Offshore & Marine - CIMB Research 2017-11-21: Shake Off Them Blues; Go Overweight

Offshore & Marine - CIMB Research 2017-11-21: Shake Off Them Blues; Go Overweight Offshore & Marine Sector Outlook Oil Price KEPPEL CORPORATION LIMITED BN4.SI SEMBCORP MARINE LTD S51.SI MERMAID MARITIME PUBLIC CO LTD DU4.SI CSE GLOBAL LTD 544.SI PACIFIC RADIANCE LTD. T8V.SI

Offshore & Marine - Shake Off Them Blues; Go Overweight

  • We take our cue from the better YTD crude oil prices and firm project pipeline in FY18F to form our view that the industry is heading for a gradual recovery in FY18F.
  • We expect OPEC to extend its caps beyond Mar 2018F, keeping sentiment on the oil market positive.
  • Upgrade sector to Overweight (from Neutral), as we think the odds are now stacked in favour of upside, rather than downside.
  • We prefer large-cap stocks to ride the rally as we think they have successfully diversified into the better production and gas segments.
  • Sembcorp Marine is our near-term pick given its 3-month underperformance vs. Keppel Corp. Keppel Corp is our 12-month top pick for its multiple growth drivers (O&M, property and investments).


Better crude oil prices YTD; strong case for OPEC to extend caps 

  • YTD, WTI/Brent crude oil prices have averaged US$50/US$53/barrel/day, up 15.6%/20.6% above CY2016’s average of US$43.2/44.1/day. At last close, they traded at US$56.6/US$62.1 respectively, within the higher range of our US$45- 60/day expectations.
  • In its Nov 17 Short-Term Energy Outlook (STEO) report, the Energy International Agency (EIA) forecast that average CY17F world production/consumption would be at a slight deficit; with average OPEC production volume within its promised cap of 32.5mmbbls/day; The higher crude oil prices YTD and rebalanced crude oil markets suggest that the strategies of global producers (OPEC and Russia) have, to some extent, worked in FY17F.
  • We believe main factors that would influence OPEC’s decision to extend production caps beyond Mar 2018F are: 
    1. The need to keep the oil market positive for the listing of Saudi Aramco’s unit, tentatively scheduled for 2018F; 
    2. Production surplus – The EIA forecasts production surplus in FY18F as it expects average world production (100mmbbls/day) to exceed consumption (99.9mmbbls/day), and average OPEC production of 33mmbbls/day; 
    3. Shale very much staying in the picture, with tight oil production volume still on an uptrend YTD (see Figures 7); 
    4. YTD US inventories excluding the Strategic Petroleum Reserve (SPR) still above the historical average of 300kbbls in 1983-3QCY14; although this has been on a downtrend since Mar 2017; and 
    5. Drilled-but-uncompleted (DUC) well count continues to creep up YTD. 
  • On a positive note, the US onshore rig count has stabilised and even fallen slightly since hitting a peak of 762 in early Sep 2017. However, we note that the lower rig count could be a product of the high existing DUC count.
  • Recent newsflow suggests that OPEC is leaning towards the extension of production caps at its upcoming meeting on 30 Nov 

Crude oil price YTD closer to projects’ average breakeven price; project sanctions returning 

  • According to players like Ensco, crude oil prices are now at levels above certain offshore projects’ breakeven levels. We also note Clarksons’ statement that project sanctions are rising; with at least c.20 offshore projects (capex of > US$1bn each) expected to reach final investment decision (FID) in FY17F; compared to c.12 FIDs in FY16. 
  • Moving forward, Clarksons expects at least 25 projects worth above US$1bn each to reach FID in FY18F. We note that some of these project sanctions tie into our estimated US$6.4bn non-rig project pipeline expected for our large-cap stocks. 
  • We are also heartened by Saudi Aramco’s announcement in Nov 2017 that it plans to invest US$300bn in oil and gas projects over the next 10 years. We take this as a sign that contract flows will eventually accelerate.

Mergers & acquisitions (M&As) gain traction in 2017F 

  • Mergers and acquisitions (M&A) have gained traction recently, which we think is a sign that companies are consolidating/tying up to emerge bigger and leaner in anticipation of sector recovery. In our view, such consolidation shrinks the industry and gives oilfield service players more clout when it comes to contract awards.
  • Some notable M&A transactions/proposals YTD include: 
    1. Subsea7 SA (SUBC NO, Not Rated) acquired a 50% stake in Seaway Heavy Lifting (Unlisted), an offshore contracts specialist that has two world-class heavy-lifting vessels, for a consideration of US$279m (with an additional option for US$40m conditional on certain performance targets) in Mar 2017; 
    2. Subsea7 acquired certain businesses of EMAS Chiyoda Subsea Ltd (Unlisted) for an acquisition price of less than US$100m in Jun 2017.
    3. The transaction:
      • increased Subsea7’s presence in the Middle East;
      • increased Subsea7’s order backlog by US$850m; and
      • led to a longterm consortium agreement (LTA) between Subsea7 and L&T Hydrocarbon Engineering Ltd (L&T, Unlisted); 
    4. Solstad Offshore, Farstad Shipping and Deep Sea Supply completed its merger in Feb-17, creating the world’s largest offshore service vessel company Solstad Farstad (SOFF NO, Not Rated); 
    5. Transocean (RIG US, Not Rated) announced its intention to acquire Songa Offshore (SONG NO; Not Rated) for a transaction value of US$3.4bn in Aug 2017. Transaction tentatively expected to be completed in 4QFY17F; 
    6. Total (FP FP, Not Rated) acquired Maersk Oil for US$7.5bn (share/debt transaction) in Aug 17 for access to its upstream assets; 
    7. In Sep 17, it was mentioned in Bloomberg that Rowan Companies (RDC US, Not Rated) is in talks to acquire the drilling business of A.P. MollerMaersk A/S (AMKBF US, Not Rated); 
    8.  Wood Group PLC (WDGJY US; Not rated) completed the GBP2.2bn takeover of Amec Foster Wheeler (Unlisted) in Oct 2017. The merger creates a global leader in the delivery of project engineering and technical services to energy and industrial markets; 
    9. Borr Drilling (BDRILL NO, Not Rated), a Norwegian drilling start-up, has acquired 17 jack-up rigs since starting operations in 2016; it was listed in Oct 2017; 
    10. Ensco (ESV US, Not Rated) completed its acquisition of Atwood Oceanics Inc (Unlisted) in Oct 2017. In May 2017, Ensco announced that the combined entity will strengthen its position as the leader in offshore drilling across a wide range of water depths around the world – creating a broad platform that it can build upon in the future; and 
    11. Total announced it entered into a definite agreement to acquire the upstream liquefied natural gas (LNG) assets of Engie for US$1.5bn in Nov 17.

Smaller offshore asset fleets and bottomed rates 

  • In our view, there is no doubt that global rigs and offshore support vessels (OSVs) are still in surplus, but we think there are signs of recovery in the form of: 
    1. narrower yoy decline in daily charter rate (DCR) for most asset classes; 
    2. stabilising utilisation rates, and
    3. smaller overall fleets. 
  • Moreover, the recent M&As and restructuring have, to some extent, reduced the number of players in the industry, in our view.

Rig segment 

  • According to Clarksons, demand contraction for the rig market will narrow to 0.7% in 2017F (vs. 21% contraction p.a. in 2015/2016), causing total rig utilisation to increase to 64.1% (vs. 63.3% in FY16). Clarksons forecasts total rig utilisation to pick up to 67.1% in 2018F. 
  • Among the rig segments, we note that the DCRS for high-specification jack-up rigs and midwater floaters have improved slightly YTD.

Offshore Support Vessels (OSV) 

  • According to Clarksons, the anchor handling tug supply/platform supply vessel (AHTS/PSV) fleets stood at 2,989/2,557 at the start of Oct 17. Average cold laid-up vessels have now risen to 34.5%/35.1% of the respective fleets; reducing the effective fleet, in our view.
  • Yoy contraction in both the AHTS/PSV daily time charter (TC) rates have narrowed YTD (except for the 80-tonne bollard-pull class), suggesting that DCRs may have also troughed for both offshore asset classes.

Worst is over for Singapore O&M sector 

  • In the large-cap space, there is little risk for further impairments as:
    1. Keppel Corp (KEP) is at the tail-end of the yard’s mothballing exercise; and
    2. Sembcorp Marine (SMM) sees a certain level of activity at its Brazilian yard from Petrobras.

Brazilian hope for 4 rigs and provision write-back 

  • Sete Brasil could resume at least four drilling units in an attempt to resume operations, according to Upstream report in Aug 17. In 2016, Sete Brasil proposed to its creditors to endorse the resumption of building 8 to 12 rigs but did not conclude the charter re-negotiation with Petrobras. The latest development of prioritising rigs that are already at an advanced stage looks more reasonable, in our view. 
  • KEP and SMM’s rigs are at the most advanced stage of completion. These include KEP’s semi-subs – Urca (91%) and Frade (70%) – and SMM’s drillships – Arproado ( > 90%) and Guarapar ( > 80%). The reactivation of these rigs may not boost cash inflow significantly as they were paid based on progress billing/completion. However, we expect to see some reversal of provisions. Total provisions made for the 6 KEP semi-subs and 7 SMM drillships were S$230m and S$329m, respectively.
  • Within the small-cap space, many companies have already entered restructuring, and those left may still see “housekeeping” exercises in the 4Q17 results season. However, we believe sizeable impairment ahead is largely expected for Ezion in the range of US$500m to US$900m in 2018 (Ezion received support for its Consent Solicitation Exercise (CSE) on 20 Nov). However, we do not expect this to shake the overall sentiment of the sector as small-cap stocks are not as widely held vs. their large-cap peers.


Time to go Overweight, higher crude oil price range of US$55-65/bbl in FY18F 

  • We believe the sector is ripe for a re-rating given that the project pipeline is on a firmer footing. In its latest Short-term Energy Outlook (STEO) report, the EIA forecasts average Brent spot prices of US$53/bbl and US$56/bbl in 2017F and 2018F, respectively, and average West Texas Intermediate (WTI) prices of US$49.8/bbl and US$51/bbl in 2017F and 2018F, respectively (US$5/bbl lower than Brent price).
  • But as crude oil price has already reached a high of US$62/bbl this year, we suspect it could easily rise to the US$65/bbl range, assuming minimal changes in the oil market sentiment. Hence, we forecast crude oil price range of US$55- 70/bbl in FY18F.

Large caps are better near-term bets, in our view 

  • We favour Singapore yards (large-cap stocks) in the near-term as we believe they will be the first beneficiaries of the upcoming production structure contracts, and as impairment risks are largely mitigated. In the past two rig upcycles (2004- 08 and 2009-11), Singapore yards’ valuations rose more than 200%, and the valuations are currently near trough. 
  • A bonus is that sustained oil prices are setting the stage for the finalisation of negotiations between Singapore yards and Sete Brasil/Petrobras in 2018F, which could re-activate the semi-subs and drillships contracts that were halted since 2015.

Keppel Corp (KEP SP, Add, TP: 8.58) 

  • We have factored in S$2bn of new orders for FY18F. YTD, Keppel Corp has secured S$1bn of orders, with its order book at S$3.9bn. We now expect a 112% rebound in O&M net profit to S$83m in FY19F. If actual orders reach S$3bn in FY18F, FY19F net profit would be 35% higher than our forecast.
  • EBIT margin weakened in FY16 and FY17F, mainly due to the depleting order book and weak order momentum. We think margin recovery would be on track from FY18F, potentially hitting 8% as Keppel Offshore & Marine executes the orders secured in FY17. We expect to see some positive operating leverage from a leaner structure, having mothballed a few yards over the past two years. Staff strength has also reduced from 36k at the beginning of 2015, to 16k currently.
  • We think negative revision cycle for O&M could be over. Re-rating catalysts could come from stronger order momentum and redevelopment plans of its Singapore landbank and Tianjin Eco City. Our SOP valuation prices O&M at 1.5x 1H17 P/BV. If we benchmark to Sembcorp Marine's 2x P/BV, our SOP would be higher at S$9.13. 
  • Downside risk is slower-than-expected completion of properties in China that de-rail the group’s earnings. 
  • Keppel Corp is our 12-month top pick within the sector, on the back of multiple growth drivers, including O&M, property and investments.

Sembcorp Marine (SMM SP, Add, TP: S$2.49) 

  • We have factored in S$2.5bn of new orders for FY18. YTD, Sembcorp Marine has secured S$270m of orders. This excludes the two Letters of Intent (LOIs) from SeaOne (c. US$500m for two Compressed Gas Liquid Carriers) and Statoil (c.US$ 490m for turnkey EPC of a newbuild FPSO hull and living quarters). Order book stood at S$1.4bn as at 3Q17, excluding Sete Brasil (S$4.8bn) and Borr Drilling’s rigs (S$1.77bn).
  • We see upside to our order assumptions as SMM is in the running for some sizeable projects, likely to be awarded in 2018. These include Shell’s Vito topside, and hull construction (estimated US$300m), Gravifloat FLNG for Polu-GCL (c. US$1bn), Maersk Oil’s gas processing and accommodation deck (c. US$1bn).
  • We expect a 56% increase in O&M net profit in FY19F to S$136m. If FY18F actual orders reach S$3.5bn, FY19F net profit would be 15% higher than our estimate.
  • With more turnkey projects, we forecast EBIT margin of 5.7% and 7.6% in FY18 and FY19 respectively. This is lower than its historical average of 15% during the boom years of rig cycle. Upside could come from stronger-than-expected ship repair volume, which typically fetches 20- 25% EBIT margins.
  • Our TP of S$2.49 is still based on 2x FY18F P/BV, or 20% discount to the 20-year average of 2.5x. 
  • Sembcorp Marine is our short-term pick given its 3- month underperformance vs. Keppel Corp. Order wins could be the key catalyst.

Stay selective on small caps for now 

  • The small-cap segment is still trading at 0.4x below the -1.s.d. of 7-year mean; however, we believe a better time to enter the small cap space is post the 4Q17 results season in Feb 18 as stocks within our coverage are still ongoing “housekeeping” exercises. 
  • Safer bets are Mermaid Maritime MMT (Reduce; TP: S$0.14) and CSE Global (Reduce; TP: S$0.32) due to their healthier balance sheets, but uncertainties do persist in the near term. We would watch Ezion (Suspended; Last call: Reduce: TP: S$0.13) and Pacra (Reduce; TP: S$0.08) post their restructuring as their assets do sit within the preferred production and maintenance segments.

CSE GLOBAL (CSE SP, Rating: Reduce, Target Price: S$0.31) 

  • Our target price is based on 10x P/E (close to 1 s.d. below 5-year mean) CY19F EPS. 
  • Although CSE is in a net cash position and has seen a slight uptick in flow contracts, the upcoming financial review in 4Q17 poses some near-term earnings risks for the stock. Beyond that, heightened competition within the oil and gas industry has led to depressed gross profit margins which may only recover from late FY18F onwards. 
  • Upside risks are higher contract wins and margins. 
  • A possible de-rating catalyst is lower-than-expected contract wins.

EZION Holdings (EZI SP, Suspended Trading, Last call: Reduce, Target Price: S$0.14) 

  • We turned negative on Ezion during its 1Q17 results review due to management’s negative undertone on the operating conditions of its fleet deployment, leading us to be concerned about its ability to redeem its bonds and the possibility of impairment risks in FY18/19F. 
  • During 2Q17 results, the company announced it would embark on a debt reforms exercise, which included a Consent Solicitation Exercise (CSE) that was successfully completed yesterday on 20 Nov. 
  • Moving ahead, the company guided for impairment exercises and the lifting of its trading suspension in Jan 18.

Mermaid Maritime (MMT SP, Rating: Reduce, Target Price: S$0.14) 

  • Our target price is based on 0.4x CY17F P/BV (1 s.d. below 5-year mean).
  • Order book has risen but FY18F contract visibility is still spotty and likely backended. Management guided that a decision on Asia Offshore Drilling (AOD) will likely have to be taken by year-end, as its Senior Secured Credit Facility (SSCF) with an outstanding balance of US$209m at Sep 17 matures in Apr 18 with a balloon payment of US$180m. Options for AOD are to participate in Seadrill’s restructuring package deal or source its own refinancing. 
  • Upside risks are more contracts and a favourable Seadrill deal. 
  • Downside risks include lower-than-expected contract wins and an unfavourable Seadrill deal.

Pacific Radiance (PACRA SP, Rating: Reduce, Target Price: S$0.07) 

  • Our target price is based on 0.15x CY17F P/BV (slight discount to -1 s.d. of 0.18x). PACRA’s mix of shallow-water OSVs is likely to make it one of the first beneficiaries of heightened activities. 
  • The company said it had appointed advisors to assist in reviewing its overall capital structure, and is looking to develop a feasible restructuring plan that will allow the group to sustain its operations going ahead. 
  • No timeline was provided on the completion of this exercise.

Risks and Potential Catalysts 

Downside risks 

  1. OPEC abandoning its production ceiling in the upcoming 30 Nov meeting which will could tank the oil market sentiment and lead to EIA’s forecasted production surplus in FY18F; 
  2. Higher-than-expected US production that would undermine market rebalancing efforts; and 
  3. Delays to expected project sanctions in FY18F.

Potential re-rating catalysts 

  1. Swifter-than-expected recovery in crude oil prices; 
  2. Instability in one or more OPEC member state (thus reducing OPEC production), and 
  3. Higher-than-expected global GDP growth, which would lift overall demand.

Cezzane SEE CIMB Research | LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2017-11-21
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