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Sembcorp Marine (SMM SP) - UOB Kay Hian 2016-10-26: 3Q16 Core Business Profitable, Impacted By Associate Losses

Sembcorp Marine (SMM SP) - UOB Kay Hian 2016-10-26: 3Q16 Core Business Profitable, Impacted By Associate Losses SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - 3Q16 Core Business Profitable, Impacted By Associate Losses

  • Sembcorp Marine (SMM) reported a loss of S$22m for 3Q16, below expectations. The quarterly loss was largely due to associate Cosco Shipyard Group (CSG) and forex losses. Excluding these, SMM reported a profit from its core business, albeit lower by 50% yoy. 
  • As SMM continues to deliver on its projects, the inflow of cash should improve its balance sheet. Core earnings are bottoming out, though the lack of contract wins is a key risk. 
  • Slash 2016 earnings by 38% due to CSG, with 2017-2018 earnings largely unchanged. 
  • Maintain HOLD with a lower target price of S$1.23. Entry price: S$1.20.


RESULTS


3Q16 earnings miss expectations. 

  • Sembcorp Marine (SMM) reported headline 3Q16 net loss of S$21.8m, due to a S$27.7m loss from associate Cosco Shipyard Group (CSG)
  • Excluding losses from CSG, and one-off items including a S$18.9m forex loss and S$3.9m impairment of an available for sale financial asset, SMMโ€™s core business reported a net profit of S$27.3m (-50% yoy). 
  • Even after adjusting for these, earnings on a 9M16 basis was still a miss, coming in at 66% of our and consensus forecasts. The weaker core earnings was largely due to lower revenue (-21%), and higher interest expense (+86% yoy).

Repair revenue weakens by 20%. 

  • SMM repaired 121 vessels for 3Q16, on par with the 123 vessels repaired in 3Q15. 
  • Repair revenue per vessel was substantially weaker, at S$0.87m per vessel, an 18.8% yoy decline. Management remarked that this was due to clients โ€œconserving cashโ€.

Core EBIT margin higher at 5.7%. 

  • This was 0.8ppt higher than 3Q15, but represented a decline of over 1ppt from margins reported in 1Q16 (7.1%) and 2Q16 (9.5%). 
  • No special charges were made in 3Q16; recall that 3Q15โ€™s core EBIT margin was low due to profit reversal for five rigs.

Net debt down to 105%, from 120% previously in 2Q16. 

  • This was helped by an increase in cash balances, as deliveries on several projects led to operational cashflow reaching S$765.1m for the quarter. 
  • Net gearing is declining to levels of ~100%, within our expectations owing to cashflow received as it delivers on its projects.

No new contracts awarded for 3Q16. 

  • Ytd contract win stood at S$320m, unchanged from 1H16. 
  • Net orderbook excluding Sete Brasil orders stood at S$5.2b.


STOCK IMPACT


Excluding associates losses, SMMโ€™s core earnings are stabilising. 

  • Associate losses from CSG are expected to continue, and we foresee no turnaround for them. However, excluding its debilitating effects, SMMโ€™s earnings appear to be stabilising at an average of S$30m per quarter. This runs on the assumption that SMM is able to maintain a certain level of contract wins going forward. 
  • We ballpark that at least S$1b-2b of contract wins are required for SMM to maintain earnings at this level.

Majority of net orderbook on progressive payment terms. 

  • Of its S$8.4b orderbook (Sete Brasil included), less than 20% of them comprise drilling rigs with back-ended payment terms. Excluding the Sete Brasil and drilling rig orders, most, if not all of SMMโ€™s projects going forward are on progressive payment terms. As such, working capital requirements have likely peaked, and we envision steady cashflow going forward.

Balance sheet on the mend. 

  • Barring any unforeseen circumstances, SMMโ€™s balance sheet is on the mend. 
  • With capex tapering off in 2017, progressive payments on its existing orderbook and a highly cash generative repair business, SMM should turn cashflow neutral. 
  • We expect net gearing to decline to around ~90%. This is predicated that at least S$1+b in contract wins can be secured per year. 
  • Rising oil price going into 2017 favors the outlook that this can be achieved.


EARNINGS REVISION


Cut 2016 capex assumption to S$1b (previous: S$1.5b). 

  • With 2016 nearing an end, and only S$0.3b in contract wins to date, we reduce this to S$1b. We maintain our S$1.5b contract win assumption for 2017-18.

2016/2017 earnings slashed by 4-38%. 

  • Our earnings estimate for 2016 has been thrown off by the loss from associate CSG. We pencil in a S$52m loss for associate CSG, which implies two things: 
    1. SMM making a core earning of S$42m for 4Q16, offset by, 
    2. a further S$24m loss from associate CSG. 
  • Our estimates do not account for potential asset impairments, as we prefer to build it directly into our target price. 
  • Our earnings forecast for 2017 and 2018 are relatively unchanged at S$101m (-4%) and S$120m (0%) respectively. 


VALUATION/RECOMMENDATION


Maintain HOLD with a lower target price of S$1.23. 

  • With balance sheet on the mend, cash call risks are abating. Lacklustre future earnings and the risk of possible asset impairments remain. However, rising oil prices may see valuations re-rate upwards.
  • Maintain HOLD. 
  • Our P/B-based target price benchmark of 1.0x 2017F P/B remains unchanged, and represents a 24% discount to its historical trading multiple from 2000-03, prior to the rig construction boom. 
  • In the unlikely event that SMM impairs its rig orders, our target price falls to S$0.91. Entry price is S$1.20.


RISKS

  • Asset impairments. 
  • Difficulty securing new orders due to high gearing level.




Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-10-26
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 1.23 Down 1.270



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