Sembcorp Marine (SMM SP) - UOB Kay Hian 2018-02-22: 4Q17 Running On Fumes; Downgrade To HOLD

Sembcorp Marine (SMM SP) - UOB Kay Hian 2018-02-22: 4Q17 Running On Fumes; Downgrade To HOLD SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - 4Q17 Running On Fumes; Downgrade To HOLD

  • Sembcorp Marine’s 2017 headline net profit of S$14m was a complete miss against consensus.
  • Excluding several one-offs, we estimate that core EBIT was close to breakeven.
  • Even though Sembcorp Marine could secure > S$2b in contract wins in 2018, it is still unlikely to generate ROE in excess of 10% that justifies its current P/B valuation of 2.2x.
  • Current Sembcorp Marine share price is supported by hope stemming from Sembcorp Industries’ strategic review. We slash earnings by 56-75% and reduce target price to S$1.90. Downgrade to HOLD on a tactical basis. Entry price: S$1.80.



RESULTS


4Q17 loss a complete miss against consensus. 

  • Sembcorp Marine (SMM) reported a headline net loss of S$33.8m (4Q16: S$34.3m profit), on lower revenue contribution from its Rig & Floaters and Offshore Platforms. Excluding one-off items such as a S$32m inventory write-back, S$20m forex gain, S$17.2m gain on disposal of available for sale (AFS) financial asset and a S$5.5m loss relating to a JV, core net loss for the period was a S$97.1m loss. 
  • The loss figure includes an unknown quantum for additional cost accrual for floater projects. The full-year core net profit figure was a loss of S$75m, a complete miss on the profit estimates for both ours (S$54m) and consensus (S$49m).

Reversing out cost accruals for floaters suggests core EBIT breakeven in 4Q17.

  • The additional cost accrual was understood to be in “the double digits”, with several floaters involved. Reverse engineering the figure and excluding other one-offs suggest that SMM’s core EBIT was just at breakeven, as compared with the headline negative EBIT margin of 6.7%. Management was most hesitant to provide colour on this point. 
  • We are not fully certain on this conclusion either; the period was marred by undisclosed revenue reversals from the termination of three rig contracts.

Lower repair and upgrade volumes, higher value per vessel. 

  • The period saw repair volumes of 62 vessels, a 31% y-o-y decline. However, revenue was up 9% y-o-y owing to the higher repair/upgrade revenue per vessel (+59% y-o-y) for the period. 
  • For 2017, Sembcorp Marine saw more high value work, completing 16 cruise ship refits, 34 LNG ship repairs/upgrades and 11 ballast water treatment system installations and retrofits. Sembcorp Marine intends to pursue higher value contracts. This suggests that repair volumes might be on the downtrend and higher value work is being pursued to compensate. Ballast tank upgrades are also likely to take a backseat in 2018, and only see a pick-up in 2019.

Capex likely to rise from 2017 levels. 

  • Management commented that 2018 capex will be on a slight uptrend from S$178m in 2017 as Sembcorp Marine executes deferred capex spending in response to business needs. 
  • Coupled with the working capital requirements for constructing the Transocean drillship, and the delayed receipt of payments for its Libra and Gina Krog projects, interest expense is likely to remain elevated.

Net gearing fell further to 1.13x in 4Q17. 

  • This was an improvement from the 1.33x seen in 3Q17, and was due to receipt of the deposit from the Borr transaction. Net gearing could have been lower, if not for a S$262m receivable that was received only in Jan 18 owing to a late billing.

S$30m+ LNG module job secured during 4Q17. 

  • Total contract win for FY17 was S$2,735m and includes S$1,770m relating to the Borr Drilling transaction. We note that Sembcorp Marine added a new LNG module job for the BP Tangguh project in 4Q17, which is estimated to be slightly over S$30m. 
  • No other contract win was reported. The contracting outlook is improving, though it remains challenging. 


STOCK IMPACT


Valuations not supportive of current financial performance. 

  • The possibility that core EBIT was at near breakeven, with no major step-up in project revenue recognition is worrisome. At face value, it suggests that SMM’s strategy is to maximise contract volume by lowering margins, generating enough profit at the EBIT level to cover its elevated interest expense. Even with contract wins exceeding S$2b in 2018, there appears to be minimal returns for shareholders. 
  • While the continued deleveraging of the balance sheet remains a positive, it does not justify current valuations given its profitability. Current P/B of 2.2x suggests a ROE of at least 10%, which SMM is hardly achieving with these set of numbers.

A complete play on strategic review. 

  • Current valuations are supported mostly by positive sentiment on higher oil price and the impending announcement of the strategic review by Sembcorp Industries. Should the latter not manifest itself as an acquisition, valuations are very likely to collapse on such weak profitability.


EARNINGS REVISION 


Slash 2018-19 earnings by 56-75%, downside revision risk exists. 

  • Our previous earnings estimate had posited a higher EBIT margin of 4%. This has been reduced to 3%, and we caution that that might have risk to the downside. Our earnings are also driven by the assumption that:
    1. Johan Castberg secures approval for work start in 2H18, and
    2. contract win of at least S$2b in 2018 and S$2.5b in 2019. 
  • Our revised 2018- 19F earnings are S$27m (-75%) and S$61m (-56%) respectively. Earnings for 2020 is introduced at S$86m.


VALUATION/RECOMMENDATION


Downgrade to HOLD, target price reduced to S$1.90. 

  • We expect a knee-jerk selldown on this set of results, with share price likely supported by hopes of a possible acquisition.
  • Should this not materialise, the downside risk is steep as current valuations are a far cry from its stated profitability. We recommend investors to top slice their holdings at this level. 
  • Our revised earnings estimates see our target price, pegged to 1.6x 2019F P/B, decline to S$1.90. On a tactical basis, downgrade to HOLD.




Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2018-02-22
UOB Kay Hian SGX Stock Analyst Report HOLD Downgrade BUY 1.90 Down 2.100



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