Shipyard Singapore - UOB Kay Hian 2017-05-29: Jack-up Fundamentals Improving, But Inventory Risks Will Remain For Longer

Shipyard ‒ Singapore - UOB Kay Hian 2017-05-29: Jack-up Fundamentals Improving, But Inventory Risks Will Remain For Longer Singapore Shipyard Stocks Shipyard Sector Update KEPPEL CORPORATION LIMITED BN4.SI SEMBCORP INDUSTRIES LTD U96.SI SEMBCORP MARINE LTD S51.SI

Shipyard ‒ Singapore - Jack-up Fundamentals Improving, But Inventory Risks Will Remain For Longer

  • Improving jack-up demand fuel hopes of an improvement for Singapore shipbuilders. However, the recovery remains protracted with sub-segments seeing different recovery timeframes. 
  • High-spec rigs will likely see a recovery first, and the large backlog in global yards means that yards will continue to face inventory risks on their undelivered premium rigs. 
  • Earnings outlook for yards remains lacklustre, but could be catalysed by the outcome of SCI’s strategic review. SCI remains our top pick. 
  • Maintain MARKET WEIGHT.



WHAT’S NEW


Rising jack-up utilisation fuelling hopes of a recovery. 

  • Recent reports have flagged a recovery for shallow water demand, indicated by rising jack-up utilisation numbers.
  • Floaters however, will see a recovery much later. The improving conditions are boosting sentiments of a recovery that will see alleviation of concerns on unsold rig inventories at shipyards, and the potential for a gradual order demand recovery.

Jack-up recovery only likely to be seen in the mid term. 

  • According to Bassoe Offshore, demand for harsh-environment, high spec semis is likely to pick up in the near term (next 12 months), given that the segment sees little oversupply and clients’ demand for harsh environment development projects. Jack-ups are likely to see recovery kick in later, with demand for premium and high-spec models to lead the recovery. 
  • While signs are picking up, the downturn remains “protracted, phased and challenging”, quoting ENSCO in their 1Q17 results.

Recent transactions point to higher demand for high-spec rigs. 

  • Examining jack-up rig transactions since May 16, transactions which involved purchases from shipyards have mostly been high-spec units. This implies that resale demand is likely starting with high-spec units, before moving down to the lower-spec units on the yard’s inventory.


ACTION 


High-spec units will likely be soaked up by the market first. 

  • Based on Infield, the jack-up market is sub-divided into high specification (high-spec), premium and standard units. At present, there are 87 jack-ups that remain undelivered to clients. About 46 units (52%) of these are high-spec units, of which 34 units (83%, excluding the recently transacted Transocean rigs by Borr Drilling) are built by Chinese yards. 
  • With marketed jack-up utilisation at 69.7% (marketed supply: 452 units), resale of high-spec units will take a while to work through.

Remaining premium rigs will face prolonged resale issues. 

  • Given the backlog of undelivered high spec rigs, it is likely that premium rigs in the yards’ inventory will be cleared much later in the future. Completed, but undelivered rigs will likely compete with other units on market as the former is essentially a stacked rig. 
  • Unless yards are willing to give discounts, buyers will logically go with comparable assets of distressed rig firms that are likely to be highly discounted. 
  • Risks associated with holding the rigs on inventory are expected to persist for a while more.

Keppel has more premium rigs on order than SMM, but likely to fare better.

  • Between the two SG rigbuilders, Keppel has 9 premium-classed rigs totalling US$1.9b, while Sembcorp Marine (SMM) has 6 premium rigs totalling US$1.3b. While it appears that Keppel has more units at risk, we highlight that Keppel has other businesses to supplement the cashflow shortfalls, while SMM is fully exposed. 
  • Furthermore, Keppel has demonstrated its ability to negotiate a more favourable outcome while SMM has yet to demonstrate as such.

Yard inventories have to be cleared before new orders come. 

  • New rig orders for the shipyards remain quite distant in the future. Conditions have to improve to the point that all competitive supply from active, stacked and rigs on order are absorbed by the market before new contracting work resumes.


RECOMMENDATION 


Maintain MARKET WEIGHT. 

  • We maintain MARKET WEIGHT for the Shipyards sector.
  • While the rig market is seeing improving fundamentals from a stabilising oil price market, a translation to the shipyards will be lagged. Risks associated with the unsold rig inventories for the shipyards are abating, but is unlikely to see a sharp turnaround even next year. Balance sheets will remain stretched for a longer period. 
  • New contract awards will largely be limited to production orders, with new rig orders unlikely till 2020. Earnings of shipyards will remain lacklustre till then. Share price will likely trend in tandem with oil price, catalysed by much-needed contract wins. 
  • A key catalyst likely to spur the sector would be the outcome of Sembcorp Industries’ (SCI) strategic review, which entails greater implications for the sector.

Prefer Keppel over SMM. 

  • Between the two, Keppel provides greater earnings stability due to its multiple business pillars in Property, Infrastructure and Asset Management.
  • Keppel also trades at a lower P/B multiple of 1.0x 2017F P/B than peer SMM, which trades at 1.3x 2017F P/B. This is despite Keppel’s superior management, with the O&M division just breaking even as compared to the core loss reported by SMM. 
  • Keppel has also been announcing several contract wins in the past months, as compared with SMM, in a testament of its ability in securing orders in the difficult environment.







Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-05-29
HOLD Maintain HOLD 6.550 Same 6.550
BUY Maintain BUY 3.660 Same 3.660
SELL Maintain SELL 1.430 Same 1.430



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