Singapore Shipyards - UOB Kay Hian 2016-08-11: The Production Orders That Never Came To Be

Offshore & Marine KEPPEL CORPORATION LIMITED BN4.SI SEMBCORP INDUSTRIES LTD U96.SI

Shipyards ‒ Singapore - The Production Orders That Never Came To Be

Globally, floating production system (FPS) orders are facing challenges in project sanctioning due to low oil prices. Net realisation of projects since a year ago stands at 34%.
With Singapore yards only able to bid for conversion jobs, only US$15b of projects are viable, translating to US$1.9b of FPS orders per year over 2016-19. The reality will likely be lower than this due to deferments as well as competition from the Chinese yards.
Earnings are unlikely to turn around in the next five years.

According to the latest Energy Maritime Associates report, the average floating production system (FPS) order since 2008 has been 1.5 units per month. Current orders are well below the average, with only two FPS orders recorded up to Jul 16, or 0.6 unit per month for 3Q16.

Of the 241 planned FPS projects globally, 50 are at the bidding/final design stages, representing 21% of total orders. This is the stage where contracts are awarded. The remainder 142 are in the planning stage, and 49 in the appraisal stage.
The low oil price environment has make it difficult for companies to sanction projects, evident from the percentage of projects at the bidding/ final design stage, which has fallen from a peak of 31% to 21% currently, an 8-year low.

Comparing FPS orders marked as bidding/final design stage in 3Q15 vs 3Q16, 19 orders (34%) have been awarded or remain on track for scheduled award. Of the remaining 37 orders, 18 (32%) were reverted back to the planning stage or cancelled, while 19 (34%) had their award dates delayed by a year or more.
Net realisation of orders in the continued low oil price environment is low as projects remain uneconomical.

Historically, Singapore shipyards have dominated the conversion market. Recent times saw the introduction of Chinese yards which are likely to compete fiercely for orders.
Of the US$37b of FPS orders in bidding/final design stage as of 3Q16, US$15b (41%) of orders will likely involve a conversion and therefore viable for Singapore yards to bid. This translates to US$3.8b of orders per year on average, and assuming Singapore yards continue to win half of global orders as they have historically done so, implies US$1.9b orders/year.
With net realisation of projects low, reality will likely fall short of that number.

Borrowing a quote from Keppel’s management on a “long and harsh winter”, a prolonged period of low orders for the Singapore yards is very much a reality. Coupled with our outlook of near zero newbuild rig orders until 2020 and a dismal FPS market, the yards will report poor earnings for at least the next five years.
Balance sheets will be stressed and the yards will survive through sheer skill at managing overheads. Of course, all this will change if oil prices rise significantly above US$60/bbl.

Yards will face poor earnings prospects for its rig building business for a prolonged period. Dividend payout will likely be lower as the downturn prolongs.

If investors still want to play the space, we prefer Keppel as it can lean upon its property, infrastructure and investment businesses.
SMM’s earnings are under more pressure as it has no other businesses to diversify to and risks its rig-building and conversion orderbook running low.
While gearing remains elevated for both yards, the influx of cash as they deliver on projects should bring it to bearable levels. It is difficult to conclude if those levels are comfortable gearing levels for the long winter.

Our recommendation remains unchanged for Keppel (HOLD/Target: S$5.70) and SMM (HOLD/Target: S$1.27). Entry price for Keppel is S$5.10.

Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-08-11

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