“What Should I Do With My Sembcorp Marine Shares That Are In The Red?”

I participate in Seedly’s community forums by answering investing-related questions. Recently, there was a question along the lines of “What should I do with my Sembcorp Marine shares that are in the red?” I thought my answer is worth sharing with a wider audience. It is reproduced below (with slight tweaks made for readability).

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Hello! The price you had initially purchased Sembcorp Marine’s shares at is irrelevant in deciding whether you should hold or sell the shares now.

When it comes to any stock, we should constantly be assessing what its future business prospects look like and compare it to the current stock price. At any point in time, if you realise that the current stock price reflects a bright future whereas the actual future business prospects look relatively dimmer to you, then that’s a good time to sell.

I wish I could give you a holistic framework to assess the future prospects of Sembcorp Marine. But I don’t have one. Right now, the company’s revenue depends heavily on the level of oil prices. I don’t have any skill in determining how a commodity’s price will move in the future, so I’ve largely stayed away from stocks whose revenues rely on commodity prices. 

When you make your decision about what to do with your Sembcorp Marine shares, you’ll have to make a judgement on how the company’s business will fare five to 10 years from now. This judgement will in turn depend on your views on how the price of oil changes in that timeframe.

There’s another wrinkle to the equation. Sometimes a stock’s price can still fall even when there’s a positive macro-economic change. In the case of the oil & gas industry, a company’s stock price could still decline despite rising oil prices, if said company’s balance sheet is very weak and it has significant trouble in generating positive free cash flow. 

Right now (as of 30 September 2019), Sembcorp Marine’s balance sheet holds S$468 million in cash, but S$4.15 billion in total debt. These numbers give rise to net-debt (total debt minus cash) of S$3.68 billion, which is significantly higher than the company’s shareholders’ equity of $2.25 billion. In fact, the net-debt to shareholders’ equity ratio of 164% is uncomfortably high in my view. 

If I look at data from S&P Global Market Intelligence, Sembcorp Marine’s free cash flow has also been negative in every year from 2014 to 2018, with the exception of 2016. There has been no improvement detected so far in 2019. The first nine months of this year saw the company produce negative operating cash flow and free cash flow of S$17 million and S$290 million, respectively.

A weak balance sheet and inability to generate free cash flow could be a toxic combination for a company. That’s because the company’s lenders may be concerned with the situation and demand even tougher borrowing terms in the future. This starts a vicious cycle of pricier debt leading to an even weaker ability to service and repay borrowings, resulting in even pricier debt.

Sembcorp Marine is fortunate because it has the backing of Sembcorp Industries (Sembcorp Industries owns the majority of Sembcorp Marine’s shares), which has the relatively more stable utilities business to act as a buffer. It’s worth noting too that Temasek Holdings, one of our local government’s investment arms, is a major shareholder of Sembcorp Industries. But it’s anybody’s guess as to how much support Sembcorp Industries is ultimately willing to provide Sembcorp Marine.

I hope what I’ve shared can give you useful context in making a decision with your Sembcorp Marine shares. 

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.