Earnings surprise?

The  recent  quarterly  result  season  ended  with  more positives than negatives. Keppel Corp reported solid results; despite  lower  revenue,  earnings  were  up  YoY  mainly  on positive  O&M  margin  surprise,  improvement  in  China property sales and higher profit of power and gas business. Sembcorp Marine delivered weak results due to lower-thanexpected  margins,  which  was  partially  offset  by  higher revenue. Ezion  announced  steady  earnings  driven by more SEUs deployment and higher offshore logistics contribution from  Australia’s  LNG  projects.  Ezra’s  core  earnings  swing back  into  the  black  as  Subsea  margins  recovered  from  its decision to ‘kitchen-sink’ earnings in the previous quarter.

Top pick: Keppel Corp

Management from both Keppel Corp and Sembcorp  Marine reiterate  the  O&M  sector  prospects  remain  robust underpinned  by  exploration  activities  with  increasing interests  in  harsh  environment  and  field  development programs. Keppel Corp remains our top pick within the O&M sector,  for  its  (1)  resilient  operating  performance,  (2) stronger  execution  for  its  Brazilian  projects,  and  (3) attractive dividend yield of > 4%. We also like Ezion for its (1) good business model, (2) high earnings growth visibility, and (3) undemanding valuation of < 10.0x FY14E P/E.

Rig-builders

It has been a robust 9M13 in terms of order wins for Keppel Corp,  as  it  bagged  S$5.3bn  worth  of  contracts  which included  13  jack-up  rig  orders,  which  are  all  based  on  its proprietary KFELS B Class series design. Note that we have not  taken  account  of  the  5  KFELS  Super  B  Class  jack-up rigs  order  win  of  US$1.1bn  from  Transocean,  which  was recently  secured  in  November.  Sembcorp  Marine  also  did fairly  well, securing new order wins worth S$3.9bn, inclusive of 7 jack-up rig orders. Keppel’s S$13.5bn robust order book and Sembcorp Marine’s S$13.6bn order backlog will provide long-term earnings visibility for both companies.

In  terms  of  operational  performance,  we  see  positive surprise on Keppel Corp’s O&M margin, rising from 14.2% in 2Q13 to 16.5% in 3Q13, beating our expectation of ~14-15%. Management  highlighted  that  this  is  mainly  attributed  from the delivery of 5 KFELS B Class jack-up rigs (which resulted in higher  productivity and  efficiency), as well as repair jobs (which typically yield higher margins). We continue to expect resilient  O&M margins at 14-15% for 4Q13,  as there will be another 4 jack-up rigs slated to be delivered by end of 2013.

Sembcorp  Marine’s  margin,  on  the  other  hand,  was disappointing;  declining  from  13.0%  in  2Q13  to  10.1%  in 3Q13 on conservative recognition of new design rigs  (which includes harsh environment and well intervention semi-subs). We  believe  margins  will  remain  under  downward  pressure for  the  next  2  quarters,  as  its  2 nd Brazilian  drillship  is expected to attain revenue recognition in 4Q13/1Q14.

Small/Mid Caps

Over  at  the  O&M  small/mid  cap  space,  Ezion  delivered steady results driven by  more SEUs deployment and higher offshore logistics contribution from Australia’s LNG projects. We  expect  earnings  momentum  to  continue  into  FY14E, given that 14 out of 29 SEU contracts have yet to contribute; these 14 SEUs will gradually kick in from 4Q13 (3 in 4Q13, 4 in 1H14, 3 in 2H14, and 4 in FY15).

Ezra’s core earnings swing back into the black,  as Subsea margins  recovered  from  its  decision  to  ‘kitchen-sink’ earnings in the previous quarter.  This results in 4Q13 gross margin to improve significantly to 17.9%, from 1.1% in 3Q13. That said, we remain cautious as we believe Ezra will need to show a  series of good results to kick start a sustainable upward rerating of the stock.

Top pick: Keppel Corp

Management from both Keppel Corp and Sembcorp Marine reiterate  the  O&M  sector  prospects  remain  robust underpinned  by  exploration  activities  with  increasing interests  in  harsh  environment  and  field  development programs.  Despite  fierce  competition  coming  from  the Chinese yards, we believe established drillers/operators still prefer  established  yards  (like  KEP  and  SMM)  for  their established  rig  designs,  strong  track  record,  and  ability  to deliver  on-time.  This  can  be  seen  in  Keppel  Corp’s  recent US$1.1bn contract win from Transocean for the construction of 5 KFELS Super B Class jack-up rigs, with options for an additional 5 similar rigs.

Keppel  Corp  (Accumulate,  TP:  S$12.07)  remains  our  top pick  within  the  O&M  sector,  for  its  (1)  resilient  operating performance, (2) stronger execution for its Brazilian projects, and (3) attractive dividend yield of > 4%. We also like  Ezion (Accumulate,  TP:  S$2.53)  for  its  (1)  good  business  model (ROE > 30%), (2) high earnings growth visibility  (via its SEU fleet  expansion  with  secured  contracts),  and  (3) undemanding valuation of < 10.0x FY14E P/E.

We  remain  cautious  with  Sembcorp  Marine’s  (Neutral,  TP: S$4.33)  operating  margins,  as  we  believe  its  execution  of new  design  rigs  (such  as  drillship,  well  intervention  semisubs)  would  continue  to  exert  downward  pressure  on  its margins in the near-term. Albeit Ezra’s (Neutral, TP: S$1.18) Subsea  division  turns  around  from  losses  in  the  previous quarter,  we believe Ezra will need to show a series of good results in  order to kick start a sustainable upward rerating of the stock.

Source: PhillipCapital Research - 2 Dec 2013