Shipyard – Singapore - UOB Kay Hian 2017-10-02: Don’t Hold Your Breath On The Oil Price Rally

Shipyard – Singapore - UOB Kay Hian 2017-10-02: Don’t Hold Your Breath On The Oil Price Rally Singapore Shipyard Stocks Crude Oil Price Impact KEPPEL CORPORATION LIMITED BN4.SI SEMBCORP INDUSTRIES LTD U96.SI SEMBCORP MARINE LTD S51.SI

Shipyard – Singapore - Don’t Hold Your Breath On The Oil Price Rally

  • The recent run-up in valuations for the Shipyard sector was largely driven by bullish sentiment in oil prices and the recent spate of contract wins. However, we expect the run to be short-lived as there are no clear signs of earnings recovering.
  • Singapore shipyards continue to face difficulties securing orders from traditional oil-related product classes, while orders from diversification come with lower profitability. A solid recovery is contingent on a clear earnings recovery. 
  • Maintain MARKET WEIGHT.



WHAT’S NEW


Crude price bullishness predicated on recent supply factors. 

  • The recent rally in Brent crude prices was predicated on two factors:
    1. potential supply disruption of non-OPEC production (Turkey/Iraq) and,
    2. positive comments from major producers on oil rebalancing progress. 
  • Despite these bullish sentiments, consensus has kept their oil price forecasts at US$56-57/bbl for 2018, and have not revised it to above the US$60/bbl level needed to catalyse further investment in the sector.

Industry continues to push for < US$40/bbl breakevens. 

  • Even with higher oil prices, we re-iterate that oil majors will require price stability of 6-9 months before revising up their assumptions, putting any significant offshore capex recovery at least a year off. 
  • In the meantime, oil majors continue to push for lower project breakevens, with major players such as BP, Statoil and Total reiterating their goal to keep it at US$40/bbl and below. 
  • Unit pricings for oil-related contracts are closely tied to the project budget and likely to remain suppressed. Securing tenders now is a matter of being the lowest cost supplier, as order-hungry yards drive down prices.


STOCK IMPACT


Singapore yards have lower pricing advantage in oil-related orders. 

  • Chinese and South Korean yards have been offering competitive pricing (with the Chinese especially providing attractive financing terms) to secure orders. 
  • Given the oil players’ current drive to keep costs low, Singapore yards have little pricing advantage in this environment, given their limited financial muscle and risk appetite to compete on this front.

Diversification comes at the cost of margins. 

  • Keppel Corp (KEP) and Sembcorp Marine (SMM) have secured orders of ~S$850m and ~S$250m (with LOI for another S$530m) respectively ytd. 
  • Diversification into gas-related products has been fruitful, evident from the proportion of gas related contract wins – Keppel Corp has won > S$650m in gas-related orders, while Sembcorp Marine has an LOI for >S$530m for at least two gas carriers. However, these come at the cost of lower EBIT margins (6-8%) vs historical norms of 11-12%.


ACTION 


Sector re-rating still dependent on clear earnings growth. 

  • Share price has been lifted by positive sentiment in oil prices and the recent spate of contract wins. However, there still remains no clear earnings drivers. 
  • The recovery is reminiscent of the rally in 1Q17, which was driven by positive sentiment in the oil price outlook. Since then, both Keppel Corp and Sembcorp Marine have seen consensus make significant earnings forecast downgrades. Reality has not met expectations.

Tactical top slice on Sembcorp Marine (SMM). 

  • Sembcorp Marine's share price has risen 10% since the bottom in mid-September largely on the LOI for at least two SeaOne gas carriers worth an estimated S$530m. We are less enthused by this development due to:
    1. EBIT margins are low; and
    2. we are skeptical as to how SeaOne can secure financing to fund both its orders with Sembcorp Marine ( > US$400m) and Samsung (US$1.5b).

Prefer Keppel Corp (KEP) as a long-term play. 

  • Current valuations imply a distressed valuation of 0.3x P/B for the O&M business, assuming incorporation of the valuation of Keppel’s Master Planner JV stake in Tianjin Eco City. 
  • The valuation is undeserved considering that Keppel Corp has met contract win expectations for most of this year (S$850m of our S$1.5b assumption, vs Sembcorp Marine's S$250m vs previous S$2b expectation).

Maintain MARKET WEIGHT. 

  • Despite the lacklustre outlook, impairment risks have diminished and near-term positive catalysts such as a positive outcome on Sete Brasil and the strategic review could see upside from a sector valuation re-rating. 
  • Maintain MARKET WEIGHT.


EARNINGS REVISION/RISK


Lowering contract win assumptions for KEP and SMM. 

  • We are reducing our contract win assumptions for each of the Singapore yards to S$1.2b-2.5b p.a. over 2017-19, which sees an earnings reduction of 0-1% for Keppel Corp and 0-27% for Sembcorp Marine
  • The minimal earnings impact to Keppel is attributable to our expectations for the division to just breakeven over the next few years. Sembcorp Marine sees no earnings impact for 2017 as the effects of higher contract wins this year are mostly recognised in 2018 and beyond.

Target prices lowered for Keppel Corp and SMM. 

  • Target price for Keppel Corp has been lowered to S$6.71 (previous: S$6.85) due to a lowered target price for KPTT from S$2.53 to S$1.90 (See report: Keppel Telecommunications & Transportation (KPTT SP) - Supercharging Growth Will Lead To Short-term Uncertainties dated 08-Sep-2017).
  • For Sembcorp Marine it falls to S$1.77 (previous: S$1.80) due to a revision of our PB/ROE regression, as sector valuations this year have been lifted with the improvement in sentiment.
  • Sembcorp Industries target price marginally declines to S$3.57. Incorporating our revised earnings and valuation for Sembcorp Marine, Sembcorp Industries's valuation falls to S$3.57 (previously: S$3.59).







Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-10-02
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 6.71 Down 6.860
BUY Maintain BUY 3.57 Down 3.590
HOLD Maintain HOLD 1.77 Down 1.800



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