Sembcorp Marine - UOB Kay Hian 2016-04-28: 1Q16 ~ Bears At The Door; Net Profit Down 48% yoy; Orderbook Woes Continue

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SEMBCORP MARINE LTD S51.SI 

Sembcorp Marine (SMM SP) 1Q16: Bears At The Door - Net Profit Down 48% yoy; Orderbook Woes Continue 

• SMM reported headline net earnings of S$54.8m, down 48% yoy. 
• Excluding one-offs, core earnings of S$35m was in line with our estimate, which is the lowest on the Street. 
• Net gearing rose from 1.10x to 1.15x within a quarter. 
• Low contract wins, Sete Brasil and orderbook woes continue to plague SMM. 
• Earnings will remain lacklustre and we maintain SELL with an unchanged target price of S$0.90, which represents our bear case scenario of asset impairments. 

RESULTS 

 Core earnings of S$35m within expectations. 

• Sembcorp Marine (SMM) reported headline 1Q16 net profit of S$54.8m, down 48% yoy. 
• Excluding one-offs, core net profit was closer to S$35m, down 70% yoy. 
• Core results were within expectations, at 28% of our full-year forecast. One-off items for the quarter included: 
  1. a S$17.2m forex loss, 
  2. a S$24.1m gain on fair value adjustment of hedging instruments, 
  3. an approximate S$3m write-back of prior year bonus provision, and 
  4. S$9.5m in gains from the disposal of a JV and available-for-sale asset. 
• The profit decline was largely attributed to a 43% drop in revenue from the rig and floaters segment. 

 Revenue down 30% yoy to S$918m. 

• Turnover was lower for the quarter, dragged by a 43% decline in revenue from the rig and floaters segment, due to customer deferment requests and customer restructuring. This was partially offset by a 10% increase in revenue from offshore platforms. 
• Repair revenue was flat, at S$99m vs S$100m in the prior quarter. 
• Other activities suffered a 7% decline from S$20m in 1Q15 to S$18m in 1Q16. 

 Operating margin down 2.8ppt to 7.8%. 

• SMM’s operating margin fell 2.8ppt from 10.6% in 1Q15 to 7.8% in 1Q16. The lower operating margin is significantly below its historic mean of 11.7% since 2006. Margins have been impacted by a weaker orderbook and higher fixed overheads. 
• While management gave little guidance on future operating margins, we expect it to remain at the current depressed levels.

 Net debt up slightly by 5.7ppt to 115%. 

• Net gearing rose slightly to 115% as of end 1Q16, as higher total debt was offset by a higher cash balance from receipt of cash following contract deliveries. 
• SMM has guided that it will be receiving approximately S$1.1b-S$1.5b in cash from delivery of orders this year, and we expect this to help lower gearing, albeit to still elevated levels of about 100%.

STOCK IMPACT

 No end in sight to Sete Brasil saga. 

• SMM had earlier announced that it had commenced arbitration against Sete Brasil, which is filing for judicial recovery. 
• Based on our understanding, Sete Brasil will be given 60 days from court acceptance of the bankruptcy application to draw out restructuring plans with its creditors. As a result of this, and the lengthy arbitration procedures after that point, the whole thing will be a drawn-out issue. 
• We re-iterate that the drillships were on milestone payments, and coupled with the S$329m in provisions, the issue is less grave than before. It will however, remain an overhang on SMM’s share price till the outcome of the proceedings become clear.

 Clients continue to defer deliveries; West Rigel remains unsold. 

• Clients continue to defer deliveries, with the latest being Transocean’s two drillships with SMM. 
• Perisai has yet to take delivery of Pacific 102, which was originally scheduled for 31 Mar 16. Discussions remain on-going between SMM and Perisai, as it is with Oro Negro too. 
• The US$568m West Rigel remains unsold and without a charter under the standstill agreement with North Atlantic Drilling (NAD) till Jun 16, after which SMM will take ownership in a JV with NAD.

 More order woes: Hercules Highlander delivery thrown into doubt. 

• In a SEC filing on 18 April, Hercules Offshore said that it had been blocked by creditors from the escrow account holding funds to take delivery of Hercules Highlander, due for delivery in 2Q16 at SMM’s shipyard. The fate of the rig remains unclear, should negotiations - which are on- going till 28 April - fail. 
• Management declined to comment on the issue, but we are flagging the contract to be now at risk despite it having a charter contract in hand.

 Only S$60m in contract wins for 1Q16. 

• SMM’s announcement of S$60m in LNG module fabrication orders for 1Q16 is worryingly low. 
• While contract wins picked up strongly in 2H15, we do not think history will repeat itself in this environment. We opt to review our S$2b contract win assumption after the 2Q16 results. 
• Net orderbook currently stands at S$9.7b with deliveries to 2020. Excluding Sete Brasil, net orderbook is estimated at S$6.7b.

 More provisions still possible. 

• SMM opines that it has made sufficient provisions for now. However, we think further provisions could be made if the environment deteriorates. This could take the form of: 
  1. additional profit reversals due to further cancellations, and 
  2. asset impairment for cancelled rigs. 
• Rig market values have fallen sharply, with a recent transaction for a 5-yr old drillship concluded at 10% of its book value. We have assumed a 60% decline in rig values, and estimate S$729m in impairments.

EARNINGS REVISION

 Tweak earnings forecasts slightly by 1-3%. 

• We keep our core estimates largely unchanged, adjusting our orderbook revenue recognition in view of the recent developments. 
• Our 2016 net profit is reduced slightly to S$125m (-1%); including the one- offs reported in 1Q16, we expect headline net profit of S$144m. 
• Our 2017 and 2018 estimates are S$100m (-3%) and S$130m (+2%) respectively. 
• Our estimates do not account for potential asset impairments, as we prefer to build it directly into our target price.

VALUATION/RECOMMENDATION

 Maintain SELL with an unchanged target price of S$0.90 representing our bear case. 

• Our S$0.90 target price represents our bear case, rounded up. It is based on 1.0x 2017F P/B and adjusted for S$729m of asset impairments. 
• Excluding the impairments, our base case target price is S$1.27. 
• Maintain SELL on two factors: 
  1. high risk of additional provisions, and 
  2. rising gearing, which may require a cash call by SMM to shore up its balance sheet.

RISKS

• A prolonged low oil price environment. 
• Client cancellations, or bankruptcies.

Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-04-28

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