A steal at current price. We initiate coverage on STX OSV (VARD) with a Buy and TP of SGD1.66, pegged to 9x PER on average FY13-15F earnings. As a quality Norwegian shipyard with a niche in high specification offshore support vessels (OSV), VARD deserves to trade at a premium to Asian OSV yards. The conclusion of its sale to Fincantieri Group removes the overhang on share price, while recovering OSV orders will support an earnings turnaround. With a potential capital upside of 35% and FY13F dividend yield of 4.9% (which can rise to 7.3% in FY15F), the stock is a steal.
Depressed by Fincantieri offer. Share price has been de-rated and suppressed due to the lowball offer (SGD1.22/sh) by Fincantieri for STX Group’s 50.75% stake. We suspect that the latter was forced to dispose VARD at such depressed valuations (7.2x FY12 PER/2.0x FY12 P/B) due to financial distress. With the sale concluded, the overhang on share price has been removed and VARD should re-rate positively to at least peer valuation levels.
Setting the stage for outperformance. VARD has been conservative in its order win guidance. We believe that the weakened ordering activity from 2H12 is short-term in nature and foresee a pickup towards 2H13. Offshore activities remain fundamentally strong and the need for a more sophisticated and modern OSV fleet is ever increasing as offshore operations grow more complex. In our opinion, the cautious guidance sets the stage for positive surprises when ordering activities pick up faster and stronger than expected.
Market underestimates strength of recovery. Order win momentum is the key leading indicator to watch. Near-term earnings growth profile masks the real strength and timing of a turnaround given the lagged effect between order win and revenue recognition. We forecast NOK9.7b/12.8b/13.5b in new order wins for FY13F/14F/15F. We expect an 11% dip in FY13F EPS but a 30%/12% surge in FY14F/15F earnings, which puts our earnings forecasts above consensus for FY14F/15F but lower for FY13F. We believe the market has been overly cautious and underestimated the potential strength of a recovery.
Key Investment Merits
The leader in high-end OSVs. STX OSV Holdings (VARD1) is the market leader in premium OSV construction and the ‘go to’ yard for the most sophisticated and complex OSVs. While emerging Asian OSV yards offer low cost alternatives, VARD is able to maintain its niche with its design and customisation capabilities. The company designs and constructs high-end vessels and offers complex customisation solutions. Its customers are mainly Norwegian and European vessel owners who operate these vessels in harsh and deepwater environment such as the North Sea. We believe that VARD enjoys a strong competitive position that is not easily displaced.
Returning OSV orders to drive earnings growth. While AHTS and PSV newbuilding orders lost momentum in 2H12, we believe that the current weakness is short-term in nature and see resumption of orders towards 2H13. We expect AHTS orders to return before PSV orders. Meanwhile, demand for OSCV appears to be strong as there is increasing need for more sophisticated vessels to support complicated subsea installation and offshore construction activities. We believe that the conservative order guidance given by management sets the stage for potential outperformance.
Recovery could be stronger than expected. We think that the short-term order weakness was created due to a let-down following an over-exuberant behavior in the beginning of 2012. We feel that the market has underestimated the potential strength and pace of a recovery for OSV orders after the disappointment in late 2012. Offshore activities remain fundamentally strong and the need for a more sophisticated and modern fleet is ever increasing as offshore operations grow more complex.
Share price overhang removed. VARD’s share price was also depressed due to the lowball offer by Fincantieri at SGD1.22/sh for STX Group’s 50.75% stake. The conclusion of the sale removes this share price overhang. It is clearly obvious that the market thinks that the offer price is too low given that share price has been trading above the SGD1.22 level, and less than 5% of shares were tendered at the close of the mandatory offer.
Attractive rewards await. At the current share price, VARD trades at FY13F/14F PER of 8.3x/6.4x, while Asian OSV builders typically trade at about 6-8x 1-yr forward PERs. As a premium Norwegian shipyard, we believe that VARD deserves to trade at a higher valuation than Asian peers. We value the stock at SGD1.66, pegged to 9x PER on average FY13-15F earnings. We use average earnings to smooth out lumpy earnings fluctuations as we expect an 11% dip in FY13F earnings followed by a 30%/12% growth in FY14F/15F earnings, driven by recovery in orders from 2H13. Order wins are leading indicators while earnings are lagging indicators. Our TP implies a 35% potential capital upside. Additionally, FY13F dividend yield looks attractive at 4.9%, and has the potential to rise further to 7.3% in FY15F, if we assume a 40% payout ratio.
Valuation and Recommendation
Re-rating to fair value, initiate with Buy. We initiate coverage on VARD with a Buy rating and target price of SGD1.66. Our target price implies a potential upside of 35%, pegged to 9x PER on average FY13F-15F earnings. We use average earnings due to the lumpiness in order flows which can take 18-24 months to be fully executed from the time the order is secured. Taking an average will smooth out its earnings profile and takes into account the potential contributions from orders secured. This is especially so given that we expect a 11% dip in FY13F earnings followed by a respective 30% and 12% YoY growth in FY14F and FY15F earnings.
In terms of a fair PER multiple, we believe that VARD should trade at a premium to the smaller OSV yards in Asia. Given the complexity and size of the vessels it builds, it should trade nearer to the rigbuilders and commercial shipbuilders. VARD’s market cap is also significantly larger than most Asian OSV shipbuilders.
When we consider the 1-year forward PER trend, we observe that VARD has been trading up higher in terms of PER since its listing in Nov 2010. The company emerged from a net loss in FY09 to marginal profitability in FY10, followed by strong growth in FY11, which explains the uptrend. While the mean PER during the entire time horizon since listing is 7.4x, if we consider only the time period from Jan 2012, the new mean is 9.5x, which we believe would be more representative of the kind of valuation range it should trade going forward.
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