Forget provision charges, here's the bigger picture for Singapore O&M investors

 Source: TheEdge Markets   |   Publish date: Fri, 17 Feb 2017, 01:13 PM   |    >> Read article in News website

SINGAPORE (Feb 17): CLSA is turning positive on Keppel Corporation and Sembcorp Marine (SMM) , upgrading its former "sell" ratings on both stocks to "buy" with the respective target prices of $7.60 and $2 on the belief that Singapore's offshore & marine (O&M) sector is set to recover this year.

The brokerage and investment firm notes that 4Q16 is "likely to mark the tail end of impairment charges" which have been the source of key investor concern over the past year.

"With $1.2 billion provisions made by Keppel and Sembcorp Marine (SMM) over the past two years, both yards are well positioned, each with $4 billion orderbook backlogs, as they exit the cyclical trough. The market has yet to price in orderbook strength," comments lead analyst Low Horng Han in a Thursday report.

Low believes Keppel and SMM should benefit from the revival of Sete Brasil orders due to their partial-owner Petrobras' recovery, as well as its foray into floating liquefaction natural gas (FLNG), which the analyst believes will support both stocks in entering the next recovery phase.

"Higher oil prices, lower borrowing costs and asset sales have led to a recovery for Petrobras. More rigs are needed for its drilling programme, which will drive a return of $1.7-2.2 billion of the $3-4 billion orderbook written off by Keppel and SMM," he explains.

"We believe investors have overlooked Petrobras' improved finances. Its recent credit upgrade by Moody's, reduced borrowing costs and liquidity improvement from asset sales imply it has better financial strength to revive its pre-salt drilling programme. Its drilling charter contract with Sete Brasil remains intact but fewer rigs will be required."

Highlighting a much-lower risk of additional provisions as compared to a year ago, the analyst also thinks competition for orders will also be "less intense" this year, as yards in Brazil have ceased operations over the past few years due to funding and/or execution issues.

Horng furthermore points out that Keppel - as leading player Golar LNG's "yard of choice" - is likely to capitalise on Golar's final investment decision (FID) for the world's first FLNG project, with another FID for the second FLNG project projected to be secured by 2Q17.

"Smaller capital outlays, faster time to market and the ability to monetise stranded gas reserves compared to onshore facilities suggest FLNG adoption could be faster than expected. This could drive the industry towards adopting FLNG conversion. Keppel, together with Golar LNG, is a pioneer in this technology and will be a key beneficiary," says the analyst.

SMM, however, stands to gain even more than Keppel with Petrobras' production recovery, in Horng's opinion.

While Keppel's second floating production, storage and offloading (FPSO) unit as completed 60% of its construction schedule, SMM has yet to begin its two FPSO projects worth US$674 million ($955 million) in total, as its hulls that were supposed to be delivered from the Brazilian Engevix yard were delayed.

CLSA notes that these projects were awarded five years ago and specification could have changed leading to higher contract value - while the contract size could potentially increase for SMM should specifications change, as Petrobras could seek 1-2 additional units to fulfil its production targets.

As at 1pm, shares of Keppel Corp and SMM are trading at $6.67 and $1.58 respectively.

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