Offshore & Marine - UOB Kay Hian Research 2016-03-07: Asset Impairments ~ Not All Are Equal; Yards vs Operators

Offshore & Marine - UOB Kay Hian Research 2016-03-07: Asset Impairments ~ Not All Are Equal; Yards vs Operators Offshore & Marine EZION HOLDINGS LIMITED 5ME.SI  NAM CHEONG LIMITED N4E.SI  KEPPEL CORPORATION LIMITED BN4.SI  EZION HOLDINGS LIMITED 5ME.SI 

Offshore & Marine Singapore: Asset Impairments – Not All Are Equal; Yards vs Operators 

  • The O&M sector racked up loss provisions totalling US$2.2b. We believe shipyards are likely to report further asset impairment. 
  • YZJ has been the most prudent, but SMM and Nam Cheong have not provided enough, in our view. 
  • OSV operators face lower risks of further impairment, as their asset valuations are guided by a DCF methodology that is applied to vessels with a long economic life of 20-25 years. 
  • Our top BUYs are Keppel Corp and Ezion Holdings while top SELLs are SMM and Nam Cheong
  • Maintain MARKET WEIGHT. 


WHAT’S NEW 


• Asset impairments – not all are equal. 

  • Singapore offshore & marine (O&M) companies made loss provisions totalling US$2.2b in FY15. These consist of asset impairments as well as provisions for difficult trade receivables. In this report, we assess the likelihood of further asset impairments as well as companies that are vulnerable to more asset impairments. 

• Yards face high risks of further asset impairments. 

  • Not all O&M companies are equal. In our view, shipyards face greater risks of asset impairment than asset operators. Yards that are building drilling jack-up rigs or/and offshore support vessels (OSV) for third-parties or on a speculative basis face major risks as asset values have collapsed. If the existing customers of the rigs/OSVs under construction walk away, the yards by default become the asset owners. 
  • At current low resale prices, they are unlikely to recover their building costs and would need to incur asset impairment. 

• Differing asset valuation methodologies between yards and OSV owners. 

  • For shipyards, asset impairment (on assets that the original customers have refused delivery) is determined by resale prices, whereas OSV/rig owners’ asset impairment is determined by the higher of value-in-use (a DCF method) or fair value (market value). 
  • Given the slump in market prices, the former methodology is likely to yield a higher value. 

• Asset impairments higher for large-cap shipyards than operators. 

  • Insofar, operators’ asset impairment as a percentage of adjusted FY15 shareholders’ equity has been smaller than that of large-cap shipyards, averaging 8% vs 15% respectively. We have excluded small-cap shipyards as they have yet to make asset impairments. 
  • The higher percentage at yards is due to the fact that drilling jack-up prices have fallen by 34% since 2014. Compared with offshore vessels, the impairment is muted by the asset’s long economic life of 20-25 years. 
  • A lack of employment spanning 1-3 years arising from a cyclical downturn, done on a DCF-basis, is unlikely to yield a huge impairment value. Channel checks indicate no decrease in economic useful life, with some assets actually seeing an increase despite the downturn. 

• Exploration assets face the greatest risks. 

  • Oil companies have drastically cut back exploration spending, preferring to enhance existing producing oilfields to sustain oil production. This has resulted in resale prices of drilling rigs falling off the cliff and banks becoming increasingly reluctant to extend loans on rig purchases without a charter contract in hand. Against this backdrop, asset buyers are using all reasons to push resell prices down. 

• Not all shipyards have been equally prudent. 

  • Yangzijiang Shipbuilding (YZJ) has demonstrated a prudent yard’s approach to asset impairment. It is currently building one jack-up rig which is 95% complete. While the contract remains valid, the yard has prudently accounted for the high chance of delivery deferment, writing down the value of the rig by 35% from US$170m to US$110m. The impairment value does not take into account the US$17m deposit it has received. Management said the outstanding net cost (after impairment) to YZJ is US$93m. Depending on whether the rig is sold below/above US$93m, further impairment/write-back will be done. 
  • In comparison, Sembcorp Marine (SMM) has largely not provided for asset impairment against the difficult rig building contracts (six jack-ups and one semi-submersible rig) it is facing. 
  • Likewise, OSV builder Nam Cheong has yet to provide for asset impairment against its vessels in the 2016-17 shipbuilding programmes. 


ACTION 


•Sufficient for most who have impaired, impairments likely for those who haven’t. 

  • Most companies have made sufficient impairments and provisions in light of the current oil price environment, save a handful. However, should conditions further deteriorate and lead to oil price falling below US$20/bbl, companies will have to make a re-assessment. Even if it does not, a sustained downturn at current price levels will likely prompt companies that have yet to impair their assets to do so by end of FY16. That said, all this will be moot should oil price revert to normal by year-end. 
  • Our views regarding impairments at select companies are penned below. 
    • Sembcorp Marine: Thus far, SMM has mainly provided provisions relating to supply chain costs and reversal of profits recognised from cancelled rigs. No provisions have been made for decline in asset values. Newbuild rig prices have fallen 30-40% on paper, but actual transacted prices imply discounts as steep as 60%. Based on the latter figure, we find that asset impairment on SMM’s rig orders at risk would amount to S$663m. 
    • Nam Cheong: Its current 2016-17 shipbuilding programme comprises 23 vessels, with 11 vessels remaining unsold. No asset impairments were made for 2015, as management stated that their cost of inventory remained well below current market values. Noting that their prior 2016 shipbuilding programme comprised 16 Built-to-Stock vessels with an estimated value of US$360m, a write-down on that value will be substantial. We suspect that these vessel deliveries have been spread out over 2016-18. Management has alluded that should the oil downturn prolong, they would have to reevaluate the impairment issue. 
    • Keppel Corporation: In their FY15 results, total provisions amounting to S$230m were made for Sete Brasil. Management believes that the provision is adequate. We see no cancellation risks on their existing orderbook that will require asset impairment. 
    • Ezion: Impairments totalling US$81m on PPE and provisions for trade receivables were made in their 4Q15 results. Management believes this to be adequate for now, but cautioned that should the oil price environment deteriorate further below the US$30/bbl level, further impairments would have to be made. 

• Core operating margins showed smaller-than-expected deterioration despite downturn. 

  • Surprisingly, the deterioration in core operating margins has been lower than expected for some (see chart on right), due to aggressive cost cutting by companies. Of note is Keppel, whose core operating margin was almost unchanged at -0.1ppt due to its acquisition of Keppel Land in 2015 which supported earnings. 

• Top BUYs are Keppel Corp and Ezion Holdings; top SELLs are SMM and Nam Cheong. 



ASSUMPTION CHANGES / CATALYSTS / RISKS 


• Rolling over target prices to 2017. 

  • We roll over our target prices by a year, now based on 2017F P/B. The new target prices can be found in the peer comparison table below. 

• 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 post-crash levels.





Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-03-07
UOB Kay Hian Analyst Report BUY Maintain BUY 6.60 Up 6.05
BUY Maintain BUY 0.79 Same 0.79
SELL Maintain SELL 0.085 Down 0.90
SELL Maintain SELL 0.90 Up 0.88
BUY Maintain BUY 4.05 Up 3.80
SELL Maintain SELL 0.36 Same 0.36
HOLD Maintain HOLD 0.12 Same 0.12
BUY Maintain BUY 0.69 Same 0.69
BUY Maintain BUY 0.48 Down 0.53


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