SG Industrial Stocks - OCBC Investment 2018-11-29: Opt For Resilience & Low Valuations

Singapore Industrial Stocks - OCBC Investment Research | SGinvestors.io SATS LTD. (SGX:S58) SINGAPORE TECH ENGINEERING LTD (SGX:S63) SINGAPORE AIRLINES LTD (SGX:C6L)

SG Industrial Stocks - Opt For Resilience & Low Valuations




EVALUATION OF PAST PERFORMANCE


2018 – a year of realisation for some

  • Our year-end report for the Oil and Gas sector last year was titled “Awaiting contract wins”, in which we expected a gradual recovery in 2018 and mentioned that a re-rating of stocks in the sector would require a continued flow of contract wins. We recall that there was significant excitement in the market in the earlier part of this year, with great expectations for new order wins especially for Sembcorp Marine (SGX:S51) (along with speculation of a possible merger), but both disappointed as we cruised through the year. This is despite crude prices continuing their upward climb till end Sep, before dropping steadily in the last two months or so.
  • We believe a clear point of realization for some erst-while bulls came in mid Jul when Sembcorp Marine’s management mentioned that the group’s transformation efforts to move up the value chain has resulted in new business opportunities but they require significant time and effort in project co-development with potential customers. Such new-build EPC projects have detailed engineering and construction planning phase, which may take as long as six to 12 months before main construction activities and corresponding revenue recognition can take place.
  • This year, our Singapore Industrials sector report comprises two key segments that are affected by movements in the oil price – the Conglomerates/ Offshore & Marine yards as well as the Transport segment.

Mostly in line with broader STI except for STE, SMM and YZJ


Mostly in line with broader STI except for ComfortDelgro, SIAEC

  • Stocks in the sub-sector mostly traded in line with the broader STI as well, with the exception of ComfortDelgro (SGX:C52), and SIA Engineering (SGX:S59) in the last few weeks.
  • The stock price of ComfortDelgro rallied in Apr/May this year with the exit of Uber from Singapore, but has softened in recent times with the impending entry of Go-Jek, along with weakness in the broader market. Our rating for ComfortDelgro was upgraded to Buy in mid Feb before it was downgraded to HOLD in early Jun. See recent report: ComfortDelGro - Monitoring The Taxi Space.
  • As for SIA Engineering (SIAEC), it has broadly tracked the market so far this year, except for a recent fall in share price post the release of its 2QFY19 results and our rating downgrade to HOLD on 9 Nov. See recent report: SIA Engineering - Headwinds And Some Turbulence. Headwinds for the company remain and we see few catalysts for now, except for
    1. less pricing pressure from airlines under a lower oil price environment, or
    2. a possible privatisation by SIA (SGX:C6L).


SUB-SECTOR TRENDS AND OUTLOOK


OIL PRICES - Brent closed at US$86/bbl in early Oct 2018

  • With rising global oil demand and production cuts by OPEC, the crude oil glut that we saw in 2014 has narrowed substantially into a mild under-supply scenario in the 12 months leading to Apr 2018 before a balance was seen subsequently.
  • Brent crude closed at its highest level in four years in early Oct, settling at more than US$86/bbl for the first time since Oct 2014.

OCBC and Bank of Singapore stuck to their guns

  • Crude oil, being a highly liquid exchange traded product that is susceptible to speculative trading, tends to overshoot on the upside as well as on the downside in the near term. OCBC Treasury Research and Strategy as well as Bank of Singapore (BOS) sounded caution when it looked as if the crude market was getting overheated, arguing on the basis of fundamentals.
  • When certain banks increased their forecasts during crude’s upward march in the middle of this year (only to decrease after Oct), both OCBC and BOS stood by their forecasts ranging from US$60-70/bbl for end 2018. Indeed from early Oct onwards, both Brent and WTI crude have tumbled by about 30% since.
  • Looking ahead, OCBC is forecasting WTI to average US$65 in 4Q19, and Brent at US$70. BOS is forecasting WTI and Brent at $60 and $65 12 months out from mid Nov 2018.

US – making history by exceeding 11m bbl/day for the first time

  • According to the US Energy Information Administration (EIA), US crude oil production reached 11.3m bbl/day in Aug 2018 – the first time that monthly US production levels surpassed 11m bbl/day. The growth in Texas and New Mexico production since the start of 2018 surpassed EIA’s previous expectations, which assumed that pipeline capacity constraints in the Permian region would dampen production growth. However, industry efficiencies in pipeline utilisation and increased trucking and tail transport in the region have allowed crude oil production to continue to grow at a higher rate than expected.
  • Over the past 10 years, US crude oil production has increased significantly (Exhibit 5 in the PDF report attached), driven mainly by production from tight oil formations using horizontal drilling and hydraulic fracturing. EIA estimates of crude oil production from tight formations in Aug 2018 reached 6.2m bbl/day, or 55% of the national total.

US - now the world’s top crude producer; upside supply risks remain

  • The US crude oil production of 11.3m bbl/day in Aug was also more than the Russian Ministry of Energy’s estimated Aug production of 11.2m bbl/day, making the US the leading crude oil producer in the world. The oil price decline in mid 2014 resulted in US producers reducing their costs and temporarily scaling back production. However, after crude oil prices increased in early 2016, investment and production began increasing later that year. In comparison, Russia and Saudi Arabia have maintained relatively steady crude oil production growth in recent years.
  • Looking ahead, EIA forecasts US crude oil production to increase by 1.0m bbl/day in 2019, and we see upside supply risks which may cap the upside on oil prices.


CONGLOMERATES/ OFFSHORE & MARINE YARDS 

  • Overall, the utilisation rate of marketed rigs has continued to increase this year, and is now hovering slightly under 75%. Supply of marketed rigs has decreased slightly, while supply of the entire rig fleet has fallen to a greater degree with scrapping of older units.
  • However, for a better idea of the outlook for our local yards, it is useful to drill down and look at the three main rig segments in turn – jack-ups, semi-submersibles and drillships.
  • After declining significantly in 2014-2016, utilisation rates for harsh environment jack-ups in NW Europe saw stabilization in 2017 before recovering this year, such that current utilisation rates hover around 65- 70% (Exhibit 9). Utilisation has to increase more first before we can see a recovery in day rates. This has been one of the segments that Keppel Corp (SGX:BN4) and Sembcorp Marine have been focused on, and a continued recovery may herald better news for both companies. In comparison, the shallow water jack-ups in the SE Asia region (Exhibit 8 in the PDF report attached) did not see a recovery unlike the NW Europe harsh environment jack-ups.
  • For ultra-deepwater semi-submersibles (Exhibit 10 in the PDF report attached), the utilization rate remains low at around 35%, and average day rates remain low as well. Unlike other rig types, this segment has not seen an uptick in utilisation rates. 
  • As for the drillship segment (Exhibit 11 in the PDF report attached), utilisation levels seem to have found a bottom in 2017, and there has been an uptick in 2018. The recovery is likely to be a very gradual one, which is not surprising given that the deep-water space is usually lagging in the recovery process. 


TRANSPORT SECTOR

  • The transport sector is very much affected by oil prices as well, due to fuel costs. However, the extent varies as well. ComfortDelgro’s business segments include public transport operations, and fare adjustments are also tied to fuel costs as well, to either contain the upside or compensate ComfortDelgro when fuel costs swing. 
  • In comparison, fuel costs affect airlines to a greater extent, but it also depends on the amount of hedges that the airline uses. In 1HFY19, fuel costs (post hedging) accounted for 30% of SIA’s total costs. For 2HFY19, SIA has hedged 58% of its fuel requirements in MOPS (jet fuel) at a weighted average price of US$71, against the current MOPS price of US$87. For FY20, 52% is hedged with 17% at US$79 on average for jet fuel) and 35% at US$56 on average for Brent. 

Outlook for transport-related names 

  • Oil prices aside, we expect ComfortDelgro (SGX:C52)’s growth to be driven by overseas acquisitions, supported by stable operating cash flows from public transport operations in Singapore. So far this year, the group has invested about S$450m in overseas acquisitions, mainly in Australia. As for its taxi operations, the market is likely to focus on the actions that Go-Jek would take in its entry to Singapore. Should an aggressive pricing strategy be pursued, sentiment on the stock may be affected. We estimate that the Singapore taxi business accounts for about 20-25% of operating income for the group. 
  • For SIA (SGX:C6L), passenger load factors should remain strong on robust passenger growth, but passenger yields may be capped by intense competition from rival airlines. For 2HFY19, earnings should improve on weaker oil prices. Over the longer term, this is a capital intensive business and significant capital expenditure is expected, and we forecast an increase in net gearing for the group. 

SIA Engineering

  • SIA Engineering (SGX:S59), in which SIA owns a 77.7% stake, faces some issues in the meantime. Aircraft are spending a longer time in the hangars than before, meaning missed opportunities to undertake maintenance work for other aircraft. The number of checks that can be undertaken is constrained by hangar capacity, so there may be a limit to growth unless the group comes up with creative solutions or new income streams. 

SATS Ltd

  • SATS (SGX:S58) has been steadily increasing its dividends over the years since FY13, backed by an average 6-7% earnings growth per year. We believe there is ample cushion for dividends to be sustained, and sufficient room for investments as well.
  • Post our downgrade on 9 Nov and the release of its 2QFY19 results, the share price of SATS Ltd has dropped by 9.1% compared to the STI’s 0.2% fall over the same period, based on the closing price on 28 Nov. Recall that results were in line with our expectations, with 1H18 net profit accounting for 51% of our full year figure.
  • We had downgraded our rating for SATS due to the limited upside potential post share price appreciation, but now with the recent correction, value is emerging again. We are now upgrading to BUY with a slightly lower Fair Value estimate of S$5.34 (prev S$5.39). 


RECOMMENDATIONS 


Gradual recovery in 2019; continued flow of orders needed 

  • Looking ahead in 2019, we expect the offshore oil and gas sector to continue its gradual recovery, underpinned by cost deflation across the industry and lower break evens. Orders are still mainly expected from the non-drilling segment as recovery in the drilling market will still take time. However, should there be significant contract wins in 2019 for Keppel Corp (SGX:BN4) and Sembcorp Marine, we see chances for trading opportunities especially for the latter.
  • A sustained recovery, however, will only ensue with a continued flow of contract wins, which will drive a re-rating of related stocks in the sector. 

Preferred picks – STE and SIA 

  • Among the Singapore Industrials space, we prefer ST Engineering (STE) [Rating: BUY; Fair Value: S$3.95] with its earnings resilience, backed by a stable and diversified order book across industries (aerospace, electronics, land systems and marine), and Singapore Airlines (SIA) [Rating: BUY; Fair Value: S$10.71] due to its low valuations and a softer oil price environment which should lend near-term support to earnings. 





Low Pei Han CFA OCBC Investment Research | https://www.iocbc.com/ 2018-11-29
SGX Stock Analyst Report BUY MAINTAIN BUY 5.340 SAME 5.340
BUY MAINTAIN BUY 3.950 SAME 3.950
BUY MAINTAIN BUY 10.710 SAME 10.710





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