2019 Outlook & Strategy ~ Offshore & Marine Sector - DBS Research 2018-11-26: Slow Pick Up In New Orders

2019 Outlook & Strategy ~ Offshore & Marine Sector - DBS Group Research | SGinvestors.io YANGZIJIANG SHIPBLDG HLDGS LTD (SGX:BS6) SEMBCORP INDUSTRIES LTD (SGX:U96) SEMBCORP MARINE LTD (SGX:S51)

2019 Outlook & Strategy ~ Offshore & Marine Sector - Slow Pick Up In New Orders

  • Lowered Brent crude oil forecast to US$70-75/bbl in 2019.
  • Order book running low, stronger contract win momentum required to re-rate shipyards.
  • Asset owners: recovery intact but remains protracted.
  • Selective BUYs – Yangzijiang (Target Price S$1.82), Sembcorp Industries (Target Price S$3.70), Sembcorp Marine (Target Price S$2.40).

Shipyards: Order win momentum to pick up

Sembcorp Marine (SMM; Target Price: S$2.40) is most leveraged to O&M recovery.

  • Contract flows YTD have disappointed, with SEMBCORP MARINE LTD (SGX:S51) securing only S$1.2bn orders – a marginal increase from ~S$1bn secured last year (excluding Borr jackups) but way behind our expectation of S$2.5-3bn contract wins made in early 2018.
  • We are hopeful of a stronger recovery in 2019, supported by steady oil prices and capex increases, leading to conclusion of project FIDs (Final Investment Decision) that were pushed back from 2018. This comes largely from production platforms and LNG related products.
  • Sembcorp Marine remains the preferred proxy as:
    1. Sembcorp Marine is a pure play to ride the recovery;
    2. sizeable new orders expected for non-drilling solutions with c.S$3bn potential order pipeline;
    3. reactivation of Sete’s projects should remove a key overhang; and
    4. Sembcorp Marine is a potential M&A play arising from a consolidation of Singapore yards.

Sembcorp Industries (SCI; Target Price S$3.70) is a safer proxy for O&M exposure.

  • SEMBCORP INDUSTRIES LTD (SGX:U96) offers a unique value proposition as a proxy to ride the cyclical O&M upturn, supported by a defensive utilities business. Assuming our fair value for Sembcorp Marine at S$2.40, Sembcorp Industries’ Utilities segment is way undervalued at 0.37x P/BV and 4.4x PE against 6% ROE.
  • At Group level, Sembcorp Industries is trading close to its historical trough of 0.6x PB (implied share price of ~S$2.40) saw in Jan-2016. We believe continuous improvements in India will re-rate Sembcorp Industries’ Utilities business.

Yangzijiang (YZJ; Target Price: S$1.82) is moving up the value chain; solid balance sheet, undervalued with decent yield.

  • As the largest and most cost efficient private shipbuilder in China, YANGZIJIANG SHIPBLDG HLDGS LTD (SGX:BS6) is well-positioned to ride the sector consolidation and shipbuilding recovery. Its strategy to move up into the LNG/LPG vessel segment through partnership with Mitsui strengthens the longer-term prospects of the yard. In addition, it is also a beneficiary of stronger USD.
  • It has a solid balance sheet, sitting on net cash of 93 Scts per share (includes investments), representing ~66% of NTA. It offers a steady dividend yield of ~4%.

Macro View – oil prices under pressure; service sector has bottomed but lacks visibility of a significant recovery

Lowered Brent price forecast to US$70-75/bbl in 2019.

  • Oil prices have recovered 35% to average US$74/bbl YTD in 2018, and 260% from the low of ~US$28/bbl in early 2016. We have lowered our average Brent forecast by US$5/bbl to US$70-75/bbl in 2019 in view of the potentially wider supply/demand gap on the back of lesser than expected impact from sanctions on Iran in the near term, weaker global GDP growth expectations amid trade wars, and emerging market weakness.

Singapore Rigbuilders: diversification to non-drilling solutions could drive order recovery.

  • Both yards have made a breakthrough into high-value non-crude solutions ( > US$200m each), and this has brightened the order outlook. While order flow of Singapore rigbuilders has been rather disappointing YTD, hovering at 2017’s ~S$2-3bn range, we expect a recovery to ~S$6-7bn in 2019, stemming from production platforms and LNG related products.
  • In addition, Sete Brasil’s rig orders at Singapore yards could be reactivated in the near future, eliminating another overhang of the yards.

OSV recovery will remain long drawn out.

  • While the outlook for the OSV sector in 2019 is more favourable compared to this year, we expect only a modest improvement in 2019 as the continued oversupply of OSVs is capping any improvement in day rates amid growing demand for production support vessels and rigs. We anticipate OSV utilisation rates to continue improving but day-rates improvement will be more of a 2020 story.
  • The oversupply situation remains a primary overhang in the sector as there is no clear answer to when and which of the significant number and type of laid-up OSVs will return to the market. We believe this will continue to weigh on sector sentiment in 2019.

Shipbuilding consolidation and recovery underway.

  • The overall conventional shipping market is expected to remain on a recovery path, albeit gradual. Global orderbook-to-fleet ratio has dropped to a low of less than 10%, implying moderating new supply going forward.
  • On the scrapping side, the new Ballast Water Management Convention rule, that took effect in Sept-2017 with 2-year gestation period, should continue to drive demolition of old vessels. However, demand growth is also expected to slow down given lower GDP growth and trade tensions. Against this backdrop, we expect shipbuilding consolidation to continue and the market to improve with moderate uptick in orders. LNG carriers is the brightest spot, followed by tankers, bulkers and containerships.

Risks and Catalysts

Lower oil prices.

  • A bear scenario of lower oil prices in the event of higher than expected supply and lower than expected demand growth, would defer any uptick in oil company spending, and derail a recovery in the services and newbuilding sectors.

Execution risk is salient for shipyards.

  • As the Singapore rigbuilders diversify their orderbooks away from the drilling rig market (e.g. Sembcorp Marine’s modularised LNG terminals), execution of the fabrication of new product types will be crucial for margins and earnings.

Pei Hwa HO DBS Group Research | Suvro SARKAR DBS Research | https://www.dbsvickers.com/ 2018-11-26
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