Sembcorp Marine - CIMB Research 2017-07-10: The Only Mega Yard In Singapore In The Next Decade

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SEMBCORP MARINE LTD S51.SI

Sembcorp Marine - The Only Mega Yard In Singapore In The Next Decade

• In its recent UK/Europe NDR with us, SMM reiterated its S$2bn-3bn order target for 2017, comprising Gravifloat gas terminals and offshore platform/ conversion work.
• FAQs by investors were 1) strategic review by SCI, 2) order outlook, and 3) cost competitiveness of SMM vs. Koreans.
• We believe SMM is unlikely to be taken private or divested by SCI in the near-term given both their stretched balance sheets; status quo could be the best for now.
• Maintain Add and target price of S$1.88, still based on 1.5x FY17F P/BV. 
• Potential key catalysts are order win, sale of completed jack-up rigs and re-inclusion on FSSTI.

The worst could be over 

FAQs by investors 

• UK/European investors were generally receptive and held the view that SMM could have bottomed out and see value emerging for the stock. Some of the FAQs by investors were as follows:
  1. - Will parent, Sembcorp Industries (SCI), divest SMM or take it private. This follows the “strategic review” comment made by SCI's new CEO in May 17.
  2. Order outlook and sustainable order book to keep the yard profitable.
  3. Barriers of entry to SMM’s new gas technology Gravifloat.
  4. Cost competitiveness of Singapore vs. Korean yards.
  5. Rig capex cycle and oil price outlook.

Stock has retraced 20% from YTD peak 

• SMM traded up to 1.6x P/BV in Mar 17 and has since retraced 20% due to the lack of sizeable orders, oil price retreat and disappointing 1Q17 earnings, in our view. 
• At current price, it is trading at 1.3x P/BV or -1 s.d. of its long-term average of 2.5x. We see buying opportunity with catalysts coming from orders in 2H17 and recovering oil price.

Unlikely to be taken private or divested by parent 

1+1 may not be 2 

• We believe the outcome from the “strategic review” at SCI's level may not lead to a major shake-up such as taking SMM private. SCI’s priority could be getting India in order, to secure power purchase agreements (PPAs) for SGPL and rationalising non-core operations and assets with low profits. 
• The key deterrent to taking SMM private is the stretched balance sheet and capex requirement at SCI's utilities level over the next 1-2 years. As at end-1Q17, SMM’s net gearing was at 1.1x while we estimate SCI's (corporate and utilities) was at 0.8x. To take over the remaining 39% stake in SMM at current price, SCI needs c.S$1bn. This is almost equivalent to the cost of a sizeable greenfield power plant project in China or two mid-size projects in emerging markets such as Bangladesh or Myanmar. 

2-1 may not be good either 

• We estimate SMM to contribute c.20% to SCI’s profit for FY17F, and that figure may increase to 30% by FY19F. If the power market in India does not recover by 2019, SMM’s contribution to SCI could rise to more than 30%. SMM's ship repair alone already generates c.S$400m-500m of cash generative revenue p.a.
• Therefore, keeping SMM intact, while waiting for the recovery of orders in the medium term could be more feasible, in our view.

Probably the only mega yard in Singapore in the next decade 

• As peer KEP continues to mothball its yards in Singapore, SMM could be the only mega yard to compete head-on with the Koreans on large-scale non-rig structures in the next decade. In addition, we believe KEP’s strategy to strengthen its diversification into property, infrastructure and investment may eventually scale down its focus on offshore and marine (O&M).
• Meanwhile, the completion of phase 2 of SMM's Tuas Boulevard Yard in 1Q17 means it now has a total of 107.8 hectares of space on reclaimed land. The yard now features seven drydocks, ample berthage of more than 5.8km with four finger piers, and basins ranging from 210 metres to 450 metres with maximum draft from 9 metres to 21 metres. 
• The expanded capacity includes 120,000 sqm wider and deeper capacity; this will allow SMM to take on large-scale non-rig structures – evident in the c.US$5.3bn order pipeline that the yard is running for, which include c.US$2.5bn of sizeable offshore platforms.

A repeat of 2015 with back-loaded orders 

• As at end-1Q17, SMM has only secured S$75m of orders but management is still comfortable maintaining its target of S$2bn-3bn wins by end-2017. 
• Recall that in 2015, SMM only started to announce its orders from Jul 15, closing the year with S$3.2bn of orders. Half of the 2017 order target could come from Gravifloat (export or import gas terminal). 
• Management also guided that to sustain the yard’s profitability in the long term, an order book of S$4bn-5bn is essential. As at 1Q17, SMM had a net order book of S$4bn (ex Sete Brasil).

Positive on Gravifloat order 

• SMM is still in discussion with Chinese PolyGCL for a potential Gravifloat contract to support the latter’s export of gas from Ethiopia. The potential customer has conducted yard visit and we expect an award by end-17. The estimated contract value for an export gas terminal are typically in the range of US$1bn. 
• There are also advanced discussions for smaller scale (US$200m- 300m) Gravifloat technology solutions to support gas import in the region, especially in remote areas in Indonesia. Instead of building land-based gas terminals, there could also be collaboration with SCI to jointly build Gravifloat gas import terminals in Myanmar and Bangladesh to support its greenfield power plant expansion.

Cost competitiveness, thanks to foreign labour 

• On investors’ concerns about its cost competitiveness, SMM believes that it is still about 15-20% cheaper than Korean yards mainly thanks to its openness to rely on foreign labour (mainly South Asians). 
• We believe the reduction of foreign worker quota in Singapore's marine shipyards from 1:4.5 (81.8%) to 1:3.5 (77.8%) effective 1 Jan 2018 may not be significant to SMM's margin as more of its processes are being automated. Its expanded Tuas facility, including the state-of-the-art steel fabrication (up to 40,000 tonnes/month), was built with reduced labour reliance in mind.

Upside from bread and butter ship repair 

Additional revenue from BWM 

• Ship repair could be the next earnings driver for SMM, providing some cushion to its earnings cyclicality over the next five years. Ship repair typically fetches EBIT margin of c.20% vs. single-digit EBIT margin for offshore platform fabrication work. 
• On a base case scenario, ship repair could rake in new revenues of S$210m-262m by FY18-19F as a result of the International Maritime Organisation's (IMO) ratification of the Ballast Water Management Convention (BWM) requiring ships due for dry dock after Sep 17 to be fitted with ballast water treatment systems. 
• The new scope of work could add S$0.5m-3m per vessel based based on management’s estimate. About 100-150 vessels p.a.would visit SMM for mandatory dry-dock work (see Figure for potential upside on ship repair revenue upside).

Next kicker is the environmental issue 

• The second wave of earnings driver for ship repair could come IMO’s tighter emissions regulations by 2020, limiting sulphur content in fuel on all ships. Ship owners can consume expensive low sulphur marine gas oil, or use engines that work with LNG or install a gas scrubber to continue regular operations with heavy fuel oil. 
• We believe the LNG and gas scrubber options would provide more scope of work for SMM beyond 2020.

Hopes to conclude some sale of completed rigs in 2017 

• Management is confident that some of SMM's completed rigs could be delivered in 2017 with potential for provision write-backs. We believe SMM could sell the rigs at US$170m-180m each or 15-20% discount to the average contract price of US$210m. KEP SP novated its high-spec rigs to Borr Drilling at US$216m/rig in Mar 2017.
• We expect net gearing to improve by end-2017 from the expected cash inflow from 
  1. sale of Cosco (S$220m), 
  2. final payment of Libra OOGTK FPSO (S$200m), and 
  3. the potential sale of two completed rigs (S$476m).

Valuation and Recommendation 

• We maintain our Add rating and target price of S$1.88, still based on 1.5x FY17F P/BV, benchmarking against its average trading band in 1996-2003, a period of weak oil prices and pre-rig boom. It is now trading at -1 s.d. of its longterm average.
• Potential key catalysts are order wins, sale of completed jack-up rigs and re-inclusion on the FSSTI. SMM was removed from the FSSTI in Sep 16 and was recently included in the reserved list together with Suntec REIT, MCT, KREIT and Yanlord Land Group. The next review will take place on 31 Aug 17.

LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2017-07-10

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