Navigate Singapore 2019 ~ Capital Goods - CGS-CIMB Research 2018-11-29: OVERWEIGHT

Navigate Singapore 2019 ~ Capital Goods - CGS-CIMB Research | SGinvestors.io SINGAPORE TECH ENGINEERING LTD (SGX:S63) SEMBCORP INDUSTRIES LTD (SGX:U96) CSE GLOBAL LTD (SGX:544)

Navigate Singapore 2019 ~ Capital Goods - OVERWEIGHT

Positive trends

Some improved operational straits.

  • Keppel’s O&M segment turned in a profit in 3Q; CSE GLOBAL LTD (SGX:544) continued to show a y-o-y recovery in 9M18 core net profit (+87.1%) and better GPM of 27.5%.
  • For PACC OFFSHORE SVCS HLDG LTD (POSH, SGX:U6C), it reported positive 9M18 gross profits (after many quarters of negative), mainly due to higher deployment of its Accommodation Vessel (SSAV) segment.

Cost rationalisation bearing fruits.

  • ST ENGINEERING (SGX:S63)’s efforts to centralise group costs have started to bear fruits. Group’s PBT margin inched up to 10.2% from an average of 8.9% in 1H18. Electronics defied the fear of compromising margin on higher sales with PBT margin up to 13.4% from an average of 9.6% in 1H18, as a result of lower R&D costs and streamlining of operations in the US, amidst a better sales mix.

Negative trends

Volatile crude oil prices.

  • Although Brent crude oil prices are still well over the levels of certain offshore projects’ breakeven levels of US$20-40/barrel, the downward trend in recent months to below US$60/bbl could affect overall sentiment on capex spending. This is clouded by rising US crude stockpile and uncertainty over OPEC’s decision to cut production.

Still a mixed performance among vessel-centric names.

  • Vessel utilisation improvements among the offshore support players and asset classes have been uneven.
  • For PACC OFFSHORE SVCS HLDG LTD (POSH), despite positive 9M18 gross profits, it mentioned that it expects to further impair its OSV fleet in 4Q18.
  • EZION HOLDINGS LIMITED (SGX:5ME) continued to report a gross loss due to lower average rates and still-low utilisation for its liftboats.
  • MERMAID MARITIME PUBLIC CO LTD (SGX:DU4)’s subsea fleet also saw low utilisation, versus 100% utilisation for its drilling rigs in the Middle East.

Looking to 2019

Crude oil price is anyone’s guess; but should skew to the upside in the longer run.

  • We believe the medium-term supply risks from:
    1. any supply disruptions from countries including Iran, Venezuela, Libya and Nigeria (21.5% of OPEC’s crude oil production in Oct according to EIA); and
    2. tight OPEC spare capacity (this has fallen to 2.3m bbls/day in Oct 18 according to Bloomberg), could provide support to crude oil prices and keep it at least above offshore projects’ breakeven levels of US$20-40/barrel. The EIA projects WTI and Brent crude oil prices at US$64.8 and US$71.9 in FY19F.

M&A has reached Singapore’s shores.

  • Since end-FY17, notable mergers and acquisitions (M&A) have taken place but primarily in international waters. However, KIMHENG OFFSHORE & MARINE (SGX:5G2), a local oilfield service provider, has been acquiring distressed assets since FY17. In Jul 18, BAKER TECHNOLOGY LIMITED (SGX:BTP) entered into a sales and purchase (S&P) agreement to acquire approximately c.52% of CH OFFSHORE LTD (SGX:C13), an offshore support vessel company.
  • Whilst it may be early days still, we believe more M&A could ensue as players anticipate a sector recovery. Such consolidations shrink the industry and give oilfield service players more clout when it comes to bidding for contract awards.

Margin recovery from execution of current orders but still need to replenish orders.

  • KEPPEL CORPORATION (SGX:BN4) is due to start building the Awilco semi-sub in 4Q18 while SEMBCORP MARINE (SGX:S51) will recognise more of the sizeable projects to reverse the trend of EBIT losses in FY18.
  • We estimate YTD order book for Keppel Corp to be at c.S$4.4bn and Sembcorp Marine’s at S$3.4bn. Replenishing of orders is still key to sustain operating leverage. We assume S$3bn-3.5bn of new wins in 2019F.

Utilities space to provide hiding place.

  • Assuming India’s spot prices normalise and turbine issues are fixed, investors should consider SEMBCORP INDUSTRIES LTD (SGX:U96) as a proxy for late-cycle investing. Its UK mini reciprocating plants should start to come onstream, contributing 5% to its utilities earnings.
  • We expect to see intensive competition among the power retailers, including Sembcorp Industries and Keppel Corp as Singapore fully liberalises the retail power market. Impact on topline for both may not be significant given their less than 15% market share in the power generation space. However, there could be a slight uptick in marketing and customer acquisition costs.

Stock preference

  • We remain Overweight on medium-to longer-term prospects for the sector on the back of crude oil prices being above breakeven levels. On a P/BV basis, the sector is still trading at trough levels.
  • ST Engineering is one of our top picks as a defensive proxy to the theme of urbanisation, smart city and cyber security trend as well as upward cycle of aircraft engine repair. With the consolidation of MRAS, FY19F profit could grow 15-17% y-o-y, breaking away from the past eight years’ single-digit unexciting growth pattern. With the second Con-Ro vessel scheduled for delivery by end-18, marine is ready to close a chapter on cost-overrun. Sustained oil price should also spur rig repair work in the US yard.
  • Sembcorp Industries is also a top pick as India is on track to turn around as the second coal power plant’s losses narrow (lower interest costs and normalised spot prices). Valuations for its utilities business are not expensive at 0.5x CY18F P/BV vs. ROE of c.6%. We are forecasting its utilities earnings to grow 26% y-o-y in FY19F driven by UK and India.
  • Within the small cap space, we like CSE Global as its recovery in FY18F earnings is intact (higher GPM, firmer contract execution). Its net cash position should provide comfort if order flow is delayed while committed FY18F DPS of 2.75 Scts implies a c.6% yield.

LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2018-11-29
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