Sembcorp Marine - CIMB Research 2015-11-18: Who blinks first

Sembcorp Marine - CIMB Research 2015-11-18: Who blinks first SEMBCORP MARINE LTD S51.SI 

Sembcorp Marine - Who blinks first 

  • Marco Polo announces on SGX that it has issued a termination notice to PPL for the building of a high-spec jack-up rig, citing failure to meet contractual obligations. 
  • It is also seeking refund of the 10% deposit paid on the US$214m contract. 
  • SMM denies that it has received termination notice and regards the claim as repudiatory breach of contract. It will terminate the contract and claim amounts due. 

■ SGX a platform for cancellation of contract? 

  • Marco Polo has announced on SGX that it is serving a notice of termination on PPL for the high-spec jack-up rig that is due for delivery in end-15. 
  • Marco Polo said that PPL failed to comply with certain material contractual obligations. It cited that cracks were found on all three legs of the new rig during two rounds of tests despite repair works carried out by PPL after the first round of tests. 
  • Marco Polo is also seeking a refund on the 10% deposit paid (US$21.4m) together with interest. 

■ Cancellation unexpected 

  • SMM’s delayed response said that it did not receive any notice of termination on the contract at the time it learnt of the announcement. It also disagreed with the allegations in the announcement and will regard this as a repudiatory breach of the contract. It will also terminate the contract and claim amounts due, enforcing its rights. 
  • As of 3Q15, no profits were reversed for the Marco Polo rigs, suggesting that construction was still ongoing. However, with the latest development, further provision will be required in 4Q15. We estimate an EBIT of US$32m for the contract could be reversed, assuming a 15% margin. 

■ Fault-finding in anaemic rig market 

  • We believe the cracks found during testing are typical but this has been used as one of the reasons for Marco Polo to cancel the contract. In our view, this could be an excuse to escape the remaining 90% payment due in an anaemic rig market. The rig is being built based on the widely-accepted Pacific Class 400 design. 
  • Marco Polo's financing is stretched, with a net gearing of 0.9x as of 3Q15. In Sep 15, the company commenced a consent solicitation exercise for the S$50m MTN due in 2016 with higher gearing ratio of 2.5x from and interest coverage from 4x to 2.5x, among other things. 
  • The rig was ordered at the peak of the rig cycle in 2014 with the intention for Marco Polo to cooperate with a partner or sell to a third party. However, we believe this has taken a turn given how the rig market has since evolved.

■ Under pressure 

  • We leave our EPS unchanged for now but see cancellation, deferrals and potential litigation as key de-rating catalysts. 
  • We maintain our Reduce call and target price (S$2.03), still based on 11x CY17 P/E (-1 s.d. from historical average).

LIM Siew Khee CIMB Securities | http://research.itradecimb.com/ 2015-11-18
CIMB Securities SGX Stock Analyst Report REDUCE MAINTAIN REDUCE 2.03 Same 2.03