Sembcorp Marine (SMM SP) - DBS Research 2017-10-05: Oro Negro Contracts Called Off

SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - Oro Negro Contracts Called Off

Sembcorp Marine (SMM) terminates three jackup contracts with Oro Negro.
Minimal impact on P&L; provisions for these unit made in 4Q15; 20% deposit will be forfeited by yard.
Re-rating catalyst: oil price recovery, jackup sale, contract wins.

Sembcorp Marine (SMM) announced that it has terminated contracts with Integradora de Servicios Petroleros Oro Negro, S.A.P.I. de C.V. and its subsidiary Oro Negro Vastus Pte. Ltd. (collectively “Oro Negro”), for the construction of three jackup rigs.
The jack-up rigs have been technically accepted by Oro Negro but delivery of the rigs has been deferred.

These high specification rigs based on the PPL Pacific Class 400 design were priced at approximately US$211m each in 2012/2013. Based on accounting practices, SMM will most likely reverse the revenue previously recognised following the contract terminations. We believe the likelihood of further profit reversals resulting from the cancellations is low, as provisions made for these units in 4Q15 (we estimate 10% of contract value) should suffice for now.
Coupled with the 20% downpayment that will be forfeited by shipyard, there is substantial buffer of 30% discount to contract value.

Following this, newbuild contracts for six out of seven undelivered jackup rigs (the last one is ordered by Japan Drilling, backed by a Japanese bank) have been terminated. Given the financial unviability of these customers (Marco Polo, Perisai and Oro Negro) to take deliveries, contract cancellations could facilitate future rig sales as SMM actively markets the rigs to prospective buyers.
We note an increase in rig transactions in the global oil and gas industry over the past six months, as highlighted in our note ‘Singapore Rigbuilders - Rolling rig-sale bandwagon’. New entrants – North Drilling and Borr Drilling, looking for distressed assets coupled with firm oil prices adds to the optimism and could speed up the process of rig sales. This will unlock cash flow for the shipyards.

Sembcorp Marine (SMM) has outperformed Keppel Corp, by 7% over the past 1 month, rising 12% alongside the oil price rebound.
Our target price is maintained at S$ 2.30, based on 1.8x FY17 P/BV, which is < 1SD of its mean since 2004.
We continue to see re-rating catalysts stemming from:
1. SMM as a pure play to ride the oil-price recovery;
2. sizeable new orders for non-drilling solutions, in particular FPSOs, Gravifloat’s modularised LNG terminals and compressed gas liquid carriers (LOIs signed in Sept);
3. the conclusion of jackup sales as rig transaction have been picking up of late;
4. the reactivation of Sete’s projects; and
5. SMM being a potential M&A play arising from a consolidation of Singapore yards.

Pei Hwa HO DBS Vickers | http://www.dbsvickers.com/ 2017-10-05

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