Sembcorp Marine - DBS Research 2018-02-22: Look Beyond Weak Near-term Earnings

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SEMBCORP MARINE LTD S51.SI

Sembcorp Marine - Look Beyond Weak Near-term Earnings

• Wider-than-expected loss in 4Q17 partly due to cost overrun for several projects’ variation orders.
• Slashed FY18/19 forecasts by 54-58% to reflect operating loss at current activity level; earnings improvement slipping into 2H18.
• Declared 1 Sct final dividend.
• Potential price pullback offers healthier entry point; Target Price adjusted to S$2.90.

Maintain BUY; Target Price reduced to S$ 2.90

• Maintain BUY; Target Price reduced to S$ 2.90 after earnings revisions, still based on higher 2.4x FY18 P/BV multiple (0.5SD below mean). We continue to like Sembcorp Marine as a key proxy to the recovery in the O&G and O&M sectors, with strong order wins as key re-rating catalyst. 
• Though, in the near term, we reckon that sentiment might be adversely affected by the wider-than-expected losses in 4Q17; and the M&A premium, which we estimated to be ~40 Sct. This could be given back if privatisation rumour is off the table.

Where We Differ: more bullish on Sembcorp Marine’s contract wins. 

• Order wins, a critical leading indicator for earnings recovery, is set to rise in the next 12 months. We believe Sembcorp Marine’s strong order pipeline would translate into S$3bn in new orders in 2018, which could potentially include
  1. a semi-submersible production unit for Shell’s Vito at S$400-800m;
  2. Newbuild FPSO for Energean’s Karish-Tanin project at S$500m;
  3. two large Compressed Gas Liquid carriers for SeaOne Caribbean valued at S$800m in total;
  4. a Gravifloat (Sembcorp Marine’s proprietary technology) modularised LNG exporting terminal for Poly-GCL at c.S$1bn.

Reactivation of Sete Brasil rig orders. 

• The landmark deal to sell all nine terminated jackup rigs to Borr Drilling and the disposal of harsh environment semisubmersible rig West Rigel have eliminated the key overhanging concerns on Sembcorp Marine. The restructuring of customer Sete Brasil is also seemingly closer to a resolution, pending approval of the revised restructuring proposal submitted at end-Aug 2017. 
• We believe Singapore rigbuilders are well-positioned to deliver at least 4-5 rigs each (which are in the advance stages of construction) out of Sete Brasil’s existing 13 orders (c.S$1bn each). 
• The reactivation of rig construction will be another re-rating catalyst.

Valuation

• Our target price of S$ 2.90 is based on 2.4x FY18 P/BV, pegged to 0.5SD below its mean valuation since 2004. 
• Sembcorp Marine’s book value has already been written down after the massive S$609m provisions taken in FY15.

Key Risks to Our View

• Key downside risks are sustained low oil prices which would affect rig count and newbuilding activities, execution risks in new product types, and corruption allegations in Brazil that, if found guilty, could lead to financial and reputational loss. 
• Upside risk could come from privatisation or M&A activities, as well as the write-back of provisions from successful deliveries or vessel sales.

WHAT’S NEW - 4Q17 losses bigger than expected 

First operating loss. 

• With the exception of 4Q15, when earnings were hit by one-off massive provision, SMM has reported its first operating loss since 2004.
• Net loss amounted to S$33.8m for 4Q17. Stripping out forex gains (S$20m), tax credit (S$19m), and inventory & work-in-progress write back (S$32m), losses would have been c.S$100m, a substantial portion of which we believe was attributable to expected cost overrun for several projects’ variation orders as customers have yet agreed to pay. 
• We believe total cost overrun for disputed variation orders exceeded S$100m last year.

Expect gradual improvement. 

• We have slashed our FY18/19 forecasts by 54-58%. Taking the cue from 4Q17, Sembcorp Marine might continue to incur some losses in 1H18 as revenue might remain low until major projects start to kick in, which will take 1-2 quarters to start being recognised. Hopefully, some of the cost overrun for disputed variation orders in 2017 could be recouped this year and better economies of scale from higher activity should be realized towards 2H18.
• Orderbook stood at S$7.58bn, as at Dec-2017, with S$1.1bn for Borr Drilling (largely to be recognised in 2018) and c.42% or S$3.2bn from the drillship projects with Sete Brasil (expect reactivation from 2019). The remaining S$3.3bn should largely be recognised in the next two years.

Higher enquiry level but competition is intense. 

• Management has seen increasing enquiries in the production segment but has cautioned that competition for orders remains intense. Its core focus continue to be on production-related and LNG solutions.

Conducting FEED study for Seaone. 

• Sembcorp Marine started FEED study for Seaone’s compressed gas carrier in Oct-2017 and expects it to complete in 1H18, following which, the customer will decide on FID for the project. Hence, if FID is achieved, the actual contract award for the two gas carriers estimated at S$800m seems likely to skew towards 4Q18 at the earliest.

Capex likely to trend upward slightly, from S$178m in 2017.

• Management may proceed with phase 3 development of its Tuas Boulevard Yard in response to business needs. The expected capex should not be more than S$500m.
• Net gearing lowered to 1.1x, from 1.3x a quarter ago, largely attributable to the receipt of a US$500m deposit from Borr Drilling. 

Declared 1 Sct final dividend

• Declared 1 Sct final dividend, bring full-year dividend payout to 2 Sct. This represents < 1% yield. 
• Given the low profitability, we expect a similar payout for the next two years.

Pei Hwa HO DBS Vickers | http://www.dbsvickers.com/ 2018-02-22

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 2.90 Down 3.100