Sembcorp Marine’s (SMM) share price has dropped by about 13.9% vs Keppel Corp’s (KEP) 8.7% fall since we switched our preference from SMM to KEP in late Feb (24 Feb 2012 report). We believe this is partly due to several reasons:
1) risk-off sentiment particularly in May which has affected the higher beta SMM stock,
2) earnings disappointment for SMM in its 1Q12 earnings, and
3) recovery in sentiment amongst property stocks (KEP has a property arm)
. … but the trend may reverse in the months ahead However, we believe that this trend may reverse in the coming months, and now favour SMM. Although there is a possibility of further market volatility due to Eurozone concerns which may affect the higher-beta SMM more, we think that the recent sell-down in the stock is unwarranted, as:
1) we still hold a positive view on the premium offshore rig market,
2) SMM is likely to catch up in the orders front in the months ahead (partly due to Petrobras orders),
3) SMM’s earnings are expected to pick up in 2H12, and
4) so-called “speculative builds” at SMM are probably better-termed “opportunistic builds”.
Newbuild enquiries remain healthy Enquiries for newbuild rigs remain healthy as
major oil companies take a long-term view on oil prices in their capital expenditure plans and hence are much less affected by short term fluctuations in oil prices. The utilisation levels and dayrates for premium rigs remain strong and the outlook for this sub-sector is still positive.
Order book provides defensiveness
Sembcorp Marine’s net order book of S$7.4b provides good earnings visibility at a time when uncertainty in the global economy has resulted in a general lack of clarity in corporate earnings outlook. We roll over our valuation to blended FY12/13F core earnings with an unchanged peg of 14x for the offshore & marine business (ex-Cosco Shipyard Group), and update the market value of Cosco Corp in our SOTP valuation. As such, our fair value estimate rises from S$5.13 to S$5.71. Maintain BUY.
SMM has underperformed KEP
Sembcorp Marine’s (SMM) share price has dropped by about 13% vs Keppel Corp’s (KEP) 8.7% fall since we switched our preference from SMM to KEP in late Feb (24 Feb 2012 report). We believe this is partly due to several reasons:
1) risk-off sentiment particularly in May which has affected the higher beta SMM stock,
2) earnings disappointment for SMM in its 1Q12 earnings that was announced in early May, and
3) recovery in sentiment amongst property stocks (KEP has a property arm in Keppel Land).
But the trend may reverse in the months ahead However, we believe that this trend may reverse itself in the coming months, and now favour SMM. Although there is a possibility of further market volatility due to developments in the Eurozone which may affect the higher-beta SMM more, we think that the recent sell-down in the stock is unwarranted, as:
1) we still hold a positive view on the premium offshore rig market,
2) SMM is likely to catch up in the orders front in the months ahead,
3) SMM’s earnings are expected to pick up in 2H12, and 4) so-called “speculative builds” at SMM are probably better-termed “opportunistic builds” which has a better connotation.
A catalyst that SMM still has
Recall that KEP announced in mid Apr this year that it had secured a letter of intent from Sete Brasil for the design and construction of five semi-submersible rigs worth US$4.12b. Though we have priced in US$4.7b worth of drillship orders in our S$8.7b FY12F new order estimate for SMM, a positive knee-jerk reaction in the stock price is still likely upon announcement of the orders. Unlike KEP, SMM typically does not announce letters of intent.
Expecting earnings to pick up in 2H12
A contributor to SMM’s underperformance relative to KEP in late Apr and May could have been the former’s 1Q12 earnings disappointment due to timing of rig recognition and lower initial margin from new design rigs. In comparison, KEP was partly buoyed by lumpy earnings from the property segment. We are expecting earnings to pick up in 2H12 as higher margin contracts contribute to SMM’s results.
Enquiries remain healthy
Enquiries for newbuild rigs remain healthy as major oil companies take a long-term view on oil prices in their capital expenditure plans and hence are much less affected by short term fluctuations in oil prices. The utilisation levels and dayrates for premium rigs remain strong and the outlook for this sub-sector is still positive. According to Upstream1, Calgary-based Husky Energy has issued a tender for a harsh environment semi-sub unit and contractors such as Transocean and Noble Corp are shopping around for suitable yard slots. Seadrill is also known to have expressed interest and may consider offering one of the recent yard slots secured with SMM’s Jurong Shipyard or Hyundai Heavy Industries.
Not all “speculative builds” are created equal
There have been earlier concerns over SMM’s “spec builds” in which the yard starts to build rigs without firm orders on hand. Although no formal contracts have been signed before the commencement of rig construction, we would prefer to call them “opportunistic builds” as SMM, with established relationships with its customers, intimate market knowledge and control over the rig construction process, is in a much better position than a fund which has ordered a newbuild in the hope of flipping it in the future.
“Opportunistic builds” have been taken up so far
We look at our contract list for SMM and point out two rigs that were “opportunistic builds”. One was ordered by Safin Gulf in Feb and the other by Gulf Drilling in Apr this year; the former’s delivery date is Nov 2012 and the latter 1Q13. We do not exclude the possibility of perhaps one or two more such builds which would in general command better pricing due to the early delivery dates. The rig market is currently in an upcycle and hence this is a workable strategy.
Strong outstanding order book provides defensiveness
Sembcorp Marine has a net order book of S$7.4b with deliveries stretching till 2Q15, and this provides good earnings visibility at a time when uncertainties are still prevalent in the global economy and there is a general lack of clarity in terms of corporate earnings outlook. The group has secured orders worth about S$3b YTD, accounting for 34% of our full year estimate (which includes orders from Petrobras).
Still has upside potential We roll over our valuation to blended FY12/13F core earnings with an unchanged peg of 14x for the offshore & marine business (ex-Cosco Shipyard Group), and update the market value of Cosco Corp in our SOTP valuation. As such, our fair value estimate rises from S$5.13 to S$5.71. Maintain BUY.
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