Offshore & Marine - 2017 Still Not Easy
Asset oversupply may spoil the party
- The OPEC production cut has been driving a sentiment rally. But we think that business wise, 2017 may still not be an easy year.
- The Singapore oil services sector is dominated by shipyards and OSV owners, which is plagued by severe asset oversupply.
- In our view, utilisation improvements (if any) from better oil price sentiment may not be fast enough before some players run out of cash.
More distinct separation
- We do not rule out more failures of weak players as banks turn more stringent in granting new and even extending existing credit.
- Access to bond and equity markets for capital are likely shut for most given the repercussions from the bond defaults seen in 2016. This means that players that cannot generate self-sustaining cashflows face the risk of going down like Swiber and Swissco. But this would more distinctively separate the wheat from the chaff, meaning that there are long-short opportunities.
Another round of provisions cannot be ruled out
- We envisage another round of provisions when companies report FY16 results from mid-Jan to end-Feb next year, which could be an overhang on stock prices till then. Any asset sales by the judicial managers of Swiber and Swissco could provide price discoveries on asset values and that is likely to be below companies’ expectations.
Position in financially strong asset owners
- But beyond this and on the assumption of a more stable oil price environment in 2017 where oil demand-supply mismatches will continue to balance out, we advocate positioning in financially strong asset owners that would be early beneficiaries (EZI SP, BUY, TP SGD0.42) from increases in oilfield activities.
- We are less optimistic of shipyards (KEP SP, SELL, TP SGD4.57 | SMM SP, SELL, TP SGD1.00) as we view them as late cyclicals, with oversupplied drilling rigs and OSVs, plus competition from yards in Korea and China. A change to a more neutral stance may be warranted in 2H17 if cancellation risks fade but we still see some time before orders return for the shipyards.
Low valuations set stage for stronger players
- The consolation is that valuations are depressed with many asset owners now trading at 0.3-0.4x P/BV, indicating that the market has already discounted asset values by 60- 70%.
- We think this sets the stage for stronger players that can demonstrate improvements in free-cash flows and balance-sheet strength to outperform.
Ezion Holdings (EZI SP, BUY, TP SGD0.42)
- Relatively more resilient exposure to production and maintenance services allows Ezion to keep most of its assets utilised and to generate free cashflows from FY16-18E.
- High chance of surviving downturn as it has no immediate balance sheet risks while it:
- restructures its bank debts,
- exercises capex discipline and
- looks for opportunities to deploy assets for windfarm installations and as MOPUs as diversification.
- Five new assets scheduled for contribution in 1H17 could drive sequential EPS growth providing a near-term stock catalyst.
- Key risks to thesis: Oil price falls below USD40/bbl for a sustained period leading to severe cut back even in production and maintenance activities. Customers cancel contracts or withhold payments, weakening cashflows. Banks withdrawing credit facilities resulting in Ezion not being able to meet its operational requirements and financial liabilities.
- Valuation basis: GGM based P/BV of 0.5x based on ROE of 8.5% and cost of equity of 18% to account for higher risks. This yields a TP of SGD0.42.
Keppel Corp (KEP SP, SELL, TP SGD4.57)
- Weak O&M order replenishments with only SGD0.5b secured YTD but revenue run-rate was SGD6.2-8.6b over the last three years. Out of outstanding orderbook of SGD4.1b, only about SGD1b was not affected by deferments.
- Took only SGD230m of provisions in FY15, do not rule out potential for more significant amount of writedowns.
- Loss of O&M as a key cash generator may affect its ability to fund dividends and investments in other business segments, which means current gearing of 0.6x at Sep 2016 may trend up. Property earnings insufficient to fill the gap left by O&M.
- Key risks to thesis: Rig market turns such that customers take delivery of their rigs at original pricing leading to strong cashflows from back-end loaded payments. Sete Brasil’s bankruptcy plans yield favourable results leading to positive writebacks. Property segment sales surprise on the upside especially in China.
- Valuation basis: SOTP-based TP of SGD4.57. O&M is valued at book value adjusted for our assessment of potential writedowns. Property is valued at 0.75x P/BV, in line with comparable peer, CapitaLand. Implied FY17E P/E and P/BV are 8.9x and 0.7x respectively.
Sembcorp Industries (SCI SP, HOLD TP SGD2.40)
- Singapore power market drag at tail end. While power oversupply is likely to persist till 2018, impact on SCI greatly diminished as segment profits now account for c.11-16% of total profits vs 40-50% in 2013.
- India’s TPCIL coal-fired power plant would finally start to deliver. But newly commissioned SGPL may incur start-up losses and worryingly, it has not secured any long-term PPAs.
- Several emerging market greenfield power projects in the pipeline may add to future earnings but we expect start-up problems, adding to short-term ROE compression.
- Key risks to thesis: Upside risks could come from better-than-expected performance in India and reversal of drag from the Singapore power market. Downsides could come from greater-than-expected losses when SGPL comes on-stream and further drags from emerging market projects.
- Valuation basis: SOTP TP of SGD2.40. We value its Utilities business at 7x FY16E P/E, -1SD of its mean as we expect ROEs to fall to 7-8% levels, compared to the low-teen ROEs it used to deliver.
Sembcorp Marine (SMM SP, SELL, TP SGD1.00)
- Weak O&M order replenishment with only SGD0.7b of orders secured YTD. Revenue run-rate was c.SGD5b over the last few years. SGD5.2b of net orderbook heavily weighted by a few big projects.
- Took SGD609m of provisions in FY15. Do not rule out more provisions but quantum and risk may be lower than for Keppel.
- Invested c.SGD1b in greenfield yard in Brazil and there is a risk of asset writedown if shipyard activities in Brazil fail to resume.
- Key risks to thesis: Rig market turns such that customers take delivery of their rigs at original pricing leading to strong cashflows from back-end loaded payments. Sete Brasil’s bankruptcy plans yield favourable results leading to positive writebacks. SMM manages to resell rigs at better margins with forfeiture of deposits. Potential privatisation at premium valuation could also be an upside risk.
- Valuation basis: TP of SGD1.00 based on NTA adjusted for potential writedowns. Implied FY16E P/BV of 0.8x.