Plunging oil prices have left a trail of destruction in the oil and gas industry.
Keppel Corporation Limited (SGX: BN4), the world’s largest rig builder, was no exception.
The rig giant reported a net loss of S$506 million for its fiscal year 2020 (FY2020) after incurring S$952 million of impairments for its offshore and marine (O&M) division.
The situation has not improved this year.
In the group’s fiscal 2021 first quarter (1Q2021) business update, it was stated that “all business units apart from O&M were profitable”, implying that the division continues to suffer from losses.
The persistent trouble within the industry appears to have pushed management to consider what was once thought to be unthinkable: exit rig building altogether.
The first move was made earlier in January, when the O&M division was restructured into three disparate companies as part of the group’s strategic review.
The second, which was just announced last week, involves the exploration of a possible combination with Sembcorp Marine Ltd (SGX: S51).
With this recent announcement, it seems management’s plan to transform the group is gaining momentum.
Here are four things investors should know about this announcement.
Forging a stronger entity
If the combination goes through, the combined entity will be listed and Keppel will receive shares in it, along with a S$500 million cash consideration.
However, Keppel intends to distribute all the combined entity’s shares to its shareholders to allow them to participate in the future growth and recovery of the oil and gas sector.
In addition, Keppel will also enter into a joint venture with the combined entity and will hold a 50% stake in a 50-50 joint venture.
The intention is to allow Keppel to provide its expertise and capabilities to assist the combined entity with the execution of its projects.
The combined entity will also be the preferred exploration, procurement and construction (EPC) partner for Keppel’s projects should staff within the entity possess the relevant expertise.
Keppel believes that the formation of this combined entity will be a game-changer, creating a stronger player that can compete effectively for larger contracts.
Keppel’s ongoing relationship with the new entity can also bring continued business for the group through the strategic partnership.
Investors should also note that Keppel has signed a non-binding memorandum of understanding (MOU) with Kyanite, a unit of Temasek Holdings.
The MOU will explore the feasibility of selling Keppel’s legacy completed and uncompleted rigs to a separate company called Asset Co.
Asset Co will be majority-owned by external investors, with Keppel retaining a stake of not more than 20%, thereby lightening the group’s balance sheet considerably.
The external investors will help to fund any uncompleted rigs and Keppel will no longer need to commit resources, manpower and money.
Over time, the intention is for Keppel to gradually reduce its exposure to Asset Co as the rigs are sold off when conditions in the oil and gas market improve.
Boosting Keppel’s financial strength
These proposed transactions, which are conditional upon each other, will help boost Keppel’s earnings for the current fiscal year.
However, discussions are still ongoing and Keppel’s CEO, Loh Chin Hua, believes that a definitive agreement can only be reached before the end of the year, likely in the fourth quarter.
Even if an agreement is hammered out, it’s still necessary to obtain regulatory and shareholders’ approval, so 2022 is a more realistic date for the transactions to be completed.
Assuming the deal is inked, the S$500 million injection will be used to fund new growth initiatives. If the group has no use for the cash, part of it may be returned to shareholders in the form of dividends.
More importantly, Keppel’s net debt will also fall due to the deconsolidation of the O&M division.
Aligned with Vision 2030
On 28 May 2020, Keppel released its Vision 2030 analyst briefing slides.
Vision 2030 is a strategic vision of what Keppel intends to morph into in 10 years.
The goal was to address macro trends such as technology proliferation, energy transition and the power of platforms to help the group to evolve and set the stage for its next leg of growth.
An important objective of this strategy is to seize opportunities in green developments and renewables as part of Keppel’s ESG push.
The move to split the O&M division into three parts and the MOU signed with Kyanite are aligned to pivot Keppel away from heavy oil and gas reliance.
To this end, Keppel has set a target for its return on equity at 15%.
The goal will be achieved via a mix of capital recycling, increased allocation to asset management, and focus on integrated projects.
By 2030, Keppel’s objective is to become a leader in ESG with a strong sustainability agenda.
And for investors, its stock should pay good dividends and also display a strong growth trajectory.
Get Smart: The jury is still out for now
While Keppel’s strategic vision sounds exciting, a lot will depend on its execution.
External factors will also play a role in determining if Keppel can achieve its long-term vision.
Keppel’s share price is still down around 7.4% since it announced its Vision 2030.
As to whether the group can be successful or not, the jury is still out for now.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.