SINGAPORE (Feb 11): As digitalisation marches on, companies from two sectors stand out in earnings and margin declines — Singapore Press Holdings (SPH, media) and Keppel Corp and Sembcorp Marine (offshore and marine, or O&M). Several companies, notably those in the technology and semiconductor sectors, have also suffered revenue and earnings declines, and many of these are on the Singapore Exchange’s watch-list, but this could be due to poor management and financial engineering.
In most parts of the world, particularly in developed economies, industries often suffer a decline after maturity. This decline is consistent, and mainly reflected by falling demand and margins. These industries, known as sunset industries, are subject to a structural decline, which should not be mistaken for a cyclical movement in economic and business cycles. The reason for the decline may be due to a permanent shift in consumer preferences or simply lack of resources to sustain the demand in the industry. Traditional print media and the oil and gas (O&G) sector are some examples of sunset industries in Singapore. Whether investors should relook at these industries depends on the extent to which the companies are able to innovate, diversify, or divest the sunset business. For SPH, diversifying is proving a lot more profitable than innovating.
Monopolistic SPH suffers from democratisation of news
News continues to be relevant, but the consumption of news and analyses has changed. The news industry is not a sunset one, but print media is. SPH has a monopoly in Singapore, but the monopolistic nature of its business has been disrupted by the democratisation of news with the internet and smartphone. Readers can get news from anywhere, anytime. They turn to SPH mainly for local news and local socio-economic issues.
SPH’s broadsheet, The Straits Times, has been a nationwide name and amassed a large market share throughout its circulation history. No surprise then, that in recent years, readership and margins are in declining mode.
Like other newspapers worldwide, SPH is focusing on a digitalisation strategy. Despite its shrinking market, SPH’s digital initiatives have been fruitful, as reflected by a 17% compound annual growth return from 2013 to 2018 for its digital revenue. Particularly, SPH’s launch of Singapore Media Exchange, a digital advertising marketplace, last May has enabled a double- digit gross profit margin in 1QFY2019 for its digital revenue segment.
On the other hand, market watchers have questioned the relevance of The Business Times. Democratisation of news implies that financial news is readily available elsewhere and at websites other than that of BT. Investors can easily access information from a plethora of financial news websites, university research arms and investment blogs that compete with BT for subscriptions. Digitalisation is not sufficient for SPH, once a monopoly. It needs another boost, particularly for the long term.
Property is the answer
Companies such as SPH can diversify and make a different, more profitable and sustainable segment their flagship revenue and net income contributor. SPH’s property segment was its largest profit before tax (PBT) contributor for FY2017 and FY2018; more importantly, though cyclical, it is not a declining segment (see Chart 1).
SPH plans to grow its property portfolio, particularly through its subsidiary, SPH Real Estate Investment Trust. SPH REIT acquired an 85% stake in an Australian shopping centre, Figtree Grove, in December 2018 for $175 million. Seletar Mall, 70%-owned by SPH, has stabilised and is a pipeline property for SPH REIT. Seletar Mall is valued at $488 million (SPH’s stake totals $342 million). SPH REIT, which has assets under management (AUM) of $3.4 billion and gearing of 26.3%, can easily acquire Seletar Mall with debt. This would raise its gearing to around 37%, which is comfortably below the ceiling of 45%.
SPH tendered for a mixed-use development site at Pasir Ris last December. Furthermore, its acquisition of a UK student accommodation portfolio for $321 million last September effectively contributed $6.3 million and $3.2 million to its total property segment’s revenue and PBT respectively, or 9.3% and 7.7%.
There are pros and cons to diversifying into the UK, according to a recent OCBC report. “We believe that it is highly likely for the group to continue to bulk up on its UK student accommodation portfolio, pursuing assets associated with the Russell Group that give a ~6% cap rate,” the report says. The UK government outlined in a December 2018 white paper that there will continue to be no limit on the number of international students who can study in the UK, and it will also offer six months’ post-study leave to all master’s and bachelor’s students at institutions with degree-awarding powers, OCBC writes. However, there are risks because of Brexit. “We believe that concerns will still linger. In particular, concerns were raised about the uncertainty created by Brexit, such as in research links, exchange of students and research funding sources,” OCBC adds.
Unfortunately for SPH, only 55% of the first 50 units released at Woodleigh Residences were sold during the soft launch, an indication that its earnings could be adversely affected with lower uptake rates after the property cooling measures last July. “With the second phase of Woodleigh Residences estimated to be launched in 3QFY2019, we expect a bumper crop of new private home launches in 1H2019 to provide some level of competition,” the OCBC report says. OCBC maintains a “hold” recommendation for SPH.
The Woodleigh site is a mixed-use development and the planned mall is likely to form a future pipeline for SPH REIT. In addition, SPH owns a 31% stake in Chinatown Point.
Future-proofing SPH
Investment properties make up almost 70% of SPH’s balance sheet. Tangible assets, especially property, are a safer bet. This is because digitalisation entails constant and superior innovation, which means SPH may find that the technologies it invests in have less utility than that of its competitors, which would affect its market share adversely because it is extremely easy to switch news providers.
Moreover, digital assets are viewed as intangible assets, so they cannot be sold off to recover losses. Secondly, property provides downside protection: SPH can still collect rental income from its investment properties even if property prices fall, but if demand for SPH’s newspapers falls, the company cannot recoup its losses from the same segment. SPH can also enhance its earnings from investment properties by selling them to SPH REIT, and further expand its property portfolio through the REIT and with private funds, to garner higher fee and rental incomes. At some point, SPH can “syndicate” its student accommodation by seeding a fund with other like-minded investors. Mapletree Investments has formed a fund for its student accommodation portfolio, which is a much larger one than SPH’s. Fund management would provide SPH with an additional stable revenue source.
Ultimately, SPH’s resources should be devoted into building a competitive edge for the media segment, backed with stable recurring income from its property portfolio. Or, SPH could divest of its media business and focus on its more profitable property- related business.
Structural decline of fossil fuel traps local players
The Intergovernmental Panel on Climate Change (IPCC) has released a report on a global carbon budget, which represents the quota of carbon emissions from the use of non-renewable fossil fuels to ensure the planet’s sustainability. Many investors tend to ignore the issues of global warming, the physical depletion of fossil fuels and the increasing usage of renewables in meeting global energy demand, as they hope to reap significant gains from the non-renewable energy industry.
The oil price collapse in 2014 affected many global O&G players throughout the entire supply chain adversely, and reminded investors that this industry with depleting resources is not loss-proof. In Singapore, Emas Offshore, Swiber Holdings, Swissco Holdings, Pacific Radiance and EMS Energy have all been suspended, owing to financial and liquidity issues. Ezion Holdings and Marco Polo Marine were able to restructure and remain listed. However, their cash flows and earnings continue to be challenged. Ezion’s cash flow turned positive within the past year, but it had a large impairment and is now believed to be in talks with a white knight. Marco Polo Marine’s cash flow remains negative for the time being.
Keppel Corp, 20.43%-owned by Temasek, is one of the O&M survivors along with Sembcorp Marine, in which Temasek has a deemed stake of 30.2%. In our story titled “Keppel gets boost from property, as O&M division continues to grapple with slowdown” (Issue 866, Jan 28), we highlighted the uncertain outlook for Keppel Corp’s O&M segment, which is its core business.
In a recent update, Deutsche Bank said Keppel Corp’s 4QFY2018 earnings were 28% below its expectations because of the O&M segment. During the quarter, Keppel Corp made an impairment of a further $167 million for the Sete Brasil rigs. “We note that O&M prospects appear to be incrementally more positive, while future earnings should be underpinned by strong pre-sales overseas,” Deutsche Bank says. During a results briefing, Loh Chin Hua, CEO of Keppel Corp, said: “We hope for the best, but we don’t expect a V-shaped recovery.”
The diversification into liquefied natural gas vessels is one that is relatively sustainable. LNG is the bridging fuel between fossil fuels and renewable energy. In addition to that, similar to SPH, Keppel Corp’s property segment is a clear and consistent contributor to its business value and earnings (see Chart 2).
On the other hand, Keppel Corp’s investment division recorded a net loss of $16 million, driven by a $53 million write-down for investments in associates, and losses related to KrisEnergy, a company that managed to survive the O&G downdraft due to the largesse of its shareholders, including Keppel Corp, in a restructuring exercise.
Sembcorp Marine’s position is more precarious. Chart 3 shows the price growth of the company against the weighted value growth. Though it appears to be fairly valued, the fundamentals of the business is weak. This is evident from the weighted value line (in blue), which shows consistent negative growth over time. In its latest 3QFY2018 results statement, the company projected negative operating profits in the immediate quarters, followed by uncertainty in the longer term over its order book outlook. Sembcorp Marine has also diversified into supporting the LNG value chain and has gained customers for its LNG-based solutions. Sembcorp Marine’s parent, Sembcorp Industries, has a diversified business underpinned by the utilities and urban development segments. These are not fast-growing businesses but provide more stable cash flows than O&M at this juncture.
From the above case studies, it is obvious that companies should divest of the unprofitable and sunset segment of their business in which they once dominated.
