Sembcorp Marine - DBS Research 2015-11-18: Hit by contract cancellation

Sembcorp Marine - DBS Research 2015-11-18: Hit by contract cancellation SEMBCORP MARINE LTD S51.SI 

Sembcorp Marine - Hit by contract cancellation 


What’s the event? 

  • Marco Polo (MPM) has terminated its jackup rig contract with Sembcorp Marine (SMM)’s PPL Shipyard, citing “failure to comply with certain of its material contractual obligations” and unsatisfactory rig quality with “cracks found on all three legs of the rig during two rounds of tests”. 
  • Hence, MPM has demanded SMM to refund its 10% downpayment (US$21.4m or approximately S$27.1m). 
  • SMM has however refuted the allegations. It has not received notice of termination from MPM but will regard this as repudiatory breach of the contract and will thus terminate the contract and forfeit the downpayment collected. 
  • In fact, the second 10% payment should have been due from MPM as the contractual payment term was supposed to be 10:10:80. 

What’s the impact? 

  • We expect SMM to reverse the revenue and profit recognized for this contract in 4Q15, which could be around S$217m and S$21.7m respectively, assuming 80% recognition of the S$271m contract price and net margin of 10%. 
  • We reckon the actual margins could be higher for the unit as the high specification jackup is built to PPL’s proprietary Pacific Class 400 design. 
  • We understand that management has been relatively prudent in its recognition for this unit. 
  • Impairment losses may be required if the resale price is estimated to have fallen by more than 25% of the contract value, assuming a buffer from the 10% downpayment and 10- 15% net margin. 
  • Risk should be low at this juncture, though we can’t rule out the possibility completely, for instance, SMM could make provision for the refund of downpayment to MPM out of prudence. 
  • Taking cue from GFC as there is no recent resale transaction, similar rigs were sold at c.US$180m back in 2009, which implies a 17% discount. 
  • The dispute is likely to take some time to resolve. The rig was scheduled to be delivered by the end of the year but has been deferred in the absence of a charter contract. 
  • Rigbuilders are facing tremendous pressure on deferments and cancellations particularly the Chinese yards. Nonetheless, we believe Singapore rigbuilders are better positioned with better payment terms, track record and probably only 10% of the newbuild contracts coming from young / less established players, based on our ballpark estimate. 

Recommendation 

  • We have a HOLD call on SMM (TP S$2.32). 
  • While we expect near term downside from a knee-jerk reaction to this news, SMM is trading close to its GFC low of 1.5x P/BV and is supported by decent dividend yield of 4%.


Pei Hwa Ho DBS Vickers | http://www.dbsvickers.com/ 2015-11-18
DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 2.32 Same 2.32


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