DBS Vickers 2015-08-06: Sembcorp Marine - Navigating Rough Seas. Maintain HOLD.

Navigating Rough Seas

We reckon order momentum will likely lag any oil price recovery amid rig supply glut and keen competition.
Nevertheless, SMM offers decent dividend yield of 4-5% on the back of 40% dividend payout.

Brazilian projects are likely to be pushed back as Petrobras has slashed its 5-year capex by 41% and production target by 30%.
Transocean recently deferred delivery of the pair of drillships under construction at SMM's yard by two years.
There could be more of such deferments which pose a risk to earnings, but this should be partially mitigated by compensation from customers.

YTD win of S$1.4bn was driven by the sizeable contract with Heerema Offshore Services to build the world’s largest semi-submersible crane vessel.
SMM’s orderbook had dwindled to S$10.9bn by end-Jun 15, from S$11.4bn in Dec-2015.

Order wins and orderbook trend are often the key leading indicators of rigbuilders’ share price and earnings.
Singapore rigbuilders’ order flow has been slow, securing S$531m worth of new orders YTD or 11% of our full-year expectation of S$5bn (down from S$9.2bn in 2014).
Based on existing capacity, SMM requires S$4-5bn worth of order replenishment every year.
We expect new orders to be half of those levels in the coming two years amidst sector headwinds, a harbinger of declining orderbook and earnings ahead.
SMM’s orderbook has dwindled to S$10.6bn by endMar-15, from S$11.4bn a quarter ago. This translates into a book-to-bill ratio of approximately 2.0x. (or 1.6x if stripping out Petrobras’ revenue recognition from 2017 onwards).

Post-GFC crisis, newbuild prices for drilling rigs tumbled 20-30% from 2008-2010.
Prices have The 5-15% price gain over the past few years could all be given back, if not worse.
In this downturn, China plays a bigger role in global rig market, garnering one-third of global orderbook.
Over 90% of these contracts are built on speculation without back-to-back charters and on 5:95 balloon payment terms, making it vulnerable to cancellations.
We expect fire sales to suppress rig prices as shipyards would be desperate to recoup their construction costs if ship owners walk away.

Low oil price adds fuel to fire, aggravating the already challenging rigbuilding market that is suffering from a massive order backlog and keen competition.
New rig supply is projected to be 5-7% a year while rig demand is expected to contract by 3-5% y-o-y in 2015, before returning to positive territory in 2016.
As a result, day rates and utilisation have fallen around 20% from June-2014 levels. It may get worse before it gets better.
We believe gradual recovery in rig market towards 2016 will set the stage for rising newbuild demand thereafter.

Pace of rigbuilding recovery is dependent on oil price rebound, retirement of old fleets and cancellations at Chinese yards.
An oil price rebound above US$80/bbl will stimulate E&P activities and thus rig demand while rig attribution and cancellations will soothe the supply pressure and eventually bring the sector back to equilibrium.

Our SOTP target price of S$2.55 is based on 11x SMM’s FY15F earnings (excluding Cosco Shipyard Group, CSG), 8x CSG’s FY15F earnings and fair value of its 4.97% stake in Cosco Corp. (prev S$2.89)

Recovery in oil prices. Rising oil prices could lift sentiment on rigbuilders, though it might lag behind the asset owners.
We believe SMM would benefit if oil prices recover to at least above the $70/bbl level, which would trigger more offshore oil & gas capex spend.
Order win momentum. Shipyards are orderbook driven. Strong order flow could push up the share price, as investors reward greater visibility on revenues and earnings.
Restructuring of Sete Brasil. The successful restructuring of Brazil will allow Sete Brasil to get financing for its rigbuilding programme. This will eliminate an overhang on the rigbuilders.

Sustained low oil price. Brent crude oil price below US$60/bbl would defer investments into deepwater, and higher cost of oilfield projects.
Execution risks in protected market. Cost pressure, lack of skilled labour, potential project delays faced in emerging markets like Brazil is a lingering concern.
Rig supply glut and competition. Slower order flow is expected as the market takes time to absorb almost 200 rigs scheduled for delivery in the next two years, representing > 20% of existing fleet. Competition is intensified with the low order backlog of Korean yards and emergence of Chinese shipyards in the offshore space.

Analyst: HO Pei Hwa

Source: http://www.dbsvickers.com/