Sembcorp Marine (SMM SP) - UOB Kay Hian 2016-10-26: 3Q16 Core Business Profitable, Impacted By Associate Losses

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SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - 3Q16 Core Business Profitable, Impacted By Associate Losses

• Sembcorp Marine (SMM) reported a loss of S$22m for 3Q16, below expectations. The quarterly loss was largely due to associate Cosco Shipyard Group (CSG) and forex losses. Excluding these, SMM reported a profit from its core business, albeit lower by 50% yoy. 
• As SMM continues to deliver on its projects, the inflow of cash should improve its balance sheet. Core earnings are bottoming out, though the lack of contract wins is a key risk. 
• Slash 2016 earnings by 38% due to CSG, with 2017-2018 earnings largely unchanged. 
• Maintain HOLD with a lower target price of S$1.23. Entry price: S$1.20.

RESULTS

3Q16 earnings miss expectations. 

• Sembcorp Marine (SMM) reported headline 3Q16 net loss of S$21.8m, due to a S$27.7m loss from associate Cosco Shipyard Group (CSG). 
• Excluding losses from CSG, and one-off items including a S$18.9m forex loss and S$3.9m impairment of an available for sale financial asset, SMM’s core business reported a net profit of S$27.3m (-50% yoy). 
• Even after adjusting for these, earnings on a 9M16 basis was still a miss, coming in at 66% of our and consensus forecasts. The weaker core earnings was largely due to lower revenue (-21%), and higher interest expense (+86% yoy).

Repair revenue weakens by 20%. 

• SMM repaired 121 vessels for 3Q16, on par with the 123 vessels repaired in 3Q15. 
• Repair revenue per vessel was substantially weaker, at S$0.87m per vessel, an 18.8% yoy decline. Management remarked that this was due to clients “conserving cash”.

Core EBIT margin higher at 5.7%. 

• This was 0.8ppt higher than 3Q15, but represented a decline of over 1ppt from margins reported in 1Q16 (7.1%) and 2Q16 (9.5%). 
• No special charges were made in 3Q16; recall that 3Q15’s core EBIT margin was low due to profit reversal for five rigs.

Net debt down to 105%, from 120% previously in 2Q16. 

• This was helped by an increase in cash balances, as deliveries on several projects led to operational cashflow reaching S$765.1m for the quarter. 
• Net gearing is declining to levels of ~100%, within our expectations owing to cashflow received as it delivers on its projects.

No new contracts awarded for 3Q16. 

• Ytd contract win stood at S$320m, unchanged from 1H16. 
• Net orderbook excluding Sete Brasil orders stood at S$5.2b.

STOCK IMPACT

Excluding associates losses, SMM’s core earnings are stabilising. 

• Associate losses from CSG are expected to continue, and we foresee no turnaround for them. However, excluding its debilitating effects, SMM’s earnings appear to be stabilising at an average of S$30m per quarter. This runs on the assumption that SMM is able to maintain a certain level of contract wins going forward. 
• We ballpark that at least S$1b-2b of contract wins are required for SMM to maintain earnings at this level.

Majority of net orderbook on progressive payment terms. 

• Of its S$8.4b orderbook (Sete Brasil included), less than 20% of them comprise drilling rigs with back-ended payment terms. Excluding the Sete Brasil and drilling rig orders, most, if not all of SMM’s projects going forward are on progressive payment terms. As such, working capital requirements have likely peaked, and we envision steady cashflow going forward.

Balance sheet on the mend. 

• Barring any unforeseen circumstances, SMM’s balance sheet is on the mend. 
• With capex tapering off in 2017, progressive payments on its existing orderbook and a highly cash generative repair business, SMM should turn cashflow neutral. 
• We expect net gearing to decline to around ~90%. This is predicated that at least S$1+b in contract wins can be secured per year. 
• Rising oil price going into 2017 favors the outlook that this can be achieved.

EARNINGS REVISION

Cut 2016 capex assumption to S$1b (previous: S$1.5b). 

• With 2016 nearing an end, and only S$0.3b in contract wins to date, we reduce this to S$1b. We maintain our S$1.5b contract win assumption for 2017-18.

2016/2017 earnings slashed by 4-38%. 

• Our earnings estimate for 2016 has been thrown off by the loss from associate CSG. We pencil in a S$52m loss for associate CSG, which implies two things: 
  1. SMM making a core earning of S$42m for 4Q16, offset by, 
  2. a further S$24m loss from associate CSG. 
• Our estimates do not account for potential asset impairments, as we prefer to build it directly into our target price. 
• Our earnings forecast for 2017 and 2018 are relatively unchanged at S$101m (-4%) and S$120m (0%) respectively. 

VALUATION/RECOMMENDATION

Maintain HOLD with a lower target price of S$1.23. 

• With balance sheet on the mend, cash call risks are abating. Lacklustre future earnings and the risk of possible asset impairments remain. However, rising oil prices may see valuations re-rate upwards.
• Maintain HOLD. 
• Our P/B-based target price benchmark of 1.0x 2017F P/B remains unchanged, and represents a 24% discount to its historical trading multiple from 2000-03, prior to the rig construction boom. 
• In the unlikely event that SMM impairs its rig orders, our target price falls to S$0.91. Entry price is S$1.20.

RISKS

• Asset impairments. 
• Difficulty securing new orders due to high gearing level.

Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-10-26

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 1.23 Down 1.270