Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-06-30: West Rigel Standstill Agreement Deadline Draws Near Once Again

SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - West Rigel Standstill Agreement Deadline Draws Near Once Again

The expiry date of the standstill agreement between Sembcorp Marine (SMM) and North Atlantic Drilling (NADL) on the West Rigel is 6 Jul 17. The agreement is expected to be extended again if no deal materialises. Effectively a stacked newbuild rig, challenges in its resale arise as operators begin to shun stacked rigs. Current provisions are sufficient if NADL forfeits its deposit, but insufficient otherwise.

SMM’s current profitability outlook does not justify premium valuations. Maintain SELL with a target price of S$1.43.

The standstill agreement between Sembcorp Marine (SMM) and North Atlantic Drilling (NADL) for the West Rigel semisubmersible expires on 6 Jul 17. The agreement has seen an extension three times, with no firm resolution for the unit in sight.
The previously rumoured acquisition of the semisubmersible by Transocean has yet to materialise.

On 28 Jun 17, Seadrill increased and extended NADL’s revolving credit facility from US$50m to US$150m, with its maturity extended from 30 Jun 17 to 31 Jul 17.
Stacked units face challenges securing charters. According to IHS, more operators are indicating in their tenders that they will not consider cold or even warm-stacked units.
Shell Malaysia, takes this further by saying it will not consider newbuilds or units that have been idle for more than a year.

The standstill agreement is likely to be extended again. The semisubmersible should have seen keen demand from potential buyers, given the supply shortage for harsh environment semi-submersibles highlighted by Bassoe Offshore. However, it appears there continues to be disagreements on price.
Ending the standstill will not be favourable for SMM as it introduces stacking costs to its income statement, which runs between US$10,000 and US$15,000 per day. As such, the most favourable outcome will be another extension.

We do not see any positives coming from the debt facility extension as the facility is provided by its beleaguered parent Seadrill, which currently faces a restructuring deadline of 31 Jul 17.
NADL remains at risk of being dragged into potential bankruptcy with its parent Seadrill, judging by the continued distressed pricing of Seadrill’s US$1b bond due Sep 17 (Last price: 31.5 cents on the dollar). It is uncertain whether SMM has made contingency plans for a NADL bankruptcy.

West Rigel likely faces some short-term hurdles in resale and chartering, as it has been effectively stacked for over a year. Its high uncovered cash cost of about US$400m, after factoring in variation orders (VOs), compounds the problem and makes any price negotiation difficult.
Assuming a resale price at a 50% discount to original price + VOs and that NADL forfeits its deposit, SMM’s current provision of S$280m will be sufficient to cover the loss. If NADL does not forfeit, the losses will easily exceed current provisions. Given the circumstances leading to the standstill agreement, it may be difficult to see NADL forfeit its deposit.

SMM has another six jack-ups that are completed but with owners unable to take delivery. These, too, face similar resale risks as they are essentially warm-stacked newbuild units, having been delivered over a year ago.

Maintain SELL and target price of S$1.43, benchmarked to 1.1x 2017F P/B (previously: 1.3x), based on a P/B-ROE relationship.
While we recognise that 2H17 could see a raft of contract awards, this is weighed down by continued oil oversupply that could see planned awards in 2017 slip into 2018.
Hopes of a buyout for SMM from a government-led restructuring of the shipyard sector may be overhyped as we believe that asset swaps are also on the cards if they occur. Even if the contract awards do come, margins will be low and probably just sufficient for SMM to maintain current profitability levels.
Construction delay issues relating to the Kaombo project may also continue to persist and drag earnings.
In short, SMM is unlikely to see earnings grow significantly that would justify its current premium P/B valuation. On these fundamental reasons, maintain SELL.

Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-06-30

UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 1.430 Same 1.430