Singapore Shipyard - Ride The Waves of “Recovery” For Now As Land Remains Out Of Sight
- OPEC’s latest deal raises oil prices and lifts hope of a rebound in 2017. However, oil companies are likely to raise capex in 2018 at the earliest. Production orders take centre stage but these orders were roughly a quarter of the total orders Singapore shipyards had secured in the last cycle.
- We revisit our valuations, and have pegged our P/B valuations to the yards’ ROE. Updating our valuations, we find that Sembcorp Industries (SCI) remains the safest proxy to the protracted sector recovery.
- Upgrade to MARKET WEIGHT.
OPEC cuts a deal, but sector remains a trading play at best.
- On 30 Nov 16, OPEC struck a historic deal that reduced OPEC production by 1.2mbpd, bringing forward oil market balance into early-17.
- While oil and gas (O&G) share prices have reacted positively to the news, we foresee risks to the price floor created by OPEC, and caps to the upside due to US shale players.
- We expect O&G shares to trade with sentiment, though we fundamentally see no immediate earnings benefit for Singapore shipyards.
Tactical trading opportunities in volatility.
- With continued oil price volatility as market moves towards balance in 2017, we see tactical trading opportunities for stocks with high correlation to oil.
- For Singapore shipyards, SMM has the highest correlation at 31%, followed by Keppel and SCI. Based on historical trading data, we have derived target prices based on various Brent crude price levels.
Shipyards to decline to a lower normal of lower contracts.
- The previous cycle saw Singapore yards secure over US$44b in contract orders, of which only 28% were for nonrig orders only. With the rig fleet oversupplied, especially in the jackup rig segment, we expect a dearth of rig orders for an extended period.
- Production orders will take centre stage, necessitating the decline into a prolonged period of lower orders.
A long drought for yards. Prefer SCI to ride the oil recovery.
- Sembcorp Industries (SCI) remains our preferred pick to play the recovery in oil prices, through its 61%-owned subsidiary Sembcorp Marine (SMM).
- Upside will also arise from its India utilities operations, which sees India fully contributing by 2018.
- Near-term utilities earnings from India are also set to grow given a 20% rise in electricity spot price.
- Post our revaluation of SMM, we raise our target price for SCI from S$3.05 to S$3.20. Maintain BUY.
Revising target prices for Keppel and SMM.
- We have pegged the P/B valuation for Keppel’s O&M unit and SMM to 1.2x and 1.1x 2017F respectively. This gives us a target price of S$6.25 for Keppel and S$1.40 for SMM.
- Maintain HOLD on both stocks.
Pegging P/B valuations to ROE.
- With little to no historical data to refer to, we have pegged our P/B valuation to ROE.
- The Japanese shipyards, who were rig builders in the previous cycle, have showed that P/B valuations decline in tandem with lower return on equity (ROE).
- We have derived a regression based model, and peg our P/B valuation to Keppel and SMM’s 2017F ROE. Our derived values are 1.2x 2017F P/B for Keppel, and 1.1x 2017F P/B for SMM. These values are surprisingly close to the stocks’ -1SD level of their long-term P/B from 1990-2016.
Increase 2017-18 earnings for Keppel by 6-7%.
- We have adjusted our 2017-18 earnings forecasts to S$812m (+5.7%) and S$758m (+6.8%) respectively on two factors:
- timing changes in contract win assumptions (earnings impact: +2-3%), and
- reinstatement of the Gandria order, which is likely to see final investment decision (FID) by end-16 (earnings impact: +4%).
- No change to earnings assumptions for SCI and SMM.
A capex recovery in 2018 at earliest.
- While forecasts point to a higher oil price outlook of US$56/bbl in 2017, we expect capex to remain flat in 2017.
- International oil companies' (IOC) and national oil companies' (NOC) operational cashflows have yet to meet capital expenditures and shareholder payouts, mandating conservation of cash. Coupled with plans requiring at least a year of price stability and balance sheet repair before committing to higher capex, a recovery in oil price is most likely only in 2018.
Consensus forecast points to oil prices averaging US$56/bbl in 2017.
- Our tracking list of 29 banks and 1 agency shows an average Brent crude price estimate of US$56.20/bbl in 2017 and US$65.54/bbl in 2018.
- We are updating our Brent crude assumption of US$54/bbl for 2017 accordingly to US$56/bbl, and introduce our 2018 Brent crude price assumption of US$65/bbl.
OpCF/Capex ratio rose above 1.0x in 3Q16...
- On a blended basis, IOCs and NOCs show that OpCF/Capex ratio has risen above 1.0x, implying operating cash flows are starting to meet capex on the back of higher oil prices and cost reductions.
- At the respective company level, the positive development is more reflective of IOCs, with Shell, ExxonMobil, Chevron and ConocoPhillips reporting a ratio above 1.0x. The situation is less encouraging for NOCs, which have their blended numbers heavily skewed by Petrobras. PEMEX for example, reported negative operating cash flow, while Petronas’ ratio swings above and below 1.0x from quarter to quarter as a result of lumpy capital spending.
...but IOCs/NOCs still unable to meet dividend payouts.
- The situation becomes less rosy once dividends are taken into account. Neither IOCs nor NOCs alike are able to meet shareholders’ distribution with residual cash flow after capital spending.
- IOCs, in particular, are deeply hesitant to cut dividend payouts and rely on debt financing to meet the cash shortfall. Only a handful of IOCs have reached a ratio above 1.0x (Shell, ConocoPhillips), as is the case with NOCs (Petrobras, Statoil).
Oversupplied rig fleet presents poor prospects of future contracts.
- The global rig fleet remains oversupplied. Excluding Iran’s order for five jackup rates, almost no orders were placed in 2016. Low contract wins should persist for years.
- The previous cycle saw a dearth of rig orders for close to a decade.
Production orders not likely to make up for drop in rig orders.
- Our analysis of floating production contracts for award over 2017-19 points to only US$4.3b p.a. in orders available for award globally. These make up a fraction of the rig orders that Keppel and SMM historically secured p.a. over 2011-14.
- While production orders will help replenish the shipyards’ diminishing orderbook, it will not make up for the drop in rig orders.
- High earnings of the previous cycle will be a thing of the past for a protracted period.