Vard Holdings - DBS Research 2017-05-15: Valuations Look Fair

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VARD HOLDINGS LIMITED MS7.SI

Vard Holdings - Valuations Look Fair

• 1Q17 net loss of NOK25m largely within expectations.
• New order win momentum is decent despite the lack of offshore orders.
• Turnaround is not imminent though; maintain HOLD with TP of S$0.25.

Valuations look fair 

• Maintain HOLD as valuation seems to factor in progress of diversification strategy so far. 
• Year-to-date order wins in 2017 amounted to around NOK3.5bn by our estimates, excluding a NOK1bn LOI for a cruise ship, and orderbook has climbed to NOK13.0bn at end-1Q17 from NOK12.6bn at end-2016. 
• Thus, despite the dearth of order wins from the legacy offshore market, Vard has done reasonably well in maintaining order win momentum through its diversification strategy. 
• While it may not be able to repeat 2016’s order win tally of about NOK10.6bn in 2017/18, and while current quarterly revenue run rate may not be enough to cover fixed costs and turn in profits, Vard looks set to at least survive the downturn and emerge stronger once the offshore tide turns. 
• The stock has thus held up well and is currently trading at 0.8x P/BV; we believe further upside is limited until we see signs of a sustainable turnaround.

Bottomline still in the red. 

• Vard reported headline net loss of NOK25m in 1Q17, largely in line with expectations. EBITDA margin before restructuring cost was 2.3% in 1Q17, down from 2.8% in 1Q16 and 3.1% in 4Q16, owing to the lower revenue recognition in the quarter. EBITDA margin continues to be affected by the lower utilisation of yards, leading to an under recovery of fixed costs.

Valuation

• Our TP of S$0.25 is based on a P/BV multiple of 0.8x, a premium to other OSV shipbuilders in the region, to account for Vard’s superior execution in attracting orders from non-offshore oil & gas vessel segments with support from parent Fincantieri. 
• However, given that the share acquisition offer from the parent has lapsed in March 2017, and there are no competing bids available for minority shareholders, further share price catalysts are not imminent. 
• Maintain HOLD.

Key Risks to Our View

• Faster-than-expected order wins from Vard’s new target markets or a turnaround in Brazilian operations could pose upside risk to our call. 
• Execution issues on new vessel types and order cancellations present downside risks.

WHAT’S NEW

Diversification strategy progressing, though legacy offshore vessels pose some risk 

Losses continue, as expected. 

• Vard reported headline net loss of NOK25m in 1Q17, on the back of revenue of NOK1,777m (down 12% y-o-y and 17% q-o-q), largely in line with expectations. 
• EBITDA margin before restructuring cost came in at 2.3% in 1Q17, down from 2.8% in 1Q16 and 3.1% in 4Q16, owing to the lower revenue recognition in the quarter. EBITDA margin continues to be affected by the lower utilisation of yards, and resultant under recovery of fixed costs amid current transition period that Vard faces as its offshore order book dwindles and is replaced by several niche segments under its diversification plan. 
• Gross margin was relatively strong at 40% in 1Q17 as many projects are in initial stages, involving less material. But the high operating leverage nature of the business means that though we expect revenue recognition to pick up over the course of the year, it may not be enough to avoid headline losses in FY17.

Order win momentum has held up so far in 2017. 

• While there have been no orders from the legacy offshore segment, Vard’s diversification strategy continues to pay off YTD in 2017. 
• Order intake of NOK 1,885m in 1Q17 included two ferries, one krill fishing vessel, and one pelagic trawler. 
• So far in 2Q17, Vard has secured a further 2 orders, and we estimate YTD order wins in 2017 to be around NOK 3.5bn, which is tracking ahead of our full year order win assumptions. Accordingly, we revised up our FY17/18 new order win assumptions from NOK5bn to NOK6bn each, given the good track record in securing non-offshore orders.

Two offshore vessels delivered in 1Q17, but risks in offshore portfolio remain. 

• Amidst challenging market conditions, Vard was able to successfully deliver two offshore vessels to European owners in 1Q17. However, many offshore players are undergoing some form of restructuring at the moment and the remaining 10 offshore vessels in Vard’s orderbook (out of 43 total) are not entirely without counterparty risk.
• Vard is also carrying three offshore vessels in its inventory which were cancelled earlier, and securing sale of these vessels could be tricky.
• It is to be noted that Vard’s successful diversification strategy has helped to mitigate this risk, at least partially, as the current orderbook of NOK13.0bn (up from NOK12.6bn as of end-FY16) largely comprises non-offshore vessels; we estimate that about half of the net orderbook comprises the 6 exploration cruise vessels secured in 2016, another 20% or so comes from the Module Carrier Vessels for Topaz Marine, and the remaining is a mix of offshore and other orders.

LOI on a seventh exploration cruise vessel announced in January 2017 has not been finalised yet. 

• Vard announced an LOI for an expedition cruise vessel with contract value pegged at c.NOK1bn from an undisclosed international cruise company in January 2017. Delivery will be from one of the Norwegian yards in 2019. 
• Despite this win early in the year, we continue to believe that 2016’s stellar performance in terms of exploration cruise vessel order wins (six secured in 2016, worth c.NOK6bn or so) is unlikely to be repeated this year, due to the small, niche market that they operate in and limited demand from ageing cruise vessel renewals.

Vietnam and Romanian yards seeing high utilisation; other yards not so much. 

• With hull construction work for Fincantieri and on the cruise vessels, as well as some Module Carrier Vessels (MCVs) being built in Romania, utilisation is high and hiring is underway, with increased use of subcontractors. 
• The Vietnam yard is also benefiting from the MCV project, with 7 vessels on its orderbook. 
• Over in Norway, utilisation is “medium-to-low”; repair and upgrade has been undertaken to offset the gap in workload, and temporary lay-offs are in place at several of the yards. Things should improve once cruise ship hulls come in from Romanian yards. 
• Meanwhile, in Brazil, the four remaining vessels are in later stages of construction and efforts are on to secure more as there is under-utilisation of the capacity involved in early stage construction. If new vessel contracts are not secured on time in Brazil, losses may again start to increase.

Revenues not yet enough to effect turnaround just yet. 

• As mentioned earlier, Vard’s network of yards remains under-utilised overall despite management’s best efforts at diversification and we do not expect annual revenues to cross the NOK10bn mark in the near to medium term. Hence it will be difficult to achieve profitability in the foreseeable future owing to high fixed cost nature of the business and costs are unlikely to drop significantly given some learning curve involved in new vessel types. 
• We expect losses of NOK107m in FY17 and NOK71m in FY18. 
• We could see signs of turnaround towards 2H-FY18 as several deliveries are expected in this period.

Suvro SARKAR DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2017-05-15

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