A soft 3Q13 on weaker margins; stay positive. While margins were weaker than expected in 3Q13, we maintain our Overweight stance on the sector. Our optimism is premised on three key investment themes: 1) an upswing in rig building continues to unfold; 2) an imminent recovery in the OSV sector; and 3) distant possibility of a sustaiable recovery in the shipbuilding industry. These themes are expected to play out over the next few years.

Positive signs are there; order wins could surprise positively. We expect E&P spending to stay robust with oil price above USD80/bbl. This should support ordering and tendering activities. The following developments underpin our view: (1) a sharp rise in global orders for jackups at 59 units YTD (2012: 20) – highest since 1980 - which demonstrates the strength of the jackup rig market; (2) the recent USD1.1b mega rig order (5+5) placed by Transocean with Keppel; (3) record order intake for OSV newbuilds (since 2007) at Vard; and (4) the ambitious build-to-stock OSV newbuild program for 2014 at Nam Cheong.

Shipbuilding rebound may disappoint. The recent surge in shipbuilding orders (in Yangzijiang) has fueled hopes of a cyclical rebound in the shipbuilding market. However, we are doubtful about its sustainability given strong headwinds. To turn more positive, we need a sharp rebound in price. At this juncture, this scenario looks remote considering an oversupplied vessel market, excess yard capacity and intense competition amid uncertainty over a sustainable recovery in global trades. Furthermore, the five-year slump in the shipping industry has weakened the financial powers of many shippers, reducing their ability to place new orders.

Execution uncertainties priced in. In our view, execution risks  have been priced into SMM and Vard given their relative underperformance. At current levels, SMM is attractively priced at 12.5x FY14 EPS, which is below its historical average of 15.2x PER since 2005. We see SNM as a key beneficiary and pure play exposure to the upswing in rig building. Vard trades at a deeper discount of 6.4x FY14 EPS near to -1 SD of 5.2x. Resolution of cost overrun issues at Niteroi yard and strong OSV order intake would position Vard for a strong recovery in 2014.

Steady performers will grow stronger. We like Ezion's liftboat  business for its the strong recurring cashflow, which would bring about a 75% FY14 EPS growth. At 8.8x FY14 EPS, there is still attractive price upside for the stock. Nam Cheong has seen strong OSV vessel sales and following an ambitious 2014 newbuild program that is already 57% sold, we expect 2015 program to be higher. We like the stock for its exposure to a recovering OSV market and Petronas oil and gas capex. At 6.1x FY14 EPS, valuation looks attractive

Top Buys - SMM SP, EZI SP, NCL SP and VARD SP.

Top Sells - COS SP and YZJ SP.

Source: Maybank Kim Eng Research - 22 Nov 2013