Offshore & Marine Sector - CIMB Securities 2015-09-02: Brazilian wax and wane.

Offshore and Marine Sector

Brazilian wax and wane 

  • Given the long-drawn-out negotiations surrounding Sete Brasil with only 15 rigs receiving the go-ahead, our new base case pencils in a 1-year delay for the rigs that have started construction and indefinite postponement for units that have not started materially. 
  • We stay Neutral on the sector, premised on valuations – big caps at -1s.d. and small caps at -2s.d. of their 5-year average. 
  • We prefer SCI over KEP for its utilities business, which is being discounted more vs. SMM. 


SETE BRASIL UPDATE 

  • According to the Upstream publication, Sete Brasil's 9% shareholder and sole customer has in recent weeks blocked Sete Brasil's plans to transform itself into a qualified drilling company, insisting that experienced drillers operate the 15 half-built or unbuilt rigs still in the plan. 
  • Petrobras has also vetoed Sete Brasil's plan to forge a JV with Seadrill to operate all of the rigs with the Norwegian pumping in US$700m of equity. Instead, the state-oil company has demanded Sete Brasil to bring in at least three experienced drillers to spread the risks. To this end, Sete Brasil's management team has been staging an international roadshow to attract other established drillers such as Transocean, Diamond Offshore, Rowan and Maersk to operate the 15 rigs and to take an equity stake in each. The latest development of approval from shareholders (including pension funds and major banks such as Bradesco, Standander and BTG Pactual) allowing Sete Brasil to operate five rigs in conjunction with a JV as well as the other 10 units operated by another company spells a glimpse of hope for the restructuring progress and the refinancing plan of Sete Brasil's US$3.6bn-3.8bn. 
  • Sete Brasil stopped paying the shipyards involved in the rig-building project in October 2014. Three of the yards, Estaleiro Rio Grande, SMM (Jurong Aracruz) and KEP (BrasFels), have been funding the construction but on a scaled-down mode. The yards have agreed to carry on until 1 October 2015 and are unlikely to continue beyond then without a workable restructuring plan in place and underway. 

KEPPEL AND SMM MAY NEED TO STOP WORK IF PAYMENTS CONTINUE TO STALL 

  • Assuming the billing cycle coincides with progress completion, our estimates indicate a negative project cashflow of US$141m for KEP and US$56m for SMM as of 2Q15. If payments continue to stall, both yards may need to stop work by 4Q15 to prevent further cash burn as project cashflow losses could widen to US$223m for KEP and US$151m for SMM. 
  • Given the long-drawn negotiations and only 15 rigs having the „go ahead' indication, we now factor in a 1-year delay for the rigs that have started construction and indefinite postponement for units that have not started materially as of 2Q15 – units 5 and 6 for KEP and units 5 to 7 for SMM. 

MORE RIGS ARE READY STACKED, WAITING FOR JOBS/NEW OWNERS 

  • The oversupply situation for jack-up offshore rigs is unchanged, with risk of more delivery deferrals by end-15. To date, only nine jack-up rigs have been delivered and are in drilling mode. Another 10 are “ready stacked”, waiting for contracts or to be sold. Also, shipyards may not have received final payments for these units, in our view. 
  • In addition, there are another 31 jack-up rigs slated for delivery in 4Q15, with only five units backed by charter. Therefore, the realistic move for rig owners at this juncture is to defer delivery. 
  • We have assumed delivery delays of 3 months-1 year for some of KEP's and SMM's projects. 

LOWER RATES WILL PRESSURE ASSET PRICES 

  • We expect to see a 30-40% reduction in asset prices in the near term given the rampant rate cuts in the industry. Jack-up rigs rates are testing new lows as seen in the latest renegotiation of rates by PTTEP on Vantage's rig, Emerald Driller (built in 2008) to US$80,000/day from US$156,000/day. 
  • With this new benchmark, jack-up rates may be approaching operating costs for some rigs in Southeast Asia (typically US$50,000-US$70,000). Elsewhere in Mexico, PEMEX is once again seen to be aggressively renegotiating lower rates for a rig already working in Mexico with Diamond Offshore, Ocean Scepter (built in 2008). The rates were reduced from US$158,000/day to US$115,000/day from now till Mar-16. 

BACK TO BASICS BUT CHUNKIER ORDERS 

  • The Singapore yards are going back to their roots as shipbuilders before the rig boom, as seen in YTD order wins. KEP has won S$1.5bn of orders, comprising mainly specialty newbuilding such as FLNG from Golar (S$923m), iced class vessels (S$265m) and FPSO conversions (S$125m). 
  • Meanwhile, SMM's order win of S$2.8bn is made up of two chunky orders – a c.S$1.4bn semi-sub crane vessel from Hereema and S$1.4bn platform topsides for Maersk Oil. We believe that while jack-up rigs will continue to see a supply glut in the next two years, both Singapore yards will see more sizeable specialised building orders to mend the gap. 
  • We cut our order assumptions for 2016 and 2017, taking a view that the weakness in offshore newbuilding is likely to persist in the next 12 months. Order momentum will remain slow as sizeable orders are less commoditised and take longer to come to fruition. 

VALUATION AND RECCOMENDATION 

  • We maintain a Reduce on SMM with a lower target price of S$2.18, still based on 11x CY16 P/E, -1 s.d. of its historical trading band. Our EPS forecasts are reduced by 5-17% for FY16-17 to account for the revised order cuts and Sete Brasil's deferrals. Based on SMM's historical P/BV valuation since 1996, the stock could test the low of 1.2x P/BV (1 s.d. below the mean), which suggests a share price of S$1.83 or a 30% downside from the current level. 
  • We keep KEP as an Add while lowering our RNAV-based target price to S$7.46 from S$8.88. Our lower target price incorporates lower O&M FY16 net profit of S$769m (factoring in lower orders and Sete Brasil's deferrals) on 11x CY16 P/E. We prefer KEP to SMM, mainly for the earnings and RNAV buffer from property. 
  • SCI stays as an Add with a lower SOP-based target price of S$3.86 (prev. S$4.02), which reflects a lower target for SMM. At its current share price, we believe market has under-appreciated SCI's utilities business as its implied valuation is 6x CY16 P/E, which is below its historical average of 7x.


LIM Siew Khee | YEO Zhi Bin | http://research.itradecimb.com/ CIMB 2015-09-02
ADD Maintain ADD 7.46 Down 8.88
ADD Maintain ADD 3.86 Down 4.02
REDUCE Maintain REDUCE 2.18 Down 2.40


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