Offshore & Marine - UOB Kay Hian 2016-05-20: Global Bellwethers ~ On An Oil Price Recovery, It's Balance Sheet First

Offshore & Marine - UOB Kay Hian 2016-05-20: Global Bellwethers ~ On An Oil Price Recovery, It's Balance Sheet First Offshore & Marine SEMBCORP INDUSTRIES LTD U96.SI  NAM CHEONG LIMITED N4E.SI  SEMBCORP MARINE LTD S51.SI  KEPPEL CORPORATION LIMITED BN4.SI 

Offshore & Marine – Singapore: Global Bellwethers: On An Oil Price Recovery, It’s Balance Sheet First

  • With the oil market moving towards equilibrium by end-16, we shift our focus to management comments from E&P companies, which are the first beneficiaries of higher oil prices. 
  • Their comments carried a more upbeat outlook, with most expecting a recovery. 
  • Unsurprisingly, their top priority is balance sheet repair and achieving cash flow neutrality before resuming capital spending. 
  • A US$60/bbl level is eyed for resumption in capital spending despite having projects viable at US$50/bbl. 
  • Maintain MARKET WEIGHT, with top BUY being SCI and top SELLs SMM and NCL.



WHAT’S NEW

  • We shift our focus to exploration & production (E&P) companies in our quarterly bellwether tracking as they will be the first beneficiaries of the higher oil prices. 
  • A look into the business strategies of E&P companies will shed light on the direction of activities post oil price recovery. 
  • Management comments proved to be slightly more upbeat this quarter, with most anticipating a recovery as soon as end-16. Key highlights below:

Balance sheet repair and cash flow neutrality key focus for oil majors. 

  • A key theme among oil majors is to repair their balance sheet and achieve cash flow neutrality post an oil price recovery. 
  • Oil majors have not significantly reduced dividend payments entering the downturn as the use of cash remained a top priority. This had the effect of stretching their balance sheets as oil prices declined. 
  • Continued high dividend payouts and production/maintenance capital spending also meant many oil majors were cash flow negative throughout 2015. Going into a recovery, oil majors are keen to reduce gearing and achieve cash flow neutrality before committing to higher capex. 
  • Brent price for industry to be cash flow neutral is estimated by WoodMac at US$53/bbl.

Capital discipline post a downturn; US$60/bbl level eyed. 

  • A key concern among analysts has been a ramp-up in oil production by shale producers on higher oil prices. 
  • Surprisingly, E&P companies are exercising capital discipline, withholding spending despite having portfolios that could be developed profitably at US$50/bbl and focusing on repairing their balance sheets. 
  • Business sustainability is an oft repeated word among management, with most eyeing US$60/bbl as the level where they would increase new capex spending.

A shift towards shorter-cycle projects. 

  • Another theme among oil majors is a shift towards shorter-cycle projects. Oil majors, caught wrong-footed with their long offshore development projects in the downturn, now want a greater mix of shorter-cycle projects to balance their portfolios. 
  • In an extreme case, ConocoPhillips said it is exiting deepwater development, while Schlumberger expects conventional land and unconventionals to meet demand in the near term. This means that post recovery, a lower focus on offshore development will have an impact on offshore activity peak levels.

Balance sheet strength helps in contract bids. 

  • While oil price recovery is on track, spending remains tight and oil majors are committed to seeing their projects developed on- time and on-budget. 
  • Remarks by Subsea 7 showed that clients were selecting contractors/operators based on their balance sheets, and seeing jobs going to tier-1 companies solely because of their balance sheets. While that alone does not guarantee a contract win, it does lend a significant advantage to contractors and operators.



ACTION


 Maintain MARKET WEIGHT, selectively accumulate. 

  • While valuations appear attractive at current levels, stocks in this segment pose downside or non-performance risks due to earnings weakness in the coming quarters. 
  • We do not expect an earnings pick-up until oil majors increase capital spending. 
  • At the same time, the stocks provide significant tactical upside potential on a mere turn in oil prices. Thus, we recommend cautious accumulation of stocks in this sector, preferring candidates with strong balance sheets. 
  • In the shipyard segment, Keppel Corporation (KEP SP/HOLD/Target: S$6.40) and Sembcorp Industries (SCI SP/BUY/Target: S$4.00) are potential candidates owing to their diversified earnings with exposure to O&M. 
  • We prefer Keppel due to its balance sheet strength and higher risk-reward. 
  • In the oilfield services space, we prefer Ezion (EZI SP/ HOLD/Target: S$0.60) due to its strong operating cash flow and balance sheet strength.



PEER COMPARISON







Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-05-20
UOB Kay Hian Analyst Report HOLD Maintain HOLD 6.40 Same 6.40
BUY Maintain BUY 4.00 Same 4.00
SELL Maintain SELL 0.07 Same 0.07
SELL Maintain SELL 0.90 Same 0.90


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