Thoughts on Sembcorp Industries - 2 Aug 2015

It's been a pretty interesting week hasn't it. I hope many of you have solid portfolios, that in spite of the recent volatility has held up well.

I recently have been receiving a few queries on Sembcorp Industries and my views on the company. As you may know I am currently holding unto 3,000 shares of this company with an average cost price of $4.26. To be very honest, although I do feel uncomfortable seeing the recent stock price plummet, I still am very convicted in this position. Now do let me make some points on why I say this, with some caveats obviously.

1. Correlation of Sembcorp Industries and Oil Prices
- Now, we know that Sembcorp Industries owns a large share of Sembcorp Marine and we have seen the recent poor numbers from the latter company. I did a correlation study of Sembcorp Industries with the price of oil, over time. What can be seen pretty obviously is the high correlation of oil price to the price of Sembcorp Industries. What I also noticed is the convergence of the stock price to oil and based on current values, the stock price still has some way down to go if it does converge.

2. Oil Market in General
- Now, in relation to the point above we need to understand the oil market and its dynamics. I could go on and on but in summary what I can describe the market is there are two main factors: Supply and Demand.
-Supply of Oil: This is closely controlled by OPEC in which there are key parties like Saudi Arabia, Russia, Kuwait, etc. The current dynamics is this, the Saudis refuse to cut production to prop up oil prices because they want to maintain market share. They also want to force out the shale oil drillers in the US because when oil prices are low, they go below the production costs of shale oil and as a result if these shale oil drillers are unable to sustain low prices and margins, they need to shut down. And the Saudis have large pockets to wait this out. However, you also have countries like Russia which need oil prices to recover to prop back up their economy.
-Demand of Oil: China has been slowing down and as such the demand for oil. Some countries are also exploring alternative energy sources which may affect oil demand albeit not in the forseeable future.
Summary of Oil: There are a myriad of other things about oil that I can nag about, however in summary what I can say is this. I expect oil to stay low, but probably come back up by next year. It is anybody's guess but I really dont see this scenario panning out for too long. And when oil does shoot back up, which it has done many times before, this stock is well-positioned to capitalise on that.

3. Sembcorp Industries's valuation and businesses
- Similarly, we can scrutinise all of their businesses to a fault and come to a premature conclusion. But I won't. However, what I can observe is that the current valuations of Sembcorp to me are very fair. I say this being fully aware of their relatively high debt levels, declining margins, etc.
- However, let us not forget these factors:
a. Sembcorp Marine is still one of the world's best offshore rig builders with superior management and a rather long history.
b. Secondly, utilities is still a necessary business model and in spite of domestic pressures, the company has expanded overseas like India to build their businesses there.
c. Most importantly I still do not see any impairment to their business models. Yes, they have lower orderbooks and declining margins, but it is obvious that these are highly correlated to the concerns on oil prices. Do I see this as a long term impairment? Clearly not.
d. The businesses that Sembcorp is in require high levels of capital investment and are large moats with high barries of entry. I love that for any business.

In summary, what I can comment about Sembcorp Industries is that even though I see declining profits currently, I don't have much concerns on it going forward. In times of uncertainty, we really need to dig deep and ask ourselves our initial reasons for investing in a current company and whether those reasons remain intact. They clearly do for me in this company as I wait out patiently for oil prices to rebound and as a result recover the margins for this well-managed, world class company that    will soon prove its detractors wrong. There is no signs of impairment of the business and more importantly its management and any near term price concerns will be shrugged off and/or good reasons for adding more positions in which I am planning to do so probably.

Comments are most welcome!

Signing Off
Transitioning Stock Investor