Offshore & Marine - UOB Kay Hian Research 2016-01-15: Cutting Target Prices Again On A Lower Oil Price Benchmark

Offshore & Marine SEMBCORP INDUSTRIES LTD U96.SI EZION HOLDINGS LIMITED 5ME.SI TRIYARDS HOLDINGS LIMITED RC5.SI EZRA HOLDINGS LIMITED 5DN.SI COSCO CORPORATION (S) LTD F83.SI NAM CHEONG LIMITED N4E.SI PACIFIC RADIANCE LTD T8V.SI

Offshore & Marine – Singapore Cutting Target Prices Again On A Lower Oil Price Benchmark

All companies are re-evaluating ways to optimise costs following a fresh round of oil price declines. We cut our Brent crude benchmark from US$60/bbl to US$50/bbl.
Following a re-run of our regression analysis, we cut OSV target prices by 22-39%. We benchmark Singapore rig builders to AFC trough P/B of 0.85x, but provide alternative valuations based on South Korean yards’ lower valuations.
Our top picks remain Ezion Holdings and Triyards. Maintain MARKET WEIGHT.

WHAT’S NEW

 Shifting oil price benchmark from US$60/bbl to US$50/bbl.

Brent crude oil price saw another step down since November to a low of US$30.31/bbl this week. This has prompted forecast downgrades - averaging 16% - among the 28 banks/agencies that we track.
The revisions in the last one month point to an average of US$48/bbl, and we expect consensus forecast to fall to around this level. As such, we pre-emptively lower the Brent crude oil price benchmark for our stock target prices from US$60/bbl to US$50/bbl.

 OSV target prices cut by 22-39%.

We re-run our regression analysis, incorporating fresh datapoints since end-Aug 15.
With history no longer a good guide for Singapore large-cap shipyards Keppel Corp (Keppel) and Sembcorp Marine (SMM), we perform a regression analysis for offshore support vessel (OSV) owners only. The results of our latest analysis are similar to that of our previous exercise, as stock prices have continued to decline in lockstep with Brent crude oil price.
We note an improvement of 3ppt in our R-square, from 0.89 to 0.93.
For a reality check, our regression analysis implies a 1-yr forward P/B of 0.30x for Brent crude oil price at US$30/bbl. This is quite in line with the current average 2016F P/B of 0.32x of our universe of OSV stocks.
Using the implied P/B of 0.58x from our regression analysis for a Brent crude oil price assumption of US$50/bbl for OSV owners, our target prices are reduced by 22-39%. The sensitivity of stock prices to various Brent crude oil price levels is shown below.

 Valuing Singapore rig builders at 2016F P/B of 0.85x, in line with AFC trough P/B.

As flagged earlier, Singapore rig builders are seeing a paradigm shift in valuations.
SMM’s trough P/B of 1.44x during the 2008-09 Great Recession is an inadequate guide for the current downturn which is steeper. A better reference would be SMM’s trough valuation of 0.85x during the 1998 Asian Financial Crisis (AFC). As such, we peg the Singapore rig builders’ marine businesses at 2016F P/B of 0.85x, but are cognisant that this is still above the current 2016F P/B of 0.55x for South Korean yards.

 Benchmarked to South Korean yards, SMM’s target price could fall as much as 48%.

We had earlier revised our target prices for Keppel, SMM and Sembcorp Industries (SCI), after benchmarking their marine businesses to a 2016F P/B of 0.85x.
We provide another set of valuations based on the South Korean yards’ lower 2016F P/B.
Singapore yards have traded at a P/B premium of >200% over South Korean yards’ valuations over the last five years since 2011. We have seen gradual premium erosion in the current downturn. These lower valuations serve as an alternative reference point.
The South Koreans currently trade at 0.55x. Excluding Daewoo (due to its abnormally high P/B despite a net gearing of 811%), the average P/B falls to 0.44x.
Based on these two lower benchmarks (refer to table on front page), we find that Keppel’s and SCI’s target prices are lowered by another 7-10%, whilst SMM’s is lowered by another 35-48%.

ACTION

 Maintain MARKET WEIGHT.

Despite our steep target price cuts, our stock recommendations remain largely unchanged. We however downgrade Ezra to HOLD due to its heightened earnings risk despite its all-time low P/B valuation. Current stock valuations are below 2008-09’s cyclical troughs.
Many stocks are deep in value. Following a fresh round of oil price declines, the global O&G industry has suffered another blow. It faces prolonged poor earnings visibility as capex sees deeper cuts.
An intense austerity drive permeates the entire industry - among oil companies, service providers, shipyards - and we expect another round of capex cuts. All companies are reevaluating ways to optimise costs.
A meaningful recovery might only be seen in 2017. Much depends on oil prices finding a floor.
Our top stock picks are Ezion and Triyards which continue to deliver earnings despite the steep industry downturn. Top sells are SMM and Nam Cheong.

ASSUMPTION CHANGES / CATALYSTS / RISKS

Oil price the key risk. Two key risks in the sector are:
1. protracted low oil prices, and
2. another sharp fall in oil prices.
Both would significantly impede future capex spending, which needs to rise to return activity levels to pre-crash levels.

Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-01-15

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