Sembcorp Marine margins impressive but sustainability in question

Upcoming projects key to maintaining margins.

According to Barclays Research, Sembcorp Marine has been beating expectations in operating margins for the past two quarters, suggesting strong operational peformance. But it echoed concerns on sustainability, which investors should eye keenly over the next few quarters, especially in the face of tighter competition from Chinese yards.

Here's more from Barclays Research:

Sembcorp Marine's 1Q13 operating profit margin of 13.7% was significantly higher than our expectations and the previous quarter's 10.8%. We believe that investors should reward the company for this strong operational performance, but concerns will still remain on the sustainability of this margin improvement. A sustained improvement over the next few quarters should go a long way in allaying these concerns, although we expect further headwinds to limit margin upside. We remain Equal Weight and prefer Keppel Corp (OW; PT: S$13.80).

Stronger-than-expect operating margins… The company attributed this to the higher percentage of repair and conversion projects (43% vs. 36% of revenues in 4Q12), as well as the effects of lower general & administrative expenses (down 20% y/y). The delivery of three jackups in the quarter was also a likely reason for the better margin.

…sustainability of current levels in question: We believe there could be scope for the company to sustain this level of margins (13-14%), with repeat designs of Noble Corp's (OW/Pos) JU3000N likely to see an improvement in margins. Also, the eventual recognition of the five Pacific Class 400 rigs could provide some upside support to margins. However, there could still be margin pressure from the resumption of recognition of revenues from the deepwater units and eventual recognition of the 2nd Sete Brasil drillship, in our view.

Long-term guidance reiterated, enquiries remain healthy: Sembcorp Marine's management reiterated their long-term margin guidance of 10-13% and stressed the likely volatility in margins quarter-on-quarter, which were highly dependent on the projects being recognized in the quarter. The company remained positive on the outlook for new orders and expects to grow its current net order book of S$13.6bn.

Improved operational performance a key upside risk: We believe the ability of the company to maintain margins at current levels or large new orders would be upside risks to our estimates and valuation. The continued threat from Chinese yards, which continue to offer aggressive financing terms, remains a key risk to the downside.