Shipbuilding - DBS Research 2019-02-01: Merger On The Cards ?

SEMBCORP MARINE LTD (SGX:S51) YANGZIJIANG SHIPBLDG HLDGS LTD (SGX:BS6)

Shipbuilding - Merger On The Cards ?

Hyundai Heavy Industries (HHI), the world’s largest shipbuilding company, has indicated interest in acquiring its rival, the second largest Korean shipbuilder - Daewoo Shipbuilding & Marine Engineering Co., Ltd (DSME).
HHI has signed a conditional MOU with Korean Development Bank (KDB) to take over the latter’s 55.7% stake in DSME via the issue of matching convertible preferred stocks and common shares in merged entity. The deal includes KDB’s liquidity support of 2.5 trillion won (US$2.25bn) for DSME.
KDB said it would also approach Korea’s third largest shipbuilding company - Samsung Heavy Industries Co Ltd (SHI) - to gauge any interest in taking over DSME.

The move comes amid growing calls the reform the Korean shipbuilding industry from the current big three― HHI, DSME and SHI― to two, to enhance competitiveness against global competitors from China and Singapore such as China State Shipbuilding (CSSC), China Shipbuilding Industry (CSIC), SEMBCORP MARINE LTD (SGX:S51), and Keppel O&M (KOM).
The merger of HHI+DSME seems to make more sense than SHI+DSME given the overlap in HHI’s and DSME’s shipbuilding products in particular liquefied natural gas (LNG) ships, very large crude carriers (VLCCs) and naval vessels, as SHI is more focused on offshore projects.
Additionally, we believe one of the chief reasons for HHI’s interest in Daewoo is attributable to Daewoo’s global leadership in LNG carriers. Growing dependence on natural gas and elevated global LNG trade would drive new orders in the future.

If merged, the combined entity will boast a combined shipbuilding backlog of ~US$49bn, dwarfing all other players in the industry with > 20% market share.

Industry consolidation helps to trim excess capacity, alleviate competition and translate into stronger pricing power for the survivors. In this case, DSME has historically been very aggressive in their pricing strategy in order to fill the yards. The merger should lift newbuild prices, in particular Korean dominated products, moving forward.
This event substantiates our thesis of continued consolidation in the shipbuilding sector. Recall the Chinese government reportedly approved the merger of the two largest SOE yards – CSIC and CSSC - last year, but there have been no updates since. There was also similar speculation for Singapore rigbuilders early last year.

Following news of the merger of CAPITALAND LIMITED (SGX:C31) and Ascendas Singbridge on 14 Jan 2019, and now HHI+DSME, there could be renewed speculation of a merger between Sembcorp Marine and KOM. We did a scenario analysis on this in our thematic report dated 20-Jul-2017 Asian Insights SparX: Shipyards: Creating Global Champions.
Merger of KOM and Sembcorp Marine could bring capacity and revenue closer to Korean peers. To get a sense of this, HHI, DSME and SHI secured ~US$10.2bn, US$7.3bn and US$6.3bn new contracts last year, driven by orders for LNG carriers, vs Singapore yards where KOM and Sembcorp Marine clinched US$1.3bn and US$0.7bn respectively.

In the event of merger speculation, Sembcorp Marine (Target Price S$2.40; +50%) could re-rate on anticipation of it being a privatisation / takeover target. In any case, we believe the current share price is a good entry point for Sembcorp Marine as:
1. We expect management tone to turn more positive as activity level, revenue and profitability are trending up;
2. optimism on new contracts for production platform in particular FPSOs for Brazil;
3. M&A angle.
YANGZIJIANG SHIPBLDG HLDGS LTD (SGX:BS6) (Target Price S$1.82; +30%) is a prime beneficiary of industry consolidation and shipbuilding recovery. Its move into LNG carrier space through partnership with Japanese yard Mitsui will pave their way into the new market. In addition, the stock offers a decent 3.5% dividend yield.

Pei Hwa HO DBS Group Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2019-02-01

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