Nam Cheong Ltd - DBS Research 2015-11-16: Stuck in the doldrums

NAM CHEONG LIMITED N4E.SI

Nam Cheong Ltd - Stuck in the doldrums

Profits at breakeven levels in 3Q15 as revenue recognition lags expectations.
No order wins since 1Q15; orderbook dwindling.
Further deferment of built-to-stock programme likely, we cut FY15/16 earnings by 57%/46%.
Maintain HOLD with lower TP of S$0.15.

Revenues of RM189m were 69% lower y-o-y, owing to lower revenues from the shipbuilding segment, as the Group delivered only two vessels in 3Q15 as compared to six in 3Q14, and there were no new vessel sales.
We reckon the pace of construction on secured contracts has also slowed down, likely on customers’ request. Shipbuilding gross margins were also lower than normal due to higher contribution from built-to-order vessels.
The chartering division dragged down performance further as it reported losses of ~RM5m at the gross profit level due to weaker utilisation rates of about 40% during the quarter.
Group net profit after tax came in at just RM0.4m for the quarter.

Nam Cheong has not secured any order wins since 1Q15, when it secured orders for two vessels worth US$58m. The Group’s net orderbook has thus experienced a steady decline from RM1.3bn as of year-end 2014 to RM880m as of 3Q15.
Eight vessels remain unsold under its 2015 built-to-stock programme, with another 18 unsold under the 2016 programme. Among these, 12 are PSVs, which remain one of the most oversupplied vessel types in the offshore service vessel market. This does not bode particularly well for Nam Cheong’s vessel sales prospects in the near to medium term.
Management indicated that delivery dates have been deferred for the built-to-stock vessels, but the number of units targeted for delivery in each year FY15/16 remains unchanged.
To be conservative, we have pushed back delivery dates for the current built-to-stock programme to 2017.

Net gearing has increased from 0.42x at end-FY14 to 0.97x as of 3Q15, as a lack of vessel sales has resulted in inventory build-up, which has been funded with additional debt. However, Nam Cheong has paid down S$110m of debt under its MTN programme on the 4th of November, which should help lower its gearing slightly in the near term.

With eight built-to-stock vessels under 2015’s shipbuilding programme yet to be sold and only one-and-a-half months remaining to the year, it looks increasingly unlikely that Nam Cheong will meet its own targets.
A further 18 unsold vessels under 2016’s programme brings the total to 26 vessels which must be sold in a span of 13 to 14 months – highly ambitious amidst the lacklustre offshore service environment that is expected to continue well into 2016.
Furthermore, 12 of these unsold vessels are PSVs, which is probably the most oversupplied segment in the OSV space, even across geographies.
As such, we think Nam Cheong’s earnings will remain depressed.
We assume that about half of the 26 unsold vessels will find buyers by end-2016, with the remaining pushed further into 2017.
Margins are also expected to dip, going forward, in line with industry weakness. Hence, we cut our FY15/16 net profit estimates by 57% and 46% to RM66m and RM81m respectively.

Nam Cheong’s chartering segment, which now includes four AHTS vessels and one PSV in addition to the legacy Safety Standby Vessels, has seen a drop in utilisation in 3Q15 to about 40%, from 60% in 1H15 and more than 80% in FY14. This has resulted in negative gross margins this quarter, down from a positive 23% in 2Q15.
Management does not expect a recovery in 4Q15 for the segment, and aims for a revival in 1Q16.
We conservatively assume breakeven profitability for the OSV chartering segment for full-year FY15 and FY16, before some pick-up in FY17.

In light of weakening earnings, Nam Cheong’s minimum required EBITDA/Interest Expense ratio of 3x, as stipulated in its Medium Term Note information memorandums, looks at risk of being breached.
The Group’s EBITDA/Interest Expense ratio – which we have attempted to calculate in line with the covenant’s definition (but may not match the company’s calculations exactly) – has slipped to 3.68x in 2Q15 and 3.04x in 3Q15, which is dangerously close to the minimum 3x level. The ratio is tested on a half-yearly basis, so if earnings (or EBITDA to be precise) deteriorates further in the fourth quarter, there is a likelihood of breaching the covenant.
One way to avoid a breach would be to undertake a consent solicitation exercise to obtain shareholders’ approval to either amend the covenant or put in place a cure mechanism, as we have seen some other SGX-listed players do recently. The absence of news on such a solicitation exercise would therefore be slightly worrying.

Given the lack of earnings momentum as well as muted vessel sales, we believe upside potential remains muted for Nam Cheong.
We retain our HOLD call with a lower target price of S$0.15 per share, pegged to 0.8x P/BV. This is in line with c.6-7% ROE expectations in the future.
Dividends could be suspended in FY15 if its balance sheet is stressed.

Slower recovery in orders and competition from China are key worries. The key risk to our view is that order wins remain lacklustre, leaving the company with excess vessel inventory on its balance sheet, which could lead to high debt levels.
Increasing competition from the Chinese yards, which have been moving up the value chain into more sophisticated OSVs, can also cause downside in the form of pricing woes and margin pressures in the longer term.

Suvro SARKAR DBS Vickers | http://www.dbsvickers.com/ 2015-11-16

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 0.15 Down 0.17