Shipyard Sector Singapore - UOB Kay Hian 2016-01-28: Who Might Make A Cash Call?

Shipyard Sector Singapore - UOB Kay Hian 2016-01-28: Who Might Make A Cash Call? Offshore & Marine SEMBCORP MARINE LTD S51.SI  SEMBCORP INDUSTRIES LTD U96.SI  KEPPEL CORPORATION LIMITED BN4.SI 

Singapore Shipyard - Who Might Make A Cash Call? 

  • In our view, a cash call by Keppel is highly unlikely while a cash call by SMM is possible. 
  • In the worst-case scenario, we estimate SMM could see a rig value impairment of S$663m which would raise its 2016 net gearing from 56% to 79%. This could lead to a cash call to bring down net gearing to 50%. SCI should be able to withstand this cash call by SMM. 
  • Our target prices for SMM and SCI are lowered to S$0.88 and S$3.47 respectively. 
  • Maintain MARKET WEIGHT. BUY Keppel, SELL SMM. 


WHAT’S NEW 

  • We assess the likelihood of Keppel Corp (Keppel), Sembcorp Marine (SMM) and Sembcorp Industries (SCI) needing an equity injection amid the current deep downturn in the oil & gas industry. 


STOCK IMPACT 


Keppel Corp 


 In our view, a cash call is highly unlikely. 

  • The bulk of Keppel’s debt belongs to its property business. Its marine business is in a net cash position (based on 2014 published accounts). 
  • Net gearing is forecast to fall from 57% as of end-15 to 48% and 49% by end- 16 and end-17 respectively. This is in line with the average net gearing of 40% for Singapore developers in our coverage. 
  • Our base case estimates assume Keppel delivers only two submersible rigs (out of a total of six semis). 

Sembcorp Marine 


 Four drillships removed from our base-case earnings forecasts. 

  • We have removed four of seven Sete Brasil’s drillships being built by SMM from our earnings forecasts. As such, our base-case earnings forecasts for 2016 and 2017 (assuming delivery of three drillships) have been knocked down by 53% and 60% respectively. This potential earnings impact was flagged in our earlier report dated 8 Jan 16. 

 A cash call is possible. 

  • The major negative impact would be rig value write-down which could lead to a huge loss in 2016. 
  • We estimate in the worst case, the total rig value writedown could amount to S$663m for SMM. This assumes non-delivery of six jack-up rigs (1x Marco Polo, 3x Oro Negro, 2x Perisai) and 1x semi (West Rigel). We assume a 60% fall in rig values since 4Q14. Current rig prices support this assumption. While this asset value impairment is a non-cash item, it leads to a sizeable erosion in shareholders’ funds as well as a higher net gearing. 
  • We estimate SMM’s 2016 net gearing would rise from 56% to 79%. In such an event, we see the likelihood of a cash call. 
  • Assuming net gearing to be brought down to 50%, this would necessitate a cash/equity injection of S$633m. This could take the form of a rights issue or a share placement. 

Sembcorp Industries 


 SCI’s balance sheet should withstand a rights issue by SMM. 

  • We estimate SCI would need to fork out S$386m in the above-mentioned rights issue by SMM. 
  • As SMM is a subsidiary, SCI’s net gearing is unaffected at the group level. 
  • Projected 2016 net gearing of 69% is relatively comfortable as utilities projects are typically funded on a non-recourse project financing basis. The average net gearing of utilities peers is > 100%. 


VALUATION 


 Keppel and SMM currently trade at 2016F P/B of 0.8x and 1.0x respectively. 

  • Stock valuations have fallen below 2008-09’s recession levels. South Korean and Japanese offshore heavy-engineering shipyards are trading at lower 2016F P/B of 0.6x. 
  • To recap, Keppel’s and SMM’s premium valuations started in 2004 on the back of the oil supercycle. Keppel had always been involved in rig building while SMM had just diversified into rig building. Both their P/B valuations shifted to higher levels because of a massive earnings uplift, good balance sheet management and decent dividend yields. 
  • Worth noting is prior to 2004, SMM - a pure shipyard - traded at a lower average P/B of 1.26x (1997-2003). Then, it was primarily a ship-repair yard. While its earnings capability was lower, SMM’s ship-repair business was low risk. Its current offshore heavy-engineering business is inherently higher risk. 
  • During the Asian financial crisis (AFC), SMM’s P/B valuation crashed to 0.85x. 

 Maintain SELL on SMM and cut target price from S$1.05 to S$0.88. 

  • We value SMM at 0.85x 2016F P/B, in line with AFC trough valuation of 0.85x. It is probable that intervention may occur well before SMM’s share price reaches our target. 

 Lowering target price for SCI from S$3.60 to S$3.47. 

  • Factoring in our lower target price of S$0.88 for SMM, our revised SOTP valuation for SCI is S$3.47, based on a 2016F PE of 12x for its utilities business. 
  • If we were to hypothetically ascribe an unlikely case of zero value for SMM, SCI’s valuation would be S$2.85/share which is still above its last share price of S$2.23. 
  • Maintain BUY but note that it faces short-term headwinds. 

 Keppel Corporation. 

  • We have also reduced our target price for Keppel from S$6.30 to S$6.05
  • Our 2016F P/B benchmark remains unchanged at 0.85x, pegged to AFC trough valuation. 
  • We adopt this conservative stance in spite of its marine business is in better shape than SMM’s. 
  • Maintain BUY on valuation grounds; current price nets the O&M unit at zero cost and confers a sustainable 6-7% dividend yield over 2016-18. 


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 in order to return activity levels to pre-crash levels.



Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-01-28
UOB Kay Hian Analyst Report BUY Maintain BUY 3.47 Down 3.60
SELL Maintain SELL 0.88 Down 1.05
BUY Maintain BUY 6.05 Down 6.30


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