STX OSV strong design and manufacturing capabilities.

Fair Value - S$1.65


STX OSV: Premium OSV builder
●High-spec shipbuilder
●Strong design and manufacturing capabilities
●Access to critical mass of offshore players

Focus on the high-end segment.
Unlike Asian shipyards, which mainly construct vessels of higher standardization and less sophistication, STX OSV focuses on building technologically advanced and highly customized offshore vessels. In other words, STX OSV competes on design quality and manufacturing flexibility, while Asian shipyards compete primarily on costs and production volume. Given the general oversupply of OSVs in the market and an uncertain global outlook, we think that STX OSV is well-positioned both for growth and to weather any storm.

High barriers of entry

It help protect STX OSV’s business from the brutal cost competition arising from Asian shipyards. We believe there are three key barriers:
(1) design capability,
(2) manufacturing flexibility, and
(3) access to a critical mass of offshore players.

Strength in design and innovation.
A key competitive strength is its ability to design and construct innovative and market-tailored OSVs. STX OSV employs some of the best designers and engineers, who work closely with customers to come up with innovative design. Asian shipyards may be able to replicate certain work processes and engineering designs, but producing innovative solutions and customizing vessels to address business needs would be much more difficult to achieve. As an example of the group’s design capability, Skandi Arctic, delivered by STX OSV in Jan 2010, won the “Ship of the Year 2010” award for her multi-functionality – the ability to perform subsea installation and construction work, along with riser-based wellintervention services.

Flexible manufacturing capabilities.
As the group’s approach to vessel production is customization-orientated, having flexibility in the manufacturing process is critical. Close interaction between design and production help the group coordinate its engineering processes and reduce manufacturing times and errors. Customers sometimes request extensive variations to a basic vessel order during the construction phase. Through its design and engineering team, STX OSV is able to customize the vessels during construction to the exact specifications without significant delays. Again, we note that such advanced level of integration between its design and manufacture processes cannot be easily copied by Asian shipyards.

Access to a critical mass of offshore players. STX OSV’s operational headquarters, in the western coast of Norway, offers several key advantages. First, the marine cluster in Norway reflects demand for advanced vessels required for the harsh North Seas environment and supports offshore research and development. Second, it provides good access to the top designers and engineers in the industry. Third, synergistic interactions between owners, shipyards and equipment manufacturers help STX OSV identify opportunities quickly and develop prototypes ahead of competition.

Exposure to emerging markets. Outside Norway, the group has shipbuilding facilities in Romania, Brazil and Vietnam. Its yard in Romania helps realize cost efficiencies (for the lower value hull production process), while yards in Brazil and Vietnam put it in closer proximity with its customers in the emerging markets.

Risks
Project management risks. In shipbuilding projects, the group may be susceptible to design errors, execution delays and cost over-runs. However, we believe that STX OSV is able to manage these risks well as it has been operating the yard business for decades and employs some of the best engineers in the industry.

Third-party risks. STX OSV is also exposed to risks from equipment manufacturers, suppliers and third-party designers. In 2009, STX OSV undertook construction of 14 vessels based on third party designs, which were later found to be flawed. This resulted in cost over-runs and late deliveries during the year.

Credit risks. Historically, the group has some concentration of credit risk arising from a small number of customers. However, the risk is mitigated in several ways. First, the group usually requires a parent company guarantee or a banker’s guarantee for any new order. Second, a portion of the vessel construction costs are funded using construction loan where the vessel itself acts as security. This implies that, in the event of a default, lenders will not have recourse to the group’s other assets. Third, STX OSV can sell off the vessel to recover its construction costs if a customer defaults.

Dependency in oil prices. As its customers operate mainly in the offshore oil and gas industry, its operations are dependent on the level of exploration, development and production activities, which are in turn driven by movements in oil and gas prices. This impact could be clearly seen during the global financial crisis 2008-09, when oil-and-gas companies cut back on their expenditures and activities, resulting in lower demand for OSV newbuilds.

Industry and company analysis Long term oil demand to remain robust. According to International Energy Agency (IEA), oil demand is expected to expand from 87m bbl/day to 99m/bbl day in 2035, with all the net growth coming from the transport sector in emerging economies, as passenger vehicle fleet doubles to almost 1.7b in 2035.

Oil prices to remain around US$100/bbl in the near term. According to OCBC Treasury Research (“Oil: Making Sense of it”, 24 Nov 2011), WTI and Brent would trade around US$92/bbl and US$105/bbl in 1Q12 on continued slowdown in the Eurozone, US and Asian economies. However, there exists a possibility of a supply shock due to Middle East political tension (Iran-Israel) which may send oil prices soaring.

Eurozone uncertainties. How the eurozone sovereign debt issues play out in FY12F-13F could have important implications for the shipbuilding and offshore industries, particularly for companies operating in Europe. Shipbuilding and offshore services are capital-intensive industries, which rely heavily on bank or capital markets for financing. Therefore, any disruption to the credit markets could impact shipbuilders directly (through the availability of construction financing) or indirectly (affecting the ability of their clients in ordering new vessels).

STX OSV’s competitive advantages intact. Notwithstanding the nearterm concerns over the eurozone, we think that STX OSV’s competitive advantages as a high-spec OSV shipbuilder remain intact. Asian shipyards compete primarily on cost and will find it difficult to challenge STX OSV’s design and manufacture capabilities. In addition, the group enjoys a natural advantage from its operational headquarters in western Norway, which remains at the forefront of offshore developments for the foreseeable future.

Risk of contracts delay, not cancellation. Given the robust long term fundamentals and near-term uncertainties, we argue that contracts are more likely to be postponed than cancelled. This would likely result in an “order boom” in the later years. Already, we have seen such a phenomenon during the global financial crisis, when new orders dried up in FY08-09 (FY07: NOK 15b; FY08: NOK6b; FY09: NOK4b), only to bounce back in FY10 (FY10: NOK13bn).

Order-book provides buffer against volatility. In any case, the group’s net order-book of NOK 13.6bn as at end-Sep 11 (against FY10’s revenue of NOK 11.8bn), should provide sufficient base load to keep its shipyard busy till end of mid-2013. In the meantime, the group has also started negotiations with Transpetro for the construction of 8 LNG carriers at its new Brazilian yard.

Financial Analysis

I. Financial performance and forecast
Fewer orders expected in FY12F. In view of the near-term eurozone headwinds, we are expecting new orders to fall to NOK 4.5bn and NOK 9.0bn for FY12F and FY13F, respectively. Accordingly, our revenue estimates are NOK 11.4bn and NOK 13.0bn for FY12F and FY13F, respectively.

Lower margins expected. We think that EBITDA margin of 15.9% for nine months ended Sep 2011 is unlikely to be repeated in the future, as the margin was based on work secured in the generally tight and heated market environment of FY10-11. Over the next two years, we think that EBITDA margin will decline to around 10-11%.

Moderate leverage level. The group uses debt mainly to finance the construction of its vessels. Therefore, the level of gearing may fluctuate according to its activity level. As of end-Sep 2011, STX OSV’s net gearing was at 67%. In line with our projection of a decline in FY12F revenue, its debt is expected to remain at a modest level.

Major capex in Brazilian yard. Besides construction financing, STX OSV’s other major capital requirement is the development of its Brazil yard with an estimated cost of USD126m. We think that financing should not be an issue given the group’s strong balance sheet and positive cash generative ability.

Valuation and Recommendation
Peer valuation. STX OSV’s direct competitors are mainly Norwegian and European shipyards, such as Ulstein Group ASA, Kleven Maritime AS, Havyard Group and IHC Merwde. As these are mainly private companies, we would compare STX OSV against major offshore yards and local midcap offshore players.

BUY with S$1.65 fair value.
The shares of major global offshore yards and local midcap offshore players are trading at 10x and 9.4x FY12F EPS respectively. For STX OSV, we feel that 9.7x FY12F EPS would be appropriate given its meaningful order backlog and good execution record. Initiate with a BUY with fair value estimate of S$1.65.

STX Corp has been divesting its stake since 2010

12 Nov 2010 - STX OSV is listed on SGX Mainboard. STX Europe retains a 69.0% stake in STX OSV.


8 July 2011 - STX Europe placed out 18.3% stake to funds affiliated with Och-Ziff Asset Management (OZ) at S$1.33 per share. Following this transaction, STX Europe and OZ hold 50.7% and 20.0% stakes respectively in STX OSV.


24 Jan 2012 - Market talk that STX Corp may sell off its remaining stake in STX OSV to raise cash for debt repayment.


25 Jan 2012 - STX Europe announced that it is exploring potential sale of its remaining 50.7% stake in STX OSV.

52 Weeks Range 0.790 - 1.580

Company Background

Leading OSV shipbuilder. STX OSV Holdings Ltd (STX OSV) is one of the major shipbuilders of offshore vessels used in oil-and-gas exploration, production and oil services industries. It specializes in the design and construction of complex and highly customized vessels, including platform supply vessels (PSVs), anchor handling tug supply (AHTS) vessels and advanced offshore subsea construction vessels (OSCVs), which are used in the most challenging and difficult offshore environment. The group currently has nine yards in Norway, Romania, Vietnam and Brazil.

STX parentage. Since STX OSV’s listing on SGX on 12 Nov 10, its parent STX Corp – one of Korea’s biggest business groups with business interests spanning shipbuilding & machinery, shipping & trading, energy and plant & construction – has been steadily reducing its ownership stake. STX Corp, through STX Europe, currently holds a 51% stake in STX OSV, but is exploring a potential sale of the remaining shares. We understand that STX Corp faces substantial refinancing needs this year and will be keen to raise cash.