Sembcorp Marine - RHB Invest 2015-11-18: First Cracks In The Dam

Sembcorp Marine - RHB Invest 2015-11-18: First Cracks In The Dam SEMBCORP MARINE LTD S51.SI 

Sembcorp Marine (SMM SP) - First Cracks In The Dam 

  • SembMarine has suffered its first formal rig contract cancellation, with MP Drilling canning its USD214.3m Pacific Class 400 (PC400) premium jack-up rig on various factors, which include cracks on all three of the rig’s legs. 
  • Maintain SELL and SGD2.00 TP (11% downside) as this has negative implications over the company’s build quality. 
  • This is also the sixth in a growing number of rigs facing non-delivery from its yards. 

 Build quality the key point of contention. 

  • Marco Polo Drilling (I) Pte Ltd (MP Drilling) has, according to its press statement, terminated its rig under construction at PPL Shipyard Pte Ltd (PPL) due to “various factors, including cracks found on all three legs of the new rig during two rounds of tests, notwithstanding repair works carried out by PPL after the first round of tests”. 
  • We note that Sembcorp Marine’s (SembMarine) announcement did not deny that cracks existed on the rig’s legs, but stated that it “disagrees with the allegations” and “will regard this as repudiatory breach of the contract”. 
  • Important details – such as the number, severity, exact locations of the cracks and whether the classification societies have had a chance to perform non-destructive testing to verify structural integrity – have not emerged. 

 Expect substantial profit reversal in 4Q15. 

  • With the rig worth USD214.3m and at nearly full completion, we expect a SGD35m-40m profit reversal in 4Q15. 
  • This assumes mid-teen margins for the rig, above SembMarine’s c.10% blended margins as this was being built to its proprietary design. 
  • This prompts us to lower FY15F earnings by 9%. 
  • Our TP, based on 11x blended FY15F/FY16F P/Es, is unaffected, being substantially weighted towards FY16 earnings. 

 Six jack-up rigs now facing non-delivery. 

  • As stated in our 23 Oct report, A Massive Miss, SembMarine may likely face cancellations on the jack-up rigs, on which it reversed profits in 3Q15. This first officially cancelled one is now the sixth potentially undelivered jack-up rig on its books, with a > USD1.2bn value in total. Should resale values fall below costs less deposits, SembMarine may have to take in further losses. 

 Negative outlook compounded. 

  • This cancellation raises another angle into the negative outlook for SembMarine, with the issue of build quality now compounding the general market woes. 
  • Maintain SELL and SGD2.00 TP (11% downside) on 11x blended FY15F/FY16F P/Es.

Lee Yue Jer CFA RHB Research | http://www.rhbinvest.com.sg/ 2015-11-18
RHB Research SGX Stock Analyst Report SELL Maintain SELL 2.00 Same 2.00