Singapore Rigbuilders - DBS Research 2017-09-20: Rolling Rig-sale Bandwagon

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Offshore & Marine Rigbuilder Stocks KEPPEL CORPORATION LIMITED BN4.SI SEMBCORP INDUSTRIES LTD U96.SI SEMBCORP MARINE LTD S51.SI YANGZIJIANG SHIPBLDG HLDGS LTD BS6.SI

Singapore Rigbuilders - Rolling Rig-sale Bandwagon

• Rising rig transactions indicate growing optimism.
• Industry consolidation has kicked off; positive for recovery.
• Improving prospect could catalyse rig delivery.
• Reiterate BUY on Singapore rigbuilders.

Positive indicators of rig market recovery – rising rig sales volume and mergers. 

• We have observed a strong uptick in rig transactions over the past 6 months, which is typically a positive indicator of stronger demand prospects. The recent establishment of new entrants (North Drilling, Borr Drilling) as well as rumours of a potential comeback of Aker Group to the rig-owning space and China Merchant Group’s hunt for distressed operators, underscore the growing optimism. 
• The industry has also kick-started the consolidation wave – Ensco acquiring Atwood; Transocean to buy Songa – which would accelerate the recovery pace.

More perks to justify relook at Singapore rigbuilders. 

• The improving rig market could “motivate” rig owners to take delivery of existing orders and facilitate the disposal of cancelled units in the second hand market, removing a key overhang on Singapore rigbuilders. This could free up Keppel and SMM’s working capital by S$1.5-2.5bn each, lowering net gearing to 0.3-0.5x, from 0.5-1.0x currently. 
• Both yards’ breakthrough into high-value non-crude solutions (> US$200m each) – Keppel secured two contracts for LNG-fuelled containership for US Jones Act market while SMM signed LOI for at least two large Compressed Gas Liquid carriers – brightens up the order outlook. 
• Sete Brasil’s rig orders at Singapore yards could be reactivated in the near future if the recent submission of a new restructuring plan in end-Aug is approved.

Reiterate BUYs on Keppel (TP S$7.60) and SMM (S$2.30).

• We continue to like Keppel as a proxy to ride on a property and offshore & marine recovery, while SMM is a pure play to tap into an O&G recovery. 
• Order wins, which have been lacking YTD, remain the key re-rating catalysts for both. Our thesis of yard merger, if it materialises, would be bonus.
• (Refer to report “Shipyards: Creating Global Champion” dated 20 Jul 2017).

RIG SALE & CONSOLIDATION PICKING UP

Aker – set to re-enter rig-owning business? 

• Aker jumping on rig-buying bandwagon. Upstream reported on 13 Sept 2017 that Norway’s Aker is closing in on the acquisition of newbuild harsh-environment semi-submersible, Stena MidMAX, that was recently cancelled by Stena Drilling from SHI.
• According to industry sources, the newbuild, originally ordered by Stena for about US$727m in Jun 2013, could be sold for around US$450m and additional costs are required to complete the rig over the next 6-12 months.
• Samsung could be urged to dispose of the unit. Stena is understood to be pursuing a legal claim for compensation against SHI, seeking a refund of US$215.4m in pre-delivery instalments plus interest. The newbuild was terminated by Stena earlier this summer ostensibly due to delivery delays. Hence, Samsung may therefore be keen to sell the rig to generate cash to meet the costs of potential claims from Stena.
• Marking Aker’s comeback to rig-owning business. If the news is true, this would mark a comeback of Aker in the rig ownership business after selling its former unit Aker Drilling for US$2.23bn to Transocean in 2011.

Northern Drilling – actively hunting for next rig bargain 

• Fredriksen’s rig investment vehicle. Northern Drilling (Northern), a pure investment company launched in Mar 2017 by shipping magnate John Fredriksen as a distressed asset play that is looking to make money on a market recovery by picking up cheap rigs. It farms out rig management to third-party contractors in order to keep a lean operation.
• Acquired harsh-environment semi-submersible from HHI. Northern has acquired harsh-environment semi-submersible newbuild West Mira – earlier cancelled by Seadrill – from Hyundai Heavy Industries (HHI) for US$365m, half the initial cost. It also has a purchase option on a similar semisub Bollsta Dolphin for US$400m, with both rigs due for delivery in 2019.
• Set eyes on stranded floaters. During Pareto conference in midSep, management revealed that it is “actively exploring the next deal”. It is focusing mainly on acquiring stranded harshenvironment floaters – of which there are five candidates for possible purchase – but is also looking more widely at drillships and jack-ups that are either stuck at yards or are distressed assets for their owners.

Borr Drilling – sees a “window of opportunity” for rig deals 

• Building high specification jackup empire. Borr Drilling Limited (Borr), founded in Aug 2016 by John Fredriksen’s ex-associate Tor Olav Troim and listed on Oslo at end-Aug 2017, has built up a fleet of 17 premium jack-ups at an average acquisition price of US$107m/rig, in two rig deals involving Transocean and bankrupt Hercules Offshore.
• Landmark Transocean deal consists of 15 jackups. In Mar 2017, Borr signed a letter of intent with Transocean for the acquisition of its entire 15 high-specification jackup rigs for US$1.35bn, including five newbuilds under construction at Keppel FELS Limited.
• In negotiation for further advantageous jackup deals. Borr is well-positioned in a price competition for contracts with a break-even cost per rig that is around 50% lower than its peers. The new CEO Simon Johnson, who comes on board 1 Aug, shared at Pareto Securities’ Oil & Offshore conference in Oslo that Borr will continue to grow their fleet as it sees a “window of opportunity” for further advantageous rig deals. He further elaborated that the company is in talks with different players and “anticipate these discussions to bear fruit”.
• Introducing new operator contracting model. Besides the cost advantage, Borr also aims to differentiate itself from rivals by offering a new contracting model for operators with features such as performance incentives based on drilling efficiency, in collaboration with partner Schlumberger that holds a 20% stake in Borr.

RIG CONSOLIDATION WAVE 

Transocean to buy Songa Transocean pays US$3.4bn for Songa. 

• In mid-Aug 2017, Transocean Ltd (Transocean) announced that it is acquiring Songa Offshore (Songa) for US$3.4bn. The offer price of NOK47.50 per Songa share represents a 37% premium to the five-day average closing price.
• Strengthen positioning in harsh-environment, deepwater rigs. The transaction strengthens Transocean’s industry-leading position with the addition of Songa’s four “Cat-D” harsh-environment, semi-submersible drilling rigs on long-term contracts with Statoil in Norway. Besides, Songa’s fleet also includes three additional semisubmersible drilling rigs.
• The combined company will operate a fleet of 51 mobile offshore drilling units, consisting of 30 ultra-deepwater floaters, 11 harsh environment floaters, three deepwater floaters and seven midwater floaters. Additionally, Transocean has four ultradeepwater drillships under construction, including two contracted with Shell for ten years each.
• Cost synergies. The transaction is expected to be earnings accretive and yields annual expense synergies of approximately US$40m.

Ensco acquires Atwood 

• Ensco to acquire Atwood Oceanics in an all-stock deal valued at about US$863m. Ensco plc (Ensco) and Atwood Oceanics, Inc. (Atwood) jointly announced in end-May 2017 that they have entered into a definitive merger agreement under which Ensco will acquire Atwood in an all-stock transaction.
• Offer price premium of 33%. The offer price of US$10.72 per Atwood share (at a swap ratio of 1.6x Ensco share for every Atwood share) represents a premium of approximately 33% to Atwood’s closing price on 26 May.
• Potential cost synergies. Post-merger, Ensco and Atwood shareholders will own approximately 69% and 31%, respectively, of Ensco. The merged entity is expected to realise annual pre-tax expense synergies of approximately U$65m for full-year 2019 and beyond.
• Widened product offerings. The deal will provide Ensco with six ultradeepwater floaters, including four drillships, and five highspecification jackups. Post-transaction, the combined company will have a fleet of 63 rigs, including ultradeepwater drillships, deep and midwater semisubmersibles, and shallow-water jackups, with a customer base of 27 national oil companies, supermajors, and independents.

China Merchants Group – from rig-builder to rig-owner? 

• Looking to acquire distressed offshore rig operators or assets? In early-Sep 2017, state-owned conglomerate China Merchants Group is reportedly exploring acquisitions of distressed offshore rig operators. It is said to have looked at various assets and companies including Seadrill Ltd (Seadrill) and Shelf Drilling Ltd (Shelf). These efforts are at an early stage, and China Merchants may also opt to pick off assets as opposed to full takeovers. 
• Moving up value chain. The group’s China Merchants Industry Holdings Co. unit builds semi-submersible rigs and other offshore equipment. It is also a minority shareholder in the parent company of CIMC Raffles, which builds drilling platforms used by oil producers, including China National Petroleum Corp.

RIG MARKET ON RECOVERY TRACK 

Brent crude oil prices holding up at the US$55/bbl level; gradual recovery expected going into 2018. 

• Our forecast of US$50- 55/bbl average Brent price in 2017 looks broadly on track to be met, with YTD Brent price averaging US$52.2/bbl currently. We believe the global crude oil rebalancing should accelerate into 2018, driven by demand outstripping supply and thus inventory drawdowns. 
• Additionally, we think worries over US shale oil production could be overblown as we see evidence of US shale productivity gains plateauing, and cash operating costs look to have bottomed. Thus, we are forecasting an average price of US$55-60/bbl for Brent in 2018, followed by US$60-65/bbl in the long term (based on a marginal cost curve analysis).

Industry capital expenditure looks to have bottomed; 2018 could see an upswing. 

• If we look at the capital expenditure (capex) budgets for 2017 of the eight largest international oil companies (IOCs), the trend is essentially flattish compared to 2016 (up 1% y-o-y). However, as the oil market rebalances, and prices stabilise in the US$50-$60/bbl range, we believe oil majors may consider revising up future capex estimates in 2018, which could support higher spending in 2H18 and 2019.

Green shoots of a recovery: offshore working rig count has bottomed in 1Q17. 

• After falling from a peak of 736 contracted offshore rigs in April 2014 to 457 rigs in January 2017, the working rig count has taken a U-shaped upward trajectory since February 2017, with the rig count as of August 2017 rising c.6.5% from January’s trough levels. 
• A meaningful rebound in the working rig count would of course be predicated on oil majors increasing their capex budgets.

CATALYSTS FOR RIG DELIVERY 

Rig-owners more incentivised to take delivery. 

• While newbuild order is not expected to come back in big way in the near to medium term, we believe the improving prospects in the oil market and rig supply/demand could “motivate” rig owners to take delivery of existing orders and facilitate the disposal of cancelled units in the second hand market, removing a key overhang on Singapore rig builders. This could free up Keppel and SMM’s working capital by S$1.5-2.5bn each, lowering net gearing to 0.3-0.5x from 0.5-1.0x currently. 
• Most of the jackup rig orders placed with Singapore rigbuilders are on 20:80 payment terms and technically completed or near completion.

Sete Brasil – a step closer to resolution. 

• In end-Aug 2017, Brazilian rig-owner Sete Brasil filed a new restructuring plan that called for the construction of at least four drilling units in an attempt to restart operations. The overall restructuring plan still provides for construction of up to 12 units for Petrobras charters, which would demand an additional investment of about US$5bn. 
• We believe Singapore rigbuilders are well-positioned to deliver at least eight rigs (which are in the advance stages of construction) out of their existing 13 rig orders (c.S$1bn each).
• With the oil price recovery, we believe the likelihood of Petrobras committing charter contracts with Sete Brasil is now higher. 
• The resumption of Sete’s projects shall serve as a rerating for Keppel and SMM that can help boost their currently low revenue line and remove a huge uncertainty.

Pei Hwa HO DBS Vickers | Glenn NG DBS Vickers | http://www.dbsvickers.com/ 2017-09-20

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