Offshore & Marine - UOB Kay Hian 2015-10-23: 3Q15 ~ Keppel In Line; Sembcorp Marine Hit By Lower Revenue And A Collapse In Margins

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SEMBCORP MARINE LTD S51.SI  KEPPEL CORPORATION LIMITED BN4.SI 

Offshore & Marine – Singapore 3Q15: Keppel In Line; Sembcorp Marine Hit By Lower Revenue And A Collapse In Margins 

• Keppel reported 3Q15 net profit of S$363m, in line with expectations. 
• SMM reported net profit of S$32m, down 76% yoy, on a profit reversal and associate losses. 
• Both companies continue to face headwinds in the O&M sector, but Keppel is buffered by its property earnings. 
• No resolution on Sete Brasil. We revise earnings estimates and lower target prices for Keppel (S$7.60) and SMM (S$2.34). 
• Maintain MARKET WEIGHT. 

WHAT’S NEW 

• Keppel results in line; Sembcorp Marine (SMM) hit by collapse in profit. 

• Both Keppel and SMM reported 3Q15 results. Keppel’s net profit was in line with expectations at S$363m. The same could not be said for SMM, which saw net profit plunge 76% yoy to S$32m, impacted by lower revenue and a collapse in margins. 

Keppel Corp (KEP SP/HOLD/S$7.29/Target: S$7.60) 

3Q15 earnings in line with estimates. 

• Keppel reported 3Q15 net profit of S$363m, down 12.4% yoy (3Q14: S$414m), and 9M15 net profit of S$1,120m, down 3.4% yoy (9M14: S$1,159m). 9M15 net profit was in line, coming at 78% of our full-year estimate. 
• Excluding exceptional items including fair value losses and write-back of impairment, 3Q15 results were marginally better than our quarterly estimate. 3Q15 results were primarily impacted by lower earnings in the offshore & marine (-34% yoy), infrastructure (-11% yoy) and investments (-41% yoy) segments. These were offset by the property earnings, which rose 57% yoy due to strong property sales in China and Vietnam. 

• Offshore and marine (O&M) earnings continued to suffer. 

• The segment’s earnings remained weak, declining 34% yoy to S$166m in 3Q15 (3Q14: S$252m). Operating margin was 12.2%, a 2.5ppt yoy decline. Contract wins remained muted, with S$1.7b of contracts secured year-to-date. Net orderbook was S$10b, with earnings visibility until 2020. Keppel highlighted that it had acceded to client requests to delay delivery of three jack-up rigs - two from Grupo R and one from Parden Holdings. 

• Strong growth in property segment provided uplift. 

• The decline in O&M earnings continued to be offset by its property segment, which saw revenue grow 122% yoy from to S$487m (3Q14: S$219m) and net profit by 57% yoy to S$144m (3Q14: S$92m). Some 3,130 homes were sold in 9M15, up 66% yoy, driven primarily by strong demand in China (Shanghai, Chengdu and Tianjin) and Vietnam, attributed to a relaxing of tightening measures in China and strong economic growth in Vietnam. 
• Property will be the main earnings driver for Keppel going forward, having formed a bigger proportion of net profit now. As of 3Q15, property made up 40% of group earnings (3Q14: 22%) while O&M was 46% (3Q14: 61%). 

• Infrastructure earnings down 11% yoy 

• Infrastructure earnings down 11% yoy on lower electricity prices, primarily impacted by lower electricity prices and absence of revenue from Keppel FMO. 

• Net gearing up from 11% to 52%

• Net gearing up from 11% to 52%, primarily due to higher working capital requirements for the O&M segment. 

Sembcorp Marine (SMM SP/HOLD/S$2.54/Target: S$2.34) 

• Below expectations, on lower turnover and a collapse in margins. 

• Sembcorp Marine (SMM) reported a net profit of S$247m for 9M15, only 56% of our full-year forecast of S$445m. Turnover for 3Q15 fell 34% yoy to S$1.1b while operating profit dropped 56% yoy to S$74.7m. Operating margin collapsed to 6.6% in 3Q15 from 10.0% a year ago. Pre-tax profit fell 87% yoy to S$22m while net profit dived 77% yoy to S$32m despite a tax write-back of S$10.2m. 

• Grief from five jack-up rigs. 

• Management has stopped recognising revenue from five drilling jack-up rigs (Perisai: 2 units, Oro Negro: 3 units) in Aug 15. Earlier profit recognised from these five rigs was reversed in 3Q15. This was prudent accounting based on SMM’s contractual right. In the event of non-payment by customers, SMM would exercise its contractual right to annex the rigs. These rigs are on 20: 80 payment terms. Only 20% has been collected by SMM. We had earlier flagged the risks of the seven jack-up rigs (2 for Perisai, 3 for Oro Negro, 1 for Marco Polo and 1 for Hercules). 

• COSCO Shipyard Group incurred a large loss. 

• Associates' losses of S$24.4m in 3Q15 were due to Cosco Shipyard Group (CSG). Cosco Corp has yet to report results. A S$17.1m impairment charge was also made relating to SMM’s investment in CSG. The losses were offset by a forex gain of S$35.1m and a tax write-back of S$10.2m. ON SETE BRASIL 

• No resolution in sight. 

• Both Keppel and SMM made similar comments on the Sete Brasil situation: a resolution originally due in October has yet to materialise. Talks were still on-going: Keppel opined that an agreement might be reached by end-October, while SMM said Sete Brasil was close to finalising terms. All in all, no definite resolution has been reached on the issue. The completion status of the rigs remained largely unchanged (see RHS table). 

ACTION 

• Keppel’s conglomerate profile provides a buffer. 

• Keppel’s conglomerate earnings will provide it some protection from the downturn in its O&M business. The strong growth in its property business will help offset some, but not all of the negative headwinds in its O&M business. Due to Keppel’s prudent selection of O&M customers, it will be less severely impacted than SMM. Contract wins have been lacklustre for 2015, but developments in its FLNG pursuits are perking up: Golar has entered discussions on a fourth conversion project. 

• Serious headwinds in SMM’s jack-up rig business. 

• We believe there is a high probability that SMM may exercise its contractual right in the three Oro Negro rigs. This would entail annexing the units if payment is not forthcoming. Shareholders of Oro Negro – including Temasek Holdings which owns a 22.5% stake - may not pump further equity into the company. The three Oro Negro rigs are 95% completed, while the two Perisai units are estimated to be 90% and 50% completed respectively. Only 20% of their contract amounts have been collected for the five units. 

ASSUMPTION CHANGES/CATALYSTS/RISKS 

Keppel Corporation 

• Tweak FY15 earnings forecast down by 1%. 

• We tweak our net profit forecasts down by 1% each to S$1,431m, S$1,336m and S$1,364m for 2015-17 respectively. The changes arise primarily from a reduction in our contract win assumptions, which we reduced to S$2.0b, S$3.0b and S$5.0b (from S$2.5b, S$3.5b and S$5.0b) respectively. 

• Maintain HOLD and lower target price to S$7.60, based on 1.7x 2016F P/B. 

• We apply a 15% discount to the O&M business owing to the risk from Sete Brasil, and a 20% discount to Keppel Land’s RNAV. The lower target price arises primarily from an 8% decline in Keppel O&M’s book value. 

Sembcorp Marine (SMM) 

• Slash earnings forecast by 21-35%. 

• We slash SMM’s 2015-17 net profit forecasts to S$290m (-35%), S$315m (-30%) and S$362m (-21%) respectively due to a change in our operating margin assumption from 13% to 10%. We also cut 2016 contract win assumption to US$3.0b, so our new assumptions are S$2.5b, S$3.0b and S$5.0b from S$2.5b, S$3.5b and S$5.0b for 2015-17 respectively. 

• Maintain HOLD and lower target price to S$2.34, based on 1.5x 2016F P/B. 

• We have applied a 25% discount to our large yard benchmark of 2.0x 2016F P/B owing to Sete Brasil and the cancellation risks on its orderbook.

Nancy Wei UOB Kay Hian | Foo ZhiWei UOB Kay Hian | http://research.uobkayhian.com/ 2015-10-23

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