Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-10-09: Borr Deal Likely Clears Concerns Of Additional Provisions; Upgrade To BUY

Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-10-09: Borr Deal Likely Clears Concerns Of Additional Provisions; Upgrade To BUY SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - Borr Deal Likely Clears Concerns Of Additional Provisions; Upgrade To BUY

  • Borr Drilling is purchasing nine rigs from Sembcorp Marine (SMM) for US$1,256m, with upfront cash payment of US$502m. 
  • Sembcorp Marine's share price will likely rally on the improvement to balance sheet and reduction in finance expense. 
  • Reverse engineering the deal suggests sufficient provisions were made, with West Rigel estimated to be written down to 50% of revised contract value, in line with recent transactions. 
  • Upgrade to BUY with target price of S$1.90.



WHAT’S NEW


Borr Drilling to acquire nine rigs from SMM for US$1,256m. 

  • Borr Drilling (Borr) is acquiring nine rigs from Sembcorp Marine (SMM) for US$1,256m, translating into US$139.5m per rig. Delivery of the rigs will be made progressively over 14 months from 4Q17 to 1Q19.


STOCK IMPACT


Improved liquidity sees net gearing falling to 76% by end-18. 

  • The immediate impact of the deal is the improved liquidity to Sembcorp Marine’s balance sheet, which will likely be the market’s focus. 
  • The sale will see Sembcorp Marine’s net gearing fall from 133% as of 2Q17 to about 76% by end-18, and positions Sembcorp Marine as one of the first few yards to have almost all their stranded assets taken off the balance sheet.

Deal demonstrates prior provisions might be sufficient. 

  • Sembcorp Marine had in 4Q15 provided S$280m for problematic rig contracts, as well as a S$85m inventory write-down. Of the S$280m provision, a portion was related to profit reversals on the Marco Polo Drilling (MPD) and North Atlantic Drilling (NADL) rigs. 
  • As the uncovered cash costs for the six rigs (including MPD’s) was discounted enough, there was no need to provide further, while the spec-build rigs were likely covered under the S$85m inventory write-down. This leaves the balance of the S$280m related to provisions for the NADL rigs. 
  • Reverse engineering the figures yields a written-down value of US$374m, a 50% discount to the revised contract price of US$762m. This written-down value seems consistent with market transactions: the semisubmersible West Mira was transacted for US$360m, about half its original contract price. 

Overhang from insufficient provisions likely to be removed. 

  • With this deal, a significant amount of concerns regarding additional provisions for Sembcorp Marine in the downturn should be removed. 
  • Sembcorp Marine was rumoured to be building 3-4 spec-builds, so even assuming a fourth spec-build rig, subsequent losses (if any) will be small. With concerns for provisions largely removed, the stock is likely to re-rate.


EARNINGS REVISION


Earnings for 2018-19 lifted by 12-18%. 

  • Financially, Sembcorp Marine will benefit from a de-gearing of its balance sheet, resulting in an estimated 15-30% decline in finance expense. We have not included any interest income contribution from Borr. While construction of the three spec-build rigs will resume, we expect no profits from them. 
  • Lastly, we have assumed that the S$15m loss will be recognised in 4Q17. Our revised earnings for 2017- 19 are S$87m (-1%), S$144m (+18%) and S$141m (+12%) respectively.


VALUATION/RECOMMENDATION


Upgrade to BUY and raise target price to S1.90. 

  • With the uplift to our earnings, our PBROE valuation returns a target price of S$1.90, pegged to 1.5x 1-year forward P/B. It is possible that share price could revert to its historical mean forward P/B of 2.3x, but we opt to maintain our more conservative, performance-driven valuation metric. 
  • Only positive catalysts for Sembcorp Marine (SMM) can be seen at this juncture, namely future contract wins such as PolyGCL and the outcome of Sembcorp Industries’ (SCI) strategic review
  • While earnings growth is limited in the near term, prior overhangs on Sembcorp Marine have largely been removed.
  • Sembcorp Marine is now positioned for growth in the new low-oil price era.

SCI’s target price rises to S$3.67. 

  • Our valuation for Sembcorp Industries (SCI) rises from S$3.57 to S$3.67 as a result of the revised valuation for SMM. 
  • Sembcorp Industries (SCI) will likely also rally on this Borr deal and on the higher electricity spot prices it is seeing in India.


RISKS

  • Execution risks from existing orderbook and future orders.
  • Unforeseen impairment risks.






Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-10-09
UOB Kay Hian SGX Stock Analyst Report BUY Upgrade HOLD 1.90 Up 1.770



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