Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-07-28: 2Q17 Earnings Uplift From Transocean Rig Contract Resumption

Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-07-28: 2Q17: Earnings Uplift From Transocean Rig Contract Resumption SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - 2Q17: Earnings Uplift From Transocean Rig Contract Resumption

  • Sembcorp Marine’s (SMM) 2Q17 core net profit came in above expectations on strong operating margins and excluding the impact of FX and provisions. 
  • Net gearing remained elevated at 133%. Earnings outlook turns for the positive with the resumption of the US$1.1b Transocean drillship contract. 
  • We raise our net profit forecasts for 2017-19 to S$86m-173m on this development. 
  • Upgrade to HOLD. Target price: S$1.80.



RESULTS


Core net profit of S$45.5m, above expectations. 

  • Sembcorp Marine (SMM) reported 2Q17 headline net profit of S$5.6m, which included one-off impact from: 
    1. forex losses of S$34.4m, and 
    2. S$5.5m provision for a joint venture. 
  • Excluding one-offs, core net profit was above expectations at S$45.5m. The improved performance came largely from a strong core operating margin of ~10%, comparable to 2Q16’s. 
  • We believe the improved margin was likely due to stronger contribution from the repair & upgrades segment (higher margins), helped by lower earnings contribution from the offshore platforms segment (lower margins).

Transocean resumed work on two drillship orders. 

  • The US$1.1b contract for two drillships was requested to resume work during 2Q17. This follows Transocean recent exit from the jack-up rig segment. Delivery for the two rigs remains unchanged at 1Q20 and 3Q20.

Repair revenue down 6% yoy, slight dip in repair value per vessel. 

  • Repair revenue was S$137.5m (-6% yoy), down on a slight dip in vessels repaired for the quarter (2Q17: 128, 2Q16: 133). Implied revenue per vessel dipped 2% yoy to S$1.1m (but up 32% qoq). The uptick in revenue per vessel was attributed to higher project values.
  • Outlook on repair revenue for Ballast Water Management Convention dampened but medium-term potential intact. Due to a two-year reprieve on the convention, the previously estimated 100-150 vessels p.a. requiring installation will be lower as the orders will now be spread out over a longer period. 
  • For 1H17, SMM did installations of ballast water treatment systems for 6-7 vessels, with an estimated value of S$0.5m-3.0m per vessel.

Net gearing jumped to 133%, expected to come down by end-17. 

  • Net gearing was 133% for 2Q17, a jump from the 118% in 1Q17. The increase was largely due to the drawdown of additional working capital loans and timing issues between receipt of milestone payments and proceeds from disposal of its equity interest in Cosco Shipyard Group. 
  • Management opined that with the receipt of the disposal proceeds and payment from the Libra project, net gearing should be lower by this year-end.

Ytd contracts wins unchanged at S$75m from 1Q17, order outlook improving. 

  • No new contract wins were announced during 2Q17. SMM might see a variation order estimated at > S$100m relating from additional work scope requested in relation to the P- 68 FPSO project. 
  • The outlook for non-drilling solutions was encouraging although management declined to give a timeline on when new orders will materialise.


STOCK IMPACT


Re-activation of Transocean drillship contract to add S$100m in earnings over 2017-20. 

  • The resumption of work came as a slight surprise, given that global drillship total utilisation remains subdued at ~60%. 
  • Nonetheless, the resumption of work is positive as it adds an estimated S$100m in earnings to be recognised progressively over 2017-20. This translates to a 20+% boost to annual earnings.

Back-ended payment of Transocean drillships could see net gearing remain elevated. 

  • While the improved earnings are welcome, we note that the drillship contracts have a tail-heavy payment structure. Unless some of its completed rigs are divested, net debt, as is its current interest expense, is expected to remain elevated. That said, the likelihood of default on the contract is low, given the client’s tier-one status.


EARNINGS REVISION 

  • We raise 2017-19 net profit forecasts to S$86m, S$158m and S$173m. 
  • The reinstatement of earnings recognition for the Transocean rigs led to our significant upward revision, given its contract size. Incorporating this and the likely variation order from P-68 (est. S$100m), our revised net profit forecasts for 2017-19 are S$86m, S$158m and S$173m respectively.


VALUATION/RECOMMENDATION


Upgrade to HOLD, roll over to 2018F target price of S$1.80. 

  • We roll over our P/B-based target price to 2018. Given the revision in earnings, our 2018F ROE rises to 6%, translating to 1.4x 2018F P/B based on a P/B-ROE relationship. This raises our target price from S$1.43 to S$1.80. 
  • While the outlook is improving, most of the upside from contract wins should largely be captured in share price and our earnings estimates. 
  • The contract environment remains challenging and does not lend to significant earnings growth and thus a higher valuation multiple. 
  • SMM's share price catalyst will largely come from: 
    1. oil price movements, 
    2. yard merger talks and 
    3. contract wins, putting it largely in range bound trading. 
  • On these, upgrade to HOLD. Entry price is S$1.60.


RISKS 

  • Insufficient contract wins to counter orderbook burn rate




Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-07-28
UOB Kay Hian SGX Stock Analyst Report HOLD Upgrade SELL 1.80 Up 1.430



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