Offshore & Marine / China Yards - 2017 Outlook ~ Consolidation wave
- Further consolidation is on the cards for regional shipyards.
- Facing structural downturn with new orders and margins normalising.
- Cost competitive industry leaders will emerge stronger.
- BUY diversified proxy Sembcorp Industries, and most cost efficient Chinese yard Yangzijiang.
- Oil price recovery lifts hope for rig deliveries; but newbuild orders unlikely to make a comeback any time soon.
- OPEC’s game-changing move to initiate production cuts at the end of Sept-2016 reinforces our view that oil prices will recover in 2017, alongside the expected oil rebalancing led by the lack of investments over the past 2- 3 years. Oil prices are expected to average US$50-55 per barrel next year, and above US$60 per barrel thereafter.
- We believe the improving oil market prospects may “motivate” rig owners to take delivery of existing orders, removing a key overhang on rigbuilders and freeing up their working capital. Nonetheless, it is unlikely to stimulate a big wave of newbuild orders as the oversupply of rigs could take a few years to clear.
- Singapore rigbuilders have seen the flow of new orders dwindling from the peak of over S$10bn per annum to less than S$1bn year-to-date, and are now reliant on orders for production related facilities, LNG solutions and specialised vessels. The speculation of a merger between Keppel O&M and Sembcorp Marine is again rife.
Shipbuilders in advance stages of consolidation.
- Ordering activities have slowed from the 2013 peak, down by over 20% y-o-y in 2015 and 60% y-o-y year-to-date. Newbuild prices have also softened by c.5% per annum over the past two years amid a depressing shipping market.
- Looking into 2017, outlook for newbuild orders remains lacklustre, though newbuild prices should stabilise at current low levels. The saving grace is that orderbook-tofleet ratio has moderated to a reasonable 15% and yard overcapacity has shrunk with massive yard closures and consolidation.
- The Chinese shipbuilding industry shrunk from over 3,000 yards in early 2012 to 1,600 as of end-2014 and is less than 100 currently. Further consolidation is underway, 20-30 survivors eventually. There has been market talk that the merger between two largest Chinese shipbuilding state-owned enterprises (SOEs) – China Shipbuilding Industry Corporation (CSIC) and China State Shipbuilding Corporation (CSSC) could take place in the light of this protracted industry downturn.
Prolonged dip in oil prices.
- Further capex cuts can be expected in the event oil prices are sustained below US$50 per barrel, and if the global economy dives into an unexpected recession. US’s energy policy is another key development to watch in 2017.
- Nevertheless, the longer that oil prices remain low and O&G investments are postponed, could eventually lead to a steeper spike in oil prices.
Heightened risks of cancellations.
- Following massive deferments over the past two years, rigbuilders face heightened default / cancellation risks in the event of an unexpected fall in oil prices.
- For shipbuilders, recovery can be bumpy as freight rates are volatile and risks of bankruptcies in shipping companies remain.
Financing constraints could affect order momentum.
- Financing institutions might be more prudent with their lending to O&G companies following this oil crisis.
- Potential funding constraints faced by customers as a result of lack of financing options and/or higher funding costs, could impact order momentum.
Asset deflation and margin contraction.
- Newbuild prices are set to fall given the drop in material costs, and potentially low-balled pricing with the dearth of new orders in an attempt to keep yards busy. This might also be exacerbated by fire sales triggered by desperate owners/shipyards on the verge of bankruptcies. As a result, margins could drop further.
Valuation & Stock Picks
Rigbuilders to lag oil recovery.
- While valuations of Singapore rigbuilders are not demanding, we believe the stock performance will lag oil price recovery as we do not expect newbuild order flow to be strong. We believe pure E&P players and the service providers are better proxies to O&G sector.
- We prefer more diversified Sembcorp Industries (SCI; TP S$2.90), where earnings are relatively more stable as c.70% of its profits are from Utilities (remaining 30% Marine through 61%-owned Sembcorp Marine) and is not affected by changes in oil prices. We believe the utilities business is undervalued at 0.6-0.7x, dragged by a bleak marine outlook. This is unwarranted as SCI offers 6% ROE and 3% yield.
- We continue to like Yangzijiang (TP S$0.95), one of the most well-run and profitable Chinese yards and a beneficiary of sector consolidation. Its valuation is undemanding at 0.6x P/BV and 8-9x PE despite offering 4- 5% dividend yield and 8% ROE.
- We have HOLD ratings on Cosco (TP S$0.27); FULLY VALUED call on Sembcorp Marine (TP S$1.15).