Sembcorp Industries Limited (SGX: U96), or SCI, made a surprise announcement last week.
The utility group is selling its entire stake in Sembcorp Energy India Limited (SEIL) for a total sum of around S$2.06 billion to a consortium led by Oman Investment Corporation (OIC), the Ministry of Defence Pension Fund, Oman, and Dar Investment SPC.
SEIL is one of the largest independent power producers in India and operates two supercritical coal-fired power plants totalling 2.6 megawatts (MW).
This sale promises to strengthen SCI’s balance sheet.
Shares of the blue-chip utility company have already soared 67% year to date.
Can this transaction lead to a further share price boost?
We take a look at five highlights of this deal.
1. Accelerating the “brown to green” transformation
During SCI’s Investor Day last year, the group unveiled a bold plan to transform its portfolio from brown (i.e. legacy energy sources such as coal and oil) to green (renewable and/or sustainable energy).
The plan back then was to grow the profit contribution from its sustainable solutions portfolio from 40% to 70% by 2025.
With the sale of SEIL, SCI can now advance on many aspects of this long-term objective.
First off, greenhouse gas (GHG) emissions intensity will fall from fiscal 2021’s (FY2021) 0.51 tonnes of carbon dioxide equivalent per megawatt hour (tCO2e/MWh) to just 0.32, already surpassing its 2025’s target of 0.4.
Furthermore, its absolute GHG emissions will fall sharply from 26.2 million tCO2e to 10.4 million.
For context, SCI’s 2030 target is to reduce GHG emissions to 2.7 million tCO2e and to hit net zero by 2050.
Meanwhile, this transaction will also bump up its total renewables capacity to around half of the total group capacity, and increase the net profit contribution from sustainable solutions to 31%, up from the current one-quarter.
2. A stronger balance sheet
The divestment will also strengthen SCI’s balance sheet by reducing its total debt level.
The group estimates that its total debt will fall from S$8.7 billion as of 30 June 2022 to S$7.1 billion as SEIL is deconsolidated from its books.
As a result, SCI’s leverage ratios are expected to improve.
Debt to EBITDA (earnings before interest, taxes, depreciation and amortisation) will dip from five times to 4.9 times while EBITDA interest cover will rise from 5.1 times to 6.3 times.
A higher EBITDA interest cover implies that SCI is better able to service its debt obligations.
SCI’s debt to capitalisation ratio will also fall from 0.66 times to 0.62 times post-transaction.
3. Settlement using a deferred payment note
The purchaser of SEIL will settle the total purchase price using a deferred payment note (DPN).
The DPN is a facility set up by the wholly-owned unit of SCI, Sembcorp Utilities Pte Ltd.
This DPN will bear interest at a rate of 1.8% plus the benchmark Indian government 10-year bond yield spot rate, minus a GHG emissions intensity reduction incentive rate.
The current Indian government 10-year bond yield is around 7.2%.
The incentive rate is capped at 1.8%, which means SCI’s DPN will enjoy an interest rate equivalent to 7.2% or higher on this transaction.
4. Slightly weaker financial metrics
The sale of SEIL is at an implied price-to-book ratio of one time, implying that SCI is not selling this asset at a discount to its book value.
However, as SEIL’s profit contribution will be deconsolidated from SCI’s books, there is a slight negative impact on net profit and net asset value (NAV).
Net profit for the first half of 2022 (1H2022) will fall from S$490 million to S$468 million while NAV will dip from S$4.2 billion to S$4.18 billion.
5. A trusted long-term partner
SEIL will be in good hands as OIC is a leading private equity investment company with a strong track record.
OIC’s track record of investments covers a wide range of industries such as energy and infrastructure, healthcare, and real estate and logistics.
OIC will own 70% of the consortium and SCI had partnered with OIC to jointly develop and operate the Salalah Independent Power and Water Plant back in 2009.
Get Smart: Killing two birds with one stone
The sale of SEIL is overall positive for SCI as it allows the group to kill two birds with one stone.
The transaction will allow SCI to accelerate its Investor Day objective to increase its share of sustainable solutions.
At the same time, the group’s balance sheet metrics will also improve.
Investors can rejoice as this move shows management’s commitment to advancing its strategic goals as part of SCI’s ongoing transformation.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.