Offshore & Marine - CIMB Research 2018-04-11: 1Q18 Preview ~ Better Qoq But O&M Margin Still Weak

Offshore & Marine - CIMB Research 2018-04-11: 1Q18 Preview ~ Better Qoq But O&M Margin Still Weak Offshore & Marine Stocks 1Q2018 Earnings Preview KEPPEL CORPORATION LIMITED BN4.SI SEMBCORP INDUSTRIES LTD U96.SI SEMBCORP MARINE LTD S51.SI

Offshore & Marine - 1Q18 Preview ~ Better Qoq But O&M Margin Still Weak

  • We expect the big 3 - Keppel Corp, Sembcorp Industries & Sembcorp Marine to report better q-o-q earnings for 1Q18F with likely limited major write-downs and provisions.
  • Keppel Corp could emerge as the relatively stronger one with above-consensus reported profit with the best balance sheet and ROE. 
  • Overall, O&M EBIT margin likely to hover around 1-3% on lacklustre yard utilisation. Sembcorp Marine may still report a slight loss for 1Q18F.
  • Sembcorp Industries’ earnings outperformance hinges on land sales in urban development. India may report narrowing loss from higher merchant prices and interest cost savings.
  • Maintain Overweight on the sector due to improving new order prospects and earnings bottoming out. Prefer Keppel Corp in the short term.

Slump trend reversed: 1Q18 orders already half of FY17 

  • Singapore yards are reversing the 3-year order slump with 1Q18 orders far exceeding 1H17.  Keppel Corp and Sembcorp Marine only secured c.S$300m and S$75m, respectively, in 1H17. 
  • In 1Q18, 
    • Keppel Corp has secured c.S$580m worth of contracts, comprising a semi-submersible from Awilco (US$425m) and dual-fuel bunker tanker (US$10m). 
    • Sembcorp Marine matched with a c.US$350m-400m hull and living EPC contract for TechnipFMC. 
  • Order book at end-1Q18 likely stood at S$4bn for Keppel Corp and S$3.5bn for Sembcorp Marine (ex. Sete Brasil and Borr Drilling).

Estimate 1Q18 Singapore yards’ EBIT margin at 1-3% 

  • With no kitchen-sinking provisions in 4Q17, the yards could achieve better q-o-q performance with narrower losses or breakeven. Yard utilisation was still likely weak as the contracts momentum only picked up in 2H17 with at least a 6-month gap before any meaningful revenue recognition. 
  • We estimate EBIT margins were 1-3% due to high fixed costs. EBIT margin for Keppel O&M and Sembcorp Marine ranged from 1-7% in 1Q-3Q17.

Keppel Corp raked in c.S$800m of cash in 1Q18 (results on 19 Apr) 

  • We estimate Keppel Corp’s 1Q18 reported profit was c.S$390m (+50% y-o-y, +215% q-o-q), boosted by the divestment gain of c.S$270m from Keppel China Marina. Net gearing likely strengthened to 0.39x (4Q17: 0.46x) with the receipt of S$590m from the divestment proceeds and US$176m (80% delivery payment) for the first of five jack-up rigs to Borr Drilling delivered in Jan 18.

Sembcorp Marine likely missed on annualised basis (results on 25 Apr) 

  • On an annualised basis, Sembcorp Marine’s earnings likely missed in 1Q18 as we estimate a slight loss (core losses of -S$7m in 1Q17, -S$44m in 4Q17). Consensus expects FY18 profit of S$70m (we expect S$60m). Seasonally weaker 1Q ship repair revenue could have also dampened the overall operating leverage. 
  • We estimate net gearing improved to 1x (4Q17: 1.1x) with the receipt of c.S$200m for milestone projects in Jan 18. Adoption of SFRS new accounting standards could also swing the quarter’s margins.

Sembcorp Industries hinges on land sales in urban development (results on 3 May) 

  • We expect Sembcorp Industries to report net profit of S$74m-86m in 1Q18F, depending on the bulky land sales. Plant load factor for TPCIL and SGPL was decent at c.79% (4Q17: 76-78%). Spot prices were strong, averaging at Rs3.62/kWhr in 1Q18 vs. Rs3.17 in 2017. 
  • We estimate a narrower q-o-q loss of S$5m for India on interest cost savings, offset by seasonally weak wind in SGI. Market will focus on timeline and valuation of India IPO.

Maintain sector Overweight on bottoming earnings and stronger orders 

  • In the short-term, we prefer Keppel Corp on
    1. capital recycling by property driving upside and consensus earnings upgrades,
    2. hopes of higher DPS and
    3. stronger ROE.


  • The fear of Singapore yards missing the mark on orders may be alleviated as contracts started to stream in only in Mar 18. Improving enquiries over the past six months have finally translated into concrete orders. 
  • Relative to 1Q17 when there were hardly any orders, 1Q18 has been a fruitful quarter. We think that both yards are on track to meet our target of S$3bn-3.5bn in 2018 based on the known projects in the pipeline, largely driven by production and gas capabilities.

Margin may still be challenged 

  • It takes time to improve margins 4Q17 EBIT losses among the yards were largely due to kitchen-sinking provisions including yard closure, negative variation orders that are mismatched against low revenue. The absence of the above would mean stronger q-o-q margins. Bottomline could barely break even for Keppel Corp, and Sembcorp Marine could turn in losses in 1Q18 with the execution of some existing sizeable complicated projects. Weaker q-o-q USD may also see some forex translation loss impact EBIT margin.
  • We think Keppel O&M and Sembcorp Marine are likely to achieve EBIT margin of 1-3% in 1Q18 based on the average seen in 9M17. For now, we are keeping our c.7% EBIT expectations unchanged for FY18, hoping for a turnaround in 2H18 upon the execution of orders secured since 2H17.

Full convergence of new accounting standards 

  • We could see volatile margins ahead with the adoption of the new Singapore Financial Reporting Standards International (SFRS (I) and new accounting standards from 1 Jan 18. 
  • In particular, there could be some impact on the timing of revenue and cost recognition under SFRS (I) 15 according to Sembcorp Marine’s latest 2017 annual report.

1. Timing of revenue and cost recognition. 

  • Currently, revenue from long-term contracts are recognised using percentage of completion method, provided that the outcome of the contract can be reliably estimated.
  • Under SFRS (I) 15, Sembcorp Marine expects most of its long-term contracts to constitute a single performance obligation. When Sembcorp Marine has an enforceable right to payment for performance completed to date or when Sembcorp Marine’s performance creates or enhances an asset that the customer controls as the asset is being created or enhanced, Sembcorp Marine will recognise revenue on these long-term contracts over time.
  • The costs associated to fulfil the performance obligation are expensed as control of goods or services is transferred to the customer over time.
  • When the right to payment for performance completed to date cannot be enforced due to non-enforceability of right to payment for performance completed to date, the revenue and related costs of sales are recognised only when the constructed assets are delivered to customers.

2. Contract cost. 

  • Currently, for long-term contracts where the stage of completion is determined by reference to surveys of work done, contract costs are recognised as an expense in profit or loss using the percentage of completion method.
  • Under SFRS (I) 15, the costs incurred to fulfil the satisfied performance obligation are recognised in P&L as control of goods or services to the customer is transferred over time. As there is no direct linkage between the costs being expensed and the output measure used to determine revenue, this may result in volatile contract margin over the life cycle of the contracts for the longterm contracts.
  • Where the control of goods and services to the customer is transferred at a future point in time, the costs incurred to fulfil the future performance obligation are capitalised as they are recoverable, and presented as “Contract Costs” within the balance sheet. The costs capitalised are recognised in P&L when the performance obligation is satisfied.

3. Variation orders (VOs). 

  • Currently, contract revenue includes the initial amount agreed in the contract plus any variations in contract work, claims and incentive payments, to the extent that it is probable that they will result in revenue and can be measured reliably. When a claim or VO is recognised, the measure of contract progress or contract price is revised and the cumulative contract position is reassessed at each reporting date.
  • SFRS (I) 15 stipulates that VOs would be considered as contract modifications, and will be included within contract accounting when they are approved. This is because any contract modification is not likely to result in a separate contract, as the services within a long-term contract are integrated.
  • Where there is variable consideration, Sembcorp Marine estimates the amount only to the extent that it is highly probable that a significant reversal of the amount will not occur in the future. This amount is included in the transaction price.

Highlighted Companies 

Keppel Corporation (Rating: ADD, Target Price: S$10.00)

  • Our Target Price is based on SOP valuations (20% discount to property RNAV, 2.5x FY18 P/BV on O&M and 18x FY19 P/E on investments).
  • Catalysts are higher DPS, more asset recycling and redevelopment of properties in Singapore.

Sembcorp Industries (Rating: ADD, Target Price: S$4.13)

  • Our Target Price is based on SOP valuations incorporating target price of S$3.01 for Sembcorp Marine and DCF for utilities (worth c.S$2.6bn).
  • Potential catalysts are faster-than-expected recovery of earnings in India.

Sembcorp Marine (Rating: ADD, Target Price S$3.01)

  • Our Target Price is based on 2.5x FY18 P/BV valuation (20-year average). Potential catalysts could come from stronger-than-expected order wins.

LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2018-04-11
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