non-profit think tank, sees the transaction as less environmentally friendly than SCI would have its investors believe. In November last year, Anthropocene published a paper calling the transaction the “carbon footprint arbitrage of a lifetime” and a “quick and dirty” solution to decarbonisation that highlights the weakness of current sustainability-linked bond structures.
In response to questions from The Edge Singapore, the paper’s co-author Cedric Rimaud says the transaction was a “blunt case of outright greenwashing” — that is, classing a transaction as “green” without tangible environmental benefits.
“In this particular case, ‘greenwashing’ represents a strategy of announcing a reduction in carbon emissions while only passing them on to another party without any reduction, with the sale being funded by the seller,” says Rimaud, senior credit analyst at Anthropocene.
According to him, SCI’s carbon emissions have been shifted from Scope 1, an integral part of SCI’s business, to Scope 3, through which SCI continues to finance the owners of the coal power asset. “The sale of SEIL does not result automatically in the reduction of the SEIL’s carbon emissions, while Sembcorp claims that it is sufficient to claim that it automatically delivers on its decarbonisation plans,” says Rimaud.
CFO Cheng, for his part, readily acknowledges that SEIL will no longer be contributing to Scope 1 and 2 emissions but instead to Scope 3 emissions.
But Rimaud believes that SEIL’s emissions have only moved from “operational to financed emissions”, making them still SCI’s responsibility to monitor. “It is important for investors in Sembcorp’s sustainability-linked bonds to engage with the company on this matter to ensure the carbon footprint is properly accounted for to avoid losing the coupon step-up of these bonds,” he says.
The way Wong sees it, the SEIL transaction was structured in a manner that would best serve the interests of SCI’s stakeholders, lenders, employees and customers. “Customer interest shouldn’t be compromised even if we promote our own green agenda,” he says. “The 2,000 employees [of SEIL] need stable earnings. They are living around the plant to serve their roles.”
According to him, an outright sale of SEIL would be conducted at a 40% discount out of a $2 billion book value, which would have adverse effects on SCI’s shareholders in terms of the company’s financial performance and balance sheet.
Wong says an outright sale would have seen SCI’s debt-to-equity ratio “float up” and hamper the company’s ability to grow. “Our book equity is $4.2 billion and $1 billion is material. Taking that big impairment is going to be a major value consideration from a shareholder perspective,” he notes.
“When we tell people we transit from brown to green, it means investing in renewables and taking the cash flow from brown assets to fund the green. In our mind, it’s very clear we are transiting from brown to green instead of selling at a 40% discount and causing a decline in equity on our balance sheet,” says the CEO.
Still, Rimaud believes that using the sale to fund a brown-to-green transition is not so straightforward. “The sale does not result in [cash flow] going to Sembcorp, given that Sembcorp funded the purchase through a loan to the buyer. As such, there is no fresh capital ready to be invested into new green projects,” he says.
For Anthropocene to not consider the transaction greenwashing, he says that SCI would have had to fund the purchase itself, and, more importantly, the sale would have to be subjected to strict conditions of reducing the carbon footprint over time. SCI could also have continued to account for the carbon emissions it was financing — through the funding it granted Tanweer Infrastructure to purchase SEIL — as part of its own Scope 3 carbon footprint until the financing had been completed, adds Rimaud.
But Wong says the manner in which the transaction was executed was the “best outcome” for the plant in India and for SCI’s stakeholders and shareholders. “We met financial accounting rules and carbon accounting rules,” he emphasises. “We’re happy with the outcome and we can move on and benefit from the brown cash flow to fund the green.
“Margins have been kind to us. Cash flow from our conventional energy segment is strong and has given us good cash flow to go into green assets and we are able to find and fund quality green projects.”