Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-04-28: 1Q17 Core Net Loss Of S$7.3m, Possibly Sunk By Delays On Kaombo Floaters

Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-04-28: 1Q17 Core Net Loss Of S$7.3m, Possibly Sunk By Delays On Kaombo Floaters SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - 1Q17 Core Net Loss Of S$7.3m, Possibly Sunk By Delays On Kaombo Floaters

  • Sembcorp Marine reported headline net profit of S$39.5m (-28% yoy), boosted by one-off gains from sale of its equity stake in Cosco Shipyard. If excluded, a core net loss of S$7.3m would have been reported, impacted by one-off costs for a floater project. 
  • SMM did not disclose the project name, but we believe it to be Saipem’s Kaombo project. 
  • New orders of S$75m announced were variation orders. 
  • Slash 2017-19 earnings by 10-40%. Downgrade to SELL, with lower target price of S$1.43.



RESULTS


Core net loss of S$7.3m, below expectations. 

  • Sembcorp Marine (SMM) reported headline net profit of S$39.5m (-28% yoy), boosted by a S$46.8m gain on sale of its 30% equity interest in Cosco Shipyard Group. 
  • Excluding the one-off, a core net loss of S$7.3m was reported, below expectations. The loss was attributed to the impact of costs incurred for a floater project, recorded within costs of goods sold that reduced GP margin from 8.8% to 2.6%. The quantum is unknown. 
  • SMM declined to state specifics, citing commercial sensitivity of the project. Higher finance expenses also led to the decline.

Repair revenue for 1Q17 declines 9%. 

  • SMM repaired 111 vessels (-11% yoy) for the quarter, recording revenue of S$90m (-9% yoy) from it. This translated to an average repair value of S$0.81m per vessel (+2% yoy).

Net debt rises to 118%, negative FCF for 1Q17. 

  • Net gearing rose from 113% in 4Q16 to 118% in 1Q17, as debt increased by S$190m (+4.6% yoy). Cash balance remained flat at S$1.2b. 
  • Negative free cashflow (FCF) of S$140m was reported for the quarter, an improvement from the negative FCF of S$175m reported in the prior period, owing to a 48% decline in capex. 
  • Operating cashflow was negative in 1Q17.

Variation orders are the new order(s). 

  • As we had expected, SMM reported S$75m of new orders, comprising S$22m for offshore platforms and S$53m for floaters. These were all variation orders (VOs), which SMM traditionally did not declare as new orders until the downturn began. The practice may be a reflection of the challenging order environment.


STOCK IMPACT


Earnings possibly sunk by Kaombo project. 

  • We don’t think the market was expecting this, and are even more perplexed by SMM’s reluctance to disclose details about the affected project. Eliminating floater orders for delivery in 2017, the suspect project is likely related to Saipem’s Kaombo project, specifically FPSO Sul-Kaombo (Antarctica).
  • Comments by Saipem during their 4Q16/1Q17 results call and a report by Upstream point to this with high probability. The S$300m (S$600m for both) project, originally scheduled for delivery in 2017 has now been delayed to 2018. Saipem has addressed the issue with an acceleration plan that involved “strengthening the workforce in Sembawang Yard”. 
  • We further note that the project (from Saipem’s perspective) to be at “break-even” after incorporating all delays and cost overruns.

Margins could remain dampened even after the one-off. 

  • It is uncertain whether the additional costs for the Kaombo project will be fully borne by Saipem. If part of the cost of additional workforce brought in to accelerate the project is forced on SMM, project margins will be impacted, dampening overall margins going forward. 
  • We are sceptical of SMM’s hope that future quarters will see its operating margins normalise to that of 2016.

Impact of low contract wins showing up on earnings. 

  • Excluding the Sete Brasil contracts, net orderbook stands at S$4.0b as of end-1Q17 (4Q16: S$4.7b, 3Q16: S$5.2b) with visibility till 2019. 
  • SMM’s net orderbook is declining at a rate of S$0.5-0.7b per quarter, and unless it secures at least S$2b of orders this year, it runs a risk of its orderbook fully depleting by 2Q19. 
  • Earnings for 2018 can slip to levels lower than this if this scenario pans out. The earnings impact of new contract wins are usually delayed by one year. Earnings are now starting to reflect the order drought in 2016, where only S$320m in orders (mostly VOs) were secured.

Continued high gearing hurting bottom-line. 

  • If poor contract wins were not enough, the continued high debt level has kept finance expenses high, impacting earnings. 
  • Even though future cashflows are on milestone basis, we do not see how SMM is able to lower its net gearing without successfully divesting its delayed/cancelled rigs, at prices above cash cost in the continued oversupplied rig market.


EARNINGS REVISION


Cut 2017-19 earnings by 10-40%. 

  • We have lowered our EBITDA margins to ~11% take into account the impact of this one-off cost from the floater project. 
  • After adjusting our orderbook recognition to account for likely delays at the Kaombo project, as well as higher finance expenses, our revised earnings for 2017-19 are S$70m (-40%), S$110m (-10%) and S$102m (-22%) respectively.


VALUATION/RECOMMENDATION


Downgrade to SELL, lower target price to S$1.43. 

  • Core ROE declines from 4.5% to 2.7% as a result of our earnings downgrade. 
  • Our P/B benchmark, tied to a P/B ROE relationship, declines to 1.1x 2017F P/B (previously: 1.3x), translating to a target price of S$1.43. 
  • While the oil price environment is improving, a translation to new orders has not materialised. Furthermore, we believe that any new contracts will have low margins given the competitive environment. An improvement in the earnings outlook remains elusive, likely for years. 
  • Given the dismal outlook and the possible lasting impact from the Kaombo delay, downgrade to SELL.


RISKS

  • Asset impairments.
  • Insufficient contract wins to counter orderbook burn rate.




Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-04-28
UOB Kay Hian SGX Stock Analyst Report SELL Downgrade HOLD 1.43 Down 1.610



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