Singapore Banking - UOB Kay Hian 2016-09-08: Gradual Progress Of Recovery From Swiber

Banking – Singapore - UOB Kay Hian 2016-09-08: Gradual Progress Of Recovery From Swiber OCBC OVERSEA-CHINESE BANKING CORP O39.SI  DBS GROUP HOLDINGS LTD D05.SI  UNITED OVERSEAS BANK LTD U11.SI 

Banking – Singapore - Gradual Progress Of Recovery From Swiber

  • IJMs, led by KPMG, have made progress by attracting 24 potential investors to rescue Swiber
  • Nevertheless, we cannot count our chickens before they are hatched, as it is an arduous task to hammer out a scheme of arrangement agreeable to all stakeholders. 
  • We prefer OCBC due to its conservative approach to recognising NPLs early. 
  • Maintain OVERWEIGHT. Preferred BUY is OCBC.



WHAT’S NEW


Met Swiber’s customer in South Asia. 

  • We understand that DBS has sent a team to meet state-owned Oil & Natural Gas Corporation (ONGC) in India, Swiber's key customer, to discuss restarting the two affected projects last week. DBS provides working capital financing for the two construction projects with life cycle of 2-3 years, which are currently 50% and 80% completed, comprising trade finance and performance/warranty bonds. 

Cash flows from the two projects are ring fenced.

  • DBS does not have exposure to the US$710m offshore field development project (offshore processing facility with associated subsea infrastructure) in West Africa from a Houston-based customer, which has been delayed indefinitely.

Completing projects crucial for all stakeholders. 

  • On Monday, interim judicial managers (IJM) led by KPMG issued a statement to the High Court stating that: 
    1. The IJMs have received 24 expressions of interest for equity and debt financing although it did not identify the potential investors.
    2. The IJMs foresee reasonable prospects for achieving a more advantagous realisation of assets compared with winding up Swiber. The prospects for saving Swiber hinge on support from all stakeholders to complete S$1.7b worth of projects.

Unsecured creditors most at risk. 

  • The IJMs have warned that for every $1 exposure, unsecured creditors would receive 2 cents from Swiber Holdings and 4 cents from Swiber Offshore Construction in a liquidation scenario. The crystalisation of contingent liabilities and liquidated damages would have wiped out US$1.2b.
  • Ironically, it is the dire consequence of losing everything that is compelling all stakeholders to bind together.
  • The IJMs have to hammer out a scheme of arrangement agreeable to all stakeholders, in time for the hearing for Swiber’s application for judicial management to be scheduled on 3 October at the earliest. This would be timely as the operational season for South Asia lasts from October to May.

No “cascading default” thus far. 

  • Many traders feared that the collapse of Swiber would trigger a “cascade of defaults” due to cross-transactions amongst O&G companies and the threats from “unknown unknowns”. We agree that asset quality remains under pressure. However, it has been more than a month since Swiber filed for judicial management on 29 Jul 16 but another major default has not materialised.

Against the odds. 

  • Judicial management allows a company to continue operating and gets rehabilitated under court supervision. It has historically failed at turning around distressed companies in Singapore. Nevertheless, we are encouraged by the statement from the IJMs, which suggests gradual progress in recovery from Swiber.


ACTION


Strain from exposure to O&G sector. 

  • Banks face risk from deterioration in asset quality from the O&G sector. In addition, sentiment remains fragile due to slower global growth and geopolitical uncertainties relating to the aftermath following Brexit (23 June) and the US Presidential Election (8 November).
  • Our OVERWEIGHT call is premised on banks’ cheap valuations, which have already built in expectations of credit losses from the O&G sector. DBS and OCBC trade at 2016F P/B of 0.92x and 1.04x, which is 1x SD and 2x SD respectively below long-term mean. They provide attractive dividend yield of 3.8-4.1%.

DBS Group Holdings (BUY/S$15.55/Target: S$17.80).

  • We have penalised DBS to take into account the higher volatility in its share price. Its pro-business and pro-growth disposition also creates a perception that DBS takes on higher risk to achieve its performance targets. 
  • We have utilised a higher beta of 1.25x (OCBC: 1.05x) and COE of 8.75% (OCBC: 7.75%) in our valuation for DBS. We would review and moderate the penalty accordingly if: 
    1. NPL formation during 2H16 is lower than our expectations, or 
    2. meaningful progress is made in recovery from Swiber.
  • Our target price of S$17.80 is based on 1.05x P/B, which is derived from the Gordon Growth Model (ROE: 9.2%, COE: 8.75% (Beta: 1.25x) and Growth: 0.0%).

Oversea-Chinese Banking Corp (BUY/S$8.84/Target: S$10.30).

  • Downside is limited as OCBC trades at 2016F P/B of 1.04x, which is 2x SD below longterm mean and near the trough P/B of 0.83x during the GFC.
  • There are signs that OCBC’s conservative approach to recognise NPLs early is working.
  • An O&G loan in Malaysia that was restructured and recognised as NPL a year ago was upgraded in 2Q16. OCBC has a pipeline of restructured loans eligible for upgrade after customers made timely repayments over 6-12 months. Thus, the deterioration of its asset quality would be mild compared with peers as NPL formation is partially offset by upgrades.
  • Our target price of S$10.30 is based on 1.21x P/B, which is derived from the Gordon Growth Model (ROE: 9.4%, COE: 7.75% (Beta: 1.05x) and Growth: 0.0%).

United Overseas Bank (NOT RATED/S$18.68).

  • UOB has the least exposure to the O&G sector. Loans extended to the O&G sector amounted to S$9.3b or 3.9% of total loans, compared with DBS’ S$20b (6.9% of total loans) and OCBC’s $12.6b (6.1% of total loans).
  • UOB is more resilient and well positioned to weather the current credit cycle.


SECTOR CATALYSTS

  • Economic growth has slowed in both Southeast Asia and China.
  • Banks’ share prices have experienced massive correction. DBS is trading at 0.92x 2016F P/B (GFC: 0.67x) and OCBC at 1.04x 2016F P/B (GFC: 0.83x). Thus, downside is limited for OCBC as valuations are near the trough levels of the GFC.


ASSUMPTION CHANGES

  • We maintain our existing earnings forecasts.


RISKS

  • Further economic slowdown and political risks in regional countries.



PEER COMPARISON







Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-09-08
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 10.30 Same 10.30
BUY Maintain BUY 17.80 Same 17.80
NOT RATED Maintain NOT RATED 99998 Same 99998


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