Downgrade to Neutral. 3Q12 net profit of S$116m (-19% QoQ, -48% YoY) lifted 9M12 net profit to S$371m (-29%), accounting for 60-62% of ours and consensus estimates. Revenue was lower than expected while operating margin was in-line. The key takeaway was the operating margin guidance of 10-12% in FY13 due to conservative margin recognition for the drillship project at the initial stage and recognition of non-repeat semisubs. Sector outlook is still strong but competition is rising as traditional shipbuilders are also eyeing offshore jobs. We cut FY12-14F net profit estimates by 12%/15%/22% respectively. Downgrade the stock to Neutral with a TP of S$4.61, implying 17.3x FY13F P/E.

Margins in-line; bottomline miss on lower revenue. 3Q12 revenue of S$892m was sharply lower (-27% QoQ, -31% YoY) as 3Q11 included lumpy recognition from Songa Eclipse project. Revenue recognition can be lumpy depending on the initial recognition of major projects. Only one Noble jackup rig achieve initial recognition in 3Q12. 3Q12 operating margin came in at 14.1% (9M12: 13.3%), in-line with our estimates, and would have been higher at 15.4% (9M12: 14.3%) if not for S$11.8m losses from forex and hedges (9M12: -S$30m).

Competition could cap ASP hike; margins expansion limited. SMM is seeing strong market fundamentals and is hoping to add more work to its existing order book by end of the year. However, intense competition from shipyard with excess capacity in Korea and China are putting pressure on margins.

Valuation: We cut our TP by 19% from S$5.70 to S$4.61 primarily due to lower earnings and lower target P/E of 16x on shipyard operations (old: 18x) to reflect rising competition. In the previous boom, O&M stocks could trade >20x P/E as the rig upcycle was running in tandem with the boom for commercial shipbuilding, leading to strong pricing power for shipyards. We think the market dynamics are slightly different now as commercial shipyards in China are struggling and Korean yards are also competing in the semisub market.

We cut our TP by 19% from S$5.70 to S$4.61 primarily due to lower earnings and lower target P/E of 16x (previously 18x) to reflect rising competition. In the previous boom, O&M stocks could trade above 20x P/E as the offshore upcycle was running in tandem with the boom for commercial shipbuilding for the Korean and Chinese shipyards, which lead to very strong pricing power for shipyards.

Following our earnings revisions, the stock now trades at 17.6x FY13F P/E. In our view, P/E valuation expansion may be challenging given intense competition and pressure on rig ASP.

Source: OSK