• SMM's 3Q18 remains in the red due to low revenue.
• Cut earnings forecast after lowering contract wins and margins.
• Look forward to stronger order wins next year.
• Recent weakness is a good entry point; reiterate BUY; Target Price $2.40.

Maintain BUY; Target Price adjusted slightly to S$2.40.

• Maintain BUY; Target Price adjusted slightly to S$2.40, after earnings revisions, still based on 2.1x FY18 P/BV (0.75SD below mean).
• Sembcorp Marine (SMM) continued its loss-making trend in 3Q18. We have trimmed our net profit forecast for FY18-19 lowering contract wins and margins. We still like SMM as the pure proxy to the recovery in the oil & gas (O&G) and offshore & marine (O&M) sectors, with order wins and earnings recovery as catalysts. These should lift SMM’s share price closer to our current Target Price.

Where We Differ contract wins.

• While order wins, a critical leading indicator for earnings lagging behind 2018 partly due to the final FIDs, we remain on offshore capital ahead.
• We believe SMM’s strong would translate into S$3 in 2019, which may potentially include,
  1. a Gravifloat gas (LNG) Poly-GCL at S$1bn;
  2. two large Compressed Caribbean valued at S$800m in total,
  3. Rosebank’s storage and US$2bn.
• YTD, SMM has clinched ~S$1bn.

Reactivation of Sete Brasil rig orders.

• The disposal of all non- Sete Brasil rig inventory through the landmark deal of selling nine jackup rigs to Borr Drilling, and a harsh environment semisubmersible rig West Rigel to Transocean in end-2017, eliminated a key overhang on SMM. The restructuring of customer Sete Brasil is also seemingly closer to a resolution, as Petrobras and Sete are reported to have struck a rig deal.
• Singapore’s rig builders are well-positioned to deliver two rigs each (which are in the advanced stages of construction) out of Sete Brasil’s existing 13 orders (c.S$1bn each).

Valuation

• Our target price of S$2.40 is based on 2.1x FY18 P/BV, pegged to 0.75SD below its mean valuation since 2004. SMM’s book value has already been written down after the massive S$609m provisions taken in FY15.

Key Risk To Our View

• Key downside risks are sustained low oil prices which would affect rig count and new building activities, execution risks in new product types, and corruption allegations in Brazil that, if the company is found guilty, could lead to financial and reputational loss.
• Upside risk could come from privatisation or merger & acquisition (M&A) activities, as well as the write-back of provisions from successful deliveries or vessel sales.

3Q18 core losses similar to 2Q.

• SMM reported a net loss of revenue from S$572m to S$773m (excluding the Borr Drilling revenue).
• Core net margin improved -5% in 2Q in 3Q. We reckon the margin recognition for floating in early 2018 are low.
• Headline revenue of S$1.3Q was boosted by delivery of two Borr. Excluding these, revenue would have been S$775 q-o-q.

Offshore outlook improving, though competition remains intense.

• In its outlook statement, management guided that offshore and marine sector continues to improve with more offshore production projects reaching their FID stage and this trend is expected to continue. However, overall improvement and offshore capex will take time to translate to new orders. In the meantime, SMM may continue to record operating losses based on the current low activity level.
• Order book declined to S$6.39bn as at end Sept, from S$7.27bn a quarter ago, of which 49% or S$3.1bn is from drillship projects with Sete Brasil. The order book should largely be recognised in the next two years.
• SMM secured S$1bn new orders YTD, including recent announced Teekay FPSO jobs. Key contracts secured in 2018 include:
  1. SMM’s second newbuild FPSO (ull and living quarter and topside modules; ~S$480m) for Energean’s Karish and Tanin deepwater field;
  2. semi-submersible production unit (~S$250m) for Shell’s Vito field;
  3. FPSO modification works (~S$230m) for Teekay (announced in Oct- 2018; subject to fulfilment of conditions)

Potential new contracts in the pipeline.

• YTD wins only accounted for ~33% of our full year expectation of S$3bn. The major contracts in the pipeline we are expecting that seem to be slipping into 2019 including:
  1. Potential first customer for SMM’s Gravifloat LNG exporting terminal - Poly-GCL has reached an agreement with Djibouti on plans for a cross-country pipeline in May-2018. This indicates positive progress of the gas development project and a step closer to the finalisation of the Gravifloat contract that is expected to be worth S$1bn;
  2. Seaone’s preliminary study for compressed gas liquid (CGL) carrier has been completed. According to an Upstream article on 18-Oct, Seaone has introduced to market its CGL technology as a cost-efficient solution to mainstream LNG refrigeration. Once Seaone decides to proceed with FID, SMM could secure contract for two such carriers worth a total of S$800m;
  3. Chevron’s divestment of its stake in the Rosebank project off the UK to Equinor has delayed the award of a newbuild FPSO contract that was supposed to be announced in end 3Q, to early 2019. The project could be worth up to US$2bn. SMM and Daewoo Shipbuilding and Marine Engineering (DSME) were the two finalists for the job prior to Chevron’s divestment.

Net gearing inched up slightly to 1.37x, from 1.26x a quarter ago.

• Including the last rig delivery by 1Q19, SMM would have outstanding receivables totalling ~S$1.1bn from Borr Drilling, which will likely to be collected within 3-years (when interest rate step- kicks in) once rig charters are secured, allowing Borr to refinance the rig cost at lower rates.
• Collection from Borr will lower current net debt of S$3bn by 33% to S$2bn, bringing net gearing down to ~0.9x.

Earnings Revisions

• Headline losses amounted to S$80m in 9M18. We had expected some write-back of cost overruns for disputed variation orders in 2017 (which we estimated to be around S$100m) which has little visibility at this point.
• In addition, we are also halving our contract wins assumptions from S$3bn to S$1.5bn for 2018 given the slower than expected project FIDs. We now expect SMM to register a ~S$101m loss for 2018 (vs +S$15m previously) and S$49m profit in 2019 (-27% from previous forecast).