Can SembCorp catch up to Keppel?

Weakening sentiments
Amid deteriorating macroeconomic conditions, softer oil prices, and potential glut in rigs entering the market in 2013/2014 we observed that rig buyers have turned more cautious in ordering new rigs in recent months. The slowdown in jackup rig orders experienced by Singaporean yards in 3Q11 is evidence that sentiments have indeed turned cautious.

Still trailing behind Keppel
We note that SembCorp Marine has continued to trail behind Keppel Corp in terms of jackup order wins. Keppel’s flagship rig, the B class rig, has been immensely popular with a whopping 20 units of B class (including variations) rigs secured since November 2010.This has resulted in a swelling of Keppel’s orderbook and its orderbook to revenue ratio now surpasses that of SembCorp marine. While we acknowledge that SembCorp marine has smaller yard operations compared to Keppel Corp, we note that such a lead has been rather unprecedented.

Future price catalysts still exists
Despite it trailing in jackup order wins to its main competitor, we believe potential price catalysts still exist for SembCorp Marine. SembCorp Marine is in the race for Petrobras ‘s 21- rig tender and an award will be a boost to its share price. It is understood that SembCorp Marine has put through a drillship design and the rigs will be built at Jurong Shipyard’s new Espirito Santo yard.

While we expect margins from this win to be relatively lower than on current contracts due to learning curve, it shall allow SembCorp Marine to break into the drill ship segment. In addition, a Petrobras win will provide its new Espirito Santos yard with the necessary baseload to justify its construction.

In the long run, we also expect SembCorp Marine to catch up on order wins as Keppel and Korean yards become increasingly filled. We think that the scenario will be a repeat of the last rig building cycle (2004-2008) when SembCorp Marine’s orders lagged Keppel Corp at the start of the cycle (2004-2007) but caught up subsequently in 2008.

This time though, it might take longer for Keppel Corp’s growth in backlog to render it uncompetitive due to a lack of semi-submersible orders in the industry, but this may change with awards from Petrobras. Finally, we believe the partial completion of SembCorp Marine’s new yard facility in 2H2012 will be an added boost to the company. The new yard is expected to reduce operating costs, improve construction time and allow SembCorp Marine to handle more repair jobs.

Valuation
We value SembCorp Marine based on our SOTP methodology to arrive at our target price of $4.31. We lower the value of SembCorp Marine’s core business to reflect a weaker competitive position vis-à-vis Keppel Corp and an uncertain macroeconomic environment, which may result in a slowdown in future rig orders.

We also lower its share of investment in Cosco Corp and Cosco shipyard group. Our target price of $4.31 implies a valuation of 15x average of FY12E earnings, in line with its historical average valuations. With an upside potential of 16% from its previous closing price, we maintain our BUY recommendation on SembCorp Marine.