Keppel Corporation, a key component of the Straits Times Index (STI) represents much of how declines in oil prices have dampened investor sentiments. Fundamentally, we have derived a 12-month discounted cash flow (DCF) valuation of S$5.36 per share for a weighted share count of 1.825 billion shares, assuming a revised weighted cost of capital (WACC) of 11 per cent, and a corporate tax rate of 17 per cent. The current share price stood at S$5.89 as of December 01, 2016.
Many investors have been asking when will the turnaround be for oil and gas (O&G) majors. Frankly speaking, these are no easy answers to begin with. Oil prices have stayed low at around US$40 to US$48 for quite a long time, and recently spiked up to above US$50 per barrel after news of an agreement by all Organization For Petroleum Exporting Countries (OPEC) member countries to undertake comprehensive reduction in oil production by around 1.2 million barrels a day for the next six months. In addition, it will produce 32.5 million barrels a day in 2017, from almost 34 million barrels this year. The November 30 decision sent Brent Crude Oil prices up by about 11 percent to US$53.31 per barrel as of December 02, 2016.
Not surprisingly, Keppel Corp. shares rose by about 10 per cent to 11 per cent, following the oil production cuts announced by OPEC, to close at S$5.89 per share as of December 01, 2016. One of the main questions on most investors’ minds is whether this is the right time to buy Keppel Corp.?
Technical charting of Brent Crude Oil prices
Brent Crude Oil prices have made a significant leap from the lows of US$27 to US$30 per barrel at the beginning of the year, and were last traded above US$50 per barrel. When moving average (MA) lines are plotted on the one-year chart, the 20-day MA cuts the 50-day MA which might suggest some short-term bullishness of Brent Crude Oil prices.
However, there is a question of whether the latest increase in Brent Crude Oil prices is sustainable in the long-run given the presence of a vast supply of shale oil that are commonly found in North America. Moreover, according to a Business Times (BT) article on December 02, 2016, the comprehensive cut by OPEC will have to depend on the level of commitment by all member countries.
Fundamental valuation for Keppel Corporation
|Valuation summary for Keppel Corp. (Absolute dollar figures are in million Sing Dollars)|
|WACC (%) assumption (including impairment charge of 7.5%)||11.0%|
|Proportion of Debt (%)||40.9%|
|Proportion of Equity (%)||59.1%|
|Corporate tax rate (%)||17.0%|
|Net present value (NPV)||$ 16,154|
|FCF due to shareholders||$ 9,789|
|Number of shares (millions)||1,825.0|
|FCF per share||$ 5.36|
Source: Company information and own estimates
The above table summarised some of the aspects of our valuation per share of Keppel Corporation using our discounted cash flows (DCF) model. In our five-year projections model, we assume that revenue growth is likely to fall each year by 30 per cent for the next five years going forward and a zero terminal growth value after five years.
One of our rationales for using such extreme forecasting measures is we would like to determine Keppel Corp.’s overall financial strength and its ability to withstand external shocks including an extended decline in crude oil prices. We chose to remain conservative in our estimates as we foresee challenging times ahead if capital expenditures were to take a hit and crude oil prices stay below US$60 per barrel for an extended period. The US$60 per barrel breakeven mark was forecasted by many market analysts as the level where widespread capital expenditures are expected to kick in.
Our one-year forecasted price per share of S$5.36 is not far off from the consensus estimate of S$5.56 per share. However, at the latest closing price of S$5.89 as of December 01, 2016, it might suggest that the stock has traded far ahead from expectations and is looking somewhat pricey.
Technical Analysis of Keppel Corp. stock price
In the chart above, we attempt to overlap both the one-year charts of Keppel Corporation and Brent Crude Oil prices in order to explain the investment case for Keppel. Based on the information, we noted that actual Brent Crude Oil prices display more volatilities as compared to Keppel Corp.’s stock price. Technically, based on the chart above, there have not been any significant episodes of any major breakdowns in the stock price of Keppel Corporation.
On a one-year chart shown above, it appeared that the 14-day relative strength index (RSI) is flashing a heavy ‘overbought’ situation. We believe that part of the optimism could stem from the November 30 OPEC’s announcement to curb oil production temporarily for the next six months. We also think that investors in Keppel Corporation’s stock should seriously think adopting good portfolio rebalancing practices that might limit the fallout of crude oil will have on stock price of Keppel Corporation. The rise in stock price could be a knee jerk response to the current favourable conditions, but not for long, we think.
Next, we move on to a twelve-month analysis where we think that much of the stock rise is mainly driven the OPEC announcement to curb oil production on November 30. However, we also think that the rise is expected to be muted or head downhill if OPEC, and some non-OPEC producing countries fail to observe the terms of the agreement. They might even move ahead to produce vast amounts of oil in their fields, thus unleashing an extended oil glut.
According to the peer comparisons table shown above, it appeared that Keppel Corporation has one the most competitive price-to-earnings (P/E) ratios and a 5.09 per cent dividend yield. However, we are disregarding the dividend yield as we believe that there are risks that management might cut or not declare any dividends to shareholders in order to preserve capital.
Based on the table, and using the other estimates like return on equity (ROE) and price-to-book (P/B) values, the fundamentals for Keppel Corporation’s financials look relatively cheap as compared to its industry peers. However, as the saying goes, “cheap does not mean good”, and investors are advised to do more thorough due diligence to determine whether Keppel Corporation is a good buy at current levels.
We think that current investors might want to take some profits if they have bought below our twelve-month price target of S$5.36 per share. However, for those who intend to buy and want to enter a Keppel trade order, one might want to think about holding off the stock purchase until crude oil prices have fell below US$40. At this drastic price level, it might sound quite surprising when compared to the recent run up in Brent Crude Oil prices, and some investors might think that it is quite impossible to think that oil prices will retrace back to below US$40 per barrel levels.
Incidentally, at the mid-to-long term 50-day and the 200-day MA for Keppel Corp. levels respectively, the stock is hovering around S$5.30 to S$5.40 per share support level. This price range further validates our expectations for a twelve-month price target of S$5.36 per share. As such, we advise investors looking to trade the stocks of Keppel Corporation to stay patient and keep monitoring the stock price for any significant pullbacks later.
Disclaimer: The views/analyses expressed by the author in this article are based on public information sources, and individual analyses. Investors seeking to trade in the stocks of Keppel Corporation and/or any other companies mentioned in this article are advised to seek the opinions from licensed financial advisers.
This article is written by Tay Hock Meng (Peak Hour), a licensed financial advisory consultant with Phillip Securities. MAS representative number is THM300399401. For a free financial health check/discussion, please contact firstname.lastname@example.org, or +(65)9721 3987.