Ezion Holdings: Positive development for Gorgon

Gorgon clears state government regulatory hurdle. It was reported this week that the Western Australian government has granted final state government's environmental approval for the Gorgon project, with the Australian Federal government's approval as the final regulatory hurdle remaining. This is a positive development, as the Gorgon project has been delayed several times in the past years. We believe that the Federal government's approval is a formality, and the market's anticipation of this news could be a near term price catalyst.

Earnings risks still exist, albeit reduced. While this Gorgon project development has reduced a major earnings risk to Ezion, we note that two of the group's four liftboats are still under MOUs. While Ezion has a firm bareboat charter contract with Ezra Holdings for the other two liftboats, the latter has yet to announce firm time charter contracts for these vessels and may still request for vessel delivery delays.

Better-than-expected 2Q09 results. Ezion's recurring net profit came in at S$4.5m (+103% y-o-y) in 2Q09, on revenues of S$21.1m (+195% y-o-y), mainly due to an expanded vessel fleet. The outperformance vs. our estimate of S$3.5m is attributable to greater contributions from the Marine Services division and lower than expected start up costs for the Gorgon project. We have hence raised our FY09 recurring net profit forecast by 18% to S$15.0m to factor in these deviations.

Raising fair value to S$0.94; maintain BUY. On the back of lowered earnings risk from the recent positive newsflow on the Gorgon project, we have pegged Ezion＊s TP to a higher 12x recurring FY10 PE (prev 10x), raising it to S$0.94. Maintain BUY.

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Ezra Holdings Ltd: Promising Subsea business; maintain BUY

Fresh segment, new opportunities. With upbeat expectations of the new Subsea business division for Ezra Holdings (Ezra), we sought to better understand its potential impact by looking through the lenses of its peers like Acergy [Not Rated] and Subsea 7 [Not Rated]. Current indications point to similar industry-wide difficulties of capex being put off in the short term but these companies have guided for better mid- to longer-term prospects as National Oil Companies and Oil Majors remain concerned on declining supplies. Order books for these companies remain in the billion dollar region although a significant amount would be recognised through 2010. 2009 was largely devoid of contracts but started to trickle back around midyear. Emerging trends of a larger proportion of charter contracts vs. lump sum contracts were also spotted.

Margin expansion for Energy division. We felt that the key message of gradual margin expansion of the Energy Division (currently 13%) to levels closer to its Offshore Division (high thirties) have not been picked up by the investing community. With higher spec-ed assets, we believe Ezra will be able to accord higher valued services, leading to better financial returns. However, we have taken the conservative option of an unhurried gross margin increment for the Energy division to cater for execution risks.

Changes to revenue contributions. We have swapped the MFSVs, liftboats and the Well Intervention vessel into the Energy Division and revisited at our charter rate assumptions. Ezra's new fleet management program for four smallish AHTS vessels will give them additional revenue with no capex costs. These vessels can also be used internally by Ezra (at cost) to make up for any temporary asset scheduling gaps instead of taking on more expensive spot charter vessels. Moreover, its recent equity placement proceeds of ~S$90m will allow it to grow organically or be used to participate in future bond/equity raising exercises by other companies that are unable to pay/refinance its debt.

Maintain BUY. Ezra remains one of our favourites for the sector with its relatively defensive earnings. Coupled with the low base earnings accretion effect from its fledgling Subsea business, valuations will inevitably be driven upwards if executed well. We have tweaked our SOTP to S$1.75 (previous: S$1.46) based on a reasonable 10x FY10F PER (prev: 8x) for its core business and stronger market value of Ezion. Stronger than expected margin expansion and keen execution will give us a reason to re-look estimates and valuation pegs.

Rickmers Maritime: DPU slashed; LTV waiver negotiations continue.

Auditor adds emphasis of matter. Rickmers Maritime (RMT)'s 2Q09 results were in line with expectations, barring a US$7.5m provision (on top of a US$3.5m provision in 4Q08) for impairment on vessel Maersk Djibouti, at risk for redelivery in February 2010. RMT has repaid a total of US$4.2m of loans in 1H09. The auditor issued an emphasis of matter, citing material uncertainty that "may cast doubt on the [trust's] ability to continue as a going concern".

DPU down 72% QoQ. The Board has declared a distribution of 0.6 US cents per unit for the quarter, down 73% YoY and 72% QoQ. This is equivalent to an annualized yield of roughly 6%. The sponsor will defer (but not waive) its right to its share of the distribution of over US$841,374. Including the sponsor's deferral, RMT saves nearly US$7.4m compared to 1Q09 within the trust. This is relatively small, in our opinion, but nonetheless significant: 1) it is highly unproductive to pay out much-needed cash in the face of financial covenant concerns and a large funding gap; 2) more importantly, it serves as an important good-faith gesture to RMT's lenders.

LTV issue unresolved, deposit payment delayed. RMT's attempts to obtain loan-to-value covenant waivers from its lenders, which began in 1Q09, are still ongoing - to our disappointment. The manager could not provide an approximate timeline for the negotiations. LTV covenants affect both existing loans and RMT's ability to drawdown on committed facilities for the three outstanding Hanjin vessels. RMT has started negotiations with banks to refinance a US$130m top-up facility maturing in April 2010. The manager said it is also in negotiations with all stakeholders (including the shipyard; the charterer; and lenders) on the unfunded US$711.6m Maersk vessels due in 2010. Payment of a US$20m deposit on two of the Maersk vessels has been delayed while discussions are ongoing. RMT has also appointed an independent financial advisor and investment bankers.

Price inadequate reflection of risk. No DPU guidance has been given. RMT's lenders may demand loan amortization in exchange for LTV waivers, which would cut into cash available for distribution. An equity issue may also be needed in the next 12 months to part-finance the Maersk vessels. We do not expect a big upward revision in DPU until at least some of these issues are resolved. In our opinion, the current unit price does not adequately reflect the risks associated with investing in RMT. Maintain SELL with S$0.39 fair value.

KS Energy: Drilling and capital equipment business provide support

Results in line with expectations, except distribution business. KS Energy Services Ltd (KS Energy) reported a 35.9% YoY fall in revenue to S$128m and a 39.5% drop in net profit to S$13.7m in 2Q09. Revenue from the drilling services and other business rose 30.6% QoQ partly because two land rigs (Discoverer 2 and 4) commenced operations and the KS Titan-2 delivered its maiden revenue. This accounted for 50% of our fullyear estimate but contributions from the distribution business accounted only about 45% of our estimates with slower demand in the oil and gas industry. Lower steel prices also affected selling prices. The group also reported an additional S$4m insurance claim for KS Titan-1's loss after proceeds of S$9m in 1Q09. 1H09 net profit accounted for 50% of our fullyear estimate.

Warrants issue oversubscribed. The group announced a 1 for 4 warrants issue in June this year which generated S$16.8m cash to increase financial flexibility and support working capital needs. It was 124.36% subscribed, and management is encouraged by the results of the issue. Though the warrants are currently out-of-the-money, they may be exercised six months after issuance, and have one and a half year's expiry.

Updates on KS Endeavour. KS Endeavour, a Super M2 design offshore rig, will be delivered in end 09. This is the only asset on KS Energy's fleet that is not contracted out yet. Charter rates have definitely fallen with the dramatic fall in oil prices, but have stabilized in recent months with oil prices trending up from its low of about US$30 to about US$69 now. When asked about prevailing rates in the market, management gave a range of about US$110,000-US$120,000/day.

Maintain HOLD. As mentioned in our earlier report, KS Energy's fixed charter rates and existing contracts will serve it well during this downturn, but its distribution business may continue to feel the impact of reduced capital expenditure by oil companies. We have revised our revenue assumptions for the distribution business, which is now about 17% lower. We are encouraged to see that recurring profit can be provided by the drilling and capital equipment business but till we see a recovery in the demand of the group's products in the distribution business or the emergence of additional growth drivers, we maintain our HOLD rating and S$1.36 fair value estimate on the stock.

Swiber - Exceeded expectations, but can it be sustained?

2Q09 results ahead of estimates. Adjusting for one-off gain of US$4.5m, Swiber turned in better-than-expected operating profit of US$18m on the back of revenue of US$111m and profit margin of 16%. Another positive was Swiber’s net gearing of 0.75x following the equity fund raising in Jun 09. However, we caution investors on Swiber’s negative FCF and its declining orderbook. We raise our FY09/10 net profit estimates by 37%/32% after adjusting up the net profit margins by 2.9ppt/2.3ppt respectively. Keeping our valuation parameter at 9x on FY10 core EPS, our target price is revised up to S$1.09 (from S$0.85 previously) accordingly. A rerating without sustained order momentum and proven execution track record is difficult. Maintain NEUTRAL.

We are encouraged by operating margin… The 11% YoY decline in 2Q09 revenue to US$110.8m was mainly due to the completion of the projects in Malaysia and execution of fewer projects (4 vs. 6 in 2Q08). Stripping away the non- recurring gain on disposal of assets of US$4.5m, core operating profit of US$17.5m was down 34% QoQ but ahead of our expectations of US$14.0m. After several disappointing quarters, an increase in operating profit margin to 15.8% in 2Q09 is encouraging, though this is some way off pre-credit crisis’ margins of 20%.

.. and enhanced cash position. In Jun 09, Swiber successfully raised net proceeds of US$49.8m which improved net debt to 0.75x as at 30 Jun 09. But investors should take note of the negative free cashflow, Working capital was negative as advanced receivables were worked down while payments were due. As such, Swiber recorded negative FCF for the quarter.

..new order replacement rate is slower than orderbook depletion. While Swiber secured US$93m in 2Q09, its orderbook showed a declining trend, from US$515m in 1Q09 to US$509m in 2Q09. Without a reversal in the shrinking orderbook, revenue growth momentum is unlikely to sustain. Our earnings model shows that FY11 revenue would fall drastically.

..and little is known publicly on the working status of Swiber’s pipelay vessels. Through our discussions with the industry players, we learn that Swiber’s vessels appear to be facing several execution difficulties. We are unable to verify them, as there is limited public information to track the working status of offshore vessels. We hope to seek greater clarity from the management.

Swissco’s 2Q09 recurring net profit in line with expectations

Swissco’s 2Q09 revenue surged 68% y-o-y to S$19.9m, beating our forecast of S$16.4m, due to earlier than expected vessel deliveries. Headline net profit of S$9.4m (+64% y-o-y) included one-off items such as disposal gains of S$4.9m from available-forsale financial assets and PPE, and a forex loss of S$0.4m. Excluding these, Swissco’s 2Q09 recurring net profit would be c. S$5.0m (+27% y-o-y), in line with our projection. Gross margin of 49.5%, while down c. 6ppt y-o-y and q-o-q, is still within historical range of 48-56%. However, operating margin dipped >10ppt on a y-o-y and q-o-q basis mainly due to 1) higher accrual of performance bonus, and 2) a S$1.9m impairment of receivables – we understand this is due to management’s more conservative stance.

Net gearing as of end June 2009 stood at 0.15x vs. 0.23x at end 1Q09 as cash of S$6.5m was raised during the quarter from disposal of PPE and 8m shares in Swiber Holdings. These proceeds as well as secured bank loans are expected to be sufficient to cover the group’s funding requirements for its outstanding capex program.

We are keeping our FY09/10 recurring net profit forecasts and our fair value for Swissco of S$0.84 unchanged. This is based on 7x recurring FY09 PE for its core business, and its 5.3% stake in Swiber, pegged to fair value of S$0.60 per Swiber share. Maintain BUY on Swissco.

SembCorp Marine - Tenders galore will surprise orders on the upside in 2H09

Limelight on Petrobras. We continue to like Sembcorp Marine (SMM) and believe that order momentum in 2H09 may surprise on the upside. While the market seems excited about the plentiful orders from Petrobras, we believe investors have yet to factor in other potential non-Petrobras contracts in the offing. We tweak our earnings model and raise our operating margin assumptions following 2Q09 results. Our new earnings estimates show that, unlike what the Street thinks, FY09 may not be the peak earnings year. We raise our target price to S$3.74 (from S$3.04 previously) as we remove the discount factor in our sum-of-the-parts valuation methodology, given less occurrence of customers defaulting in an improved credit environment. Maintain BUY.

We are equally excited on other non-Petrobras contracts. Petrobras was the focus in SMM’s recent briefing as the management stressed on its multi-prong strategy to undertake Petrobras’ projects. While the market seems excited about the plentiful orders from Petrobras, we opine investors have yet to factor in other potential non-Petrobras contracts in the offing. Our industry checks indicated that SMM is currently bidding for jack-up newbuilds from NOCs such as Saudi Arabia, Vietnam and even China. Other piecemeal contracts include FPSO conversions (potentially in Indonesia and Vietnam) – Refer to Figure 2 on the following page. A recap: strong 2Q09 results. SMM’s 2Q09 revenue rose 8% YoY, 10% QoQ, to S$1.5b, while operating profit was S$167m, an improvement of 50% YoY, 24% QoQ. SMM’s outperformance for the fourth consecutive quarter was due to its strong operating margin of 11.1%, +210bp YoY. We have raised our FY09F-10F operating margins by 20bp.

Slight earnings revision. We push further revenue recognition on PetroRig II and PetroRig III, and cut back earnings from PetroProd’s CJ Jack-up on the back of prudency measures. Our FY09/10 recurring net profits are changed marginally by - 2%/+5% respectively. We think there could be a possible upward revision to consensus’ estimates on the back of stronger margins and more-than-expected orders newsflow. Hence, FY09 may not be the peak earnings year, in our view. Given that the credit markets are improving and the risk of customers’ default is minimised, we remove the discount factor in our sum-of-the-parts valuation methodology.

Cosco - 2Q09 net profit drops 71%

Cosco Corp’s 2Q09 net profit of S$37mn was below our estimate of S$45mn, on lower shiprepair, shipbuilding and shipping earnings. Group sales (shipping and shipyard revenue) declined 31% y-y to S$718mn, against our estimate of S$695mn. Of the S$681.3mn in shipyard revenue, ship-repair accounted for 20%, conversion and offshore for 36% and new-buildings for 44%.

Group 2Q09 EBIT declined 64% y-y to S$79.5mn, against our estimate of S$62.9mn, with EBIT margins contracting by 9.9pts y-y to 11.1%. Included in this was S$25.9mn in reversal in impairment of trade and other receivables and S$8.6mn in exchange gains. This was a quicker-than-expected write-back from S$171mn in provisions made in FY08, mostly in 4Q08. Interest costs increased 637% y-y to S$11.92mn in 2Q09, as group borrowings rose 83% y-y to S$1.2bn.

Management maintained that gross margins for shiprepair remained at 36%, with ship-repair posting estimated gross profits of S$49mn. According to management, newbuildings accounted for 44% of shipyard revenue or S$299.8mn with gross margins of just 1%, giving gross profits of S$3mn. We believe that with persistent and snowballing delivery delays, shipbuilding would have been lossmaking at the EBIT level. Offshore accounted for 16% of revenue, with gross margins of 12% and conversion for 20% of shipyard revenue, with gross margins at 17%, according to management.

Shipping revenue continued to decline sharply, down 45% to S$28.7mn, on collapsing bulk charter rates. Management expects dry bulk shipping to continue to be adversely affected by the weak BDI amidst the global economic downturn.

We remain concerned about continued delays in its shipbuilding delivery schedule. Shipbuilding orderbook YTD stands at US$6.8bn. We maintain REDUCE rating and our price target of S$0.70.

SembCorp Marine - More to come; raising PT to S$3.75

2Q09 earnings came in 15% better than expected on margin expansion: Sembcorp Marine reported a recurring 2Q09 net profit of S$145.2 million (reported earnings of S$138.1 million, up 7.6% y/y), better than our estimate of S$126 million, and up 13.2% y/y. The key reason for the outperformance was the continued expansion of the operating margin to 11.1% in 2Q09 from 8% in 2Q08 driven by operating efficiencies and lower costs. Management also announced a new FPSO conversion contract for S$163 million, taking YTD contracts to S$1.1 billion. As a result we raise FY09E/10E/11E new order contracts by S$800 million/$500 million/$500 million.

Multi-yard strategy in place to take advantage of Petrobras pipeline; are more contracts in the offing? During the analyst briefing, management highlighted the potential use of a multi-yard strategy while undertaking work for Petrobras. Besides its previous and current partners of MacLaren and Maua (with whom SMM could look to undertake new-build and conversion work), management highlighted its intention to consider yard acquisition in Brazil (Upstream had earlier reported a possible greenfield yard being evaluated by SMM). Management highlighted that while rig enquiries are lower, the quality of these enquiries is much higher. Moreover, with the FPSO conversion win and Sea Dragon contract, we could see (a) more production-assetrelated projects, and (b) further transfer of rig work from other yards.

We raise FY09E/10E/11E EPS by 4.7%/7.9%/9.5%, and our SOTPbased Jun-10 PT to S$3.75: We raise our EPS estimates due to (a) higher projected order wins, (b) raising operating margins to 10.5% (from 10.3%), and (c) incorporating recent order wins. We still see upside risks to our FY09/10 estimates on margin enhancement. As a result of our revised assumptions, and rolling forward our timeframe to Jun-10, our SOTP-based PT rises to S$3.75. Current implied O&M P/S stands at 11.9x (versus the historic average of 16-17x). A key risk to our PT is worse-than-expected delays by PBR for orders.

Cosco - Industry continues to remain weak with significant vessel oversupply

Cosco Corp (COS) delivered another weak set of results in 1H09 with revenues down 19% yoy to S$1.43bn, while net income declined 67% yoy to S$70m. 2Q09 net earnings were down 71% yoy to S$37m. Prospects remain poor and risks are high for further vessel order delays and cancellations. Maintain Sell.

COS has in total rescheduled 37 deliveries and cancelled 13 vessels, and we think more may be possible. We previously highlighted that some of the rescheduled vessels may be cancelled and the recent cancellations from COS’s parent clearly demonstrate that. Repair has seen a 40% fall in revenues. COS mentioned that it has not received any direct benefits from the ship building stimulus package.

COS tracks the BDI closely which may in part explain its recent share price strength. Note, Deutsche Bank has a 1,500 and 2,000 average target for the BDI for 2009 and 2010, respectively, versus the current level of about 3,350. We have made the following modifications: (1) rolled over our target PEG from December 2009 to June 2010, (2) lowered our earnings forecasts by between 5% and 7%, and accordingly, (3) raised our target price from S$0.39 to S$0.41.

We base our target price for COS on 0.7x Jun-FY2010E BV and have crosschecked it with the ROE-COE-growth model. Upside risks include higher-thanexpected new order wins, lower-than-expected steel price increases and betterthan- expected project execution (see p. 4 for more details). Maintain Sell.

Yangzijiang Shipbuilding - 2Q09 beats estimates, raising our expectations

2Q09 beat our estimates with net income for 1H09 coming at 56% of our FY09 forecast. 2Q09 net income was up 26% QoQ and 80% YoY with shipbuilding gross margin of over 24%.

Revenue recognition for 1H09 was below our estimates, likely as a result of reschedulings of 18 vessels and a 5% rebate on eight high contracts, but overall YZJ's strategy of defending its order book and margins appears to be working.

Bottom-line was also supported by non-operating income, largely from interest income on cash and short-term investments. YZJ’s total cash and short-term investments totalled Rmb10.3 bn (S$2.1 bn) at 30 June, or S$0.59/share. Total borrowings were Rmb1 bn.

We have pushed out revenue recognition schedule (rescheduling), increased gross margins to approximately 20% (1H09: 22.5%) and raised non-operating income (1H09 was 116% of FY09E), resulting in an 11-24% increase in our 2009-11E earnings (Fig. 2).

Target price is revised to S$1.29 from S$0.6 based on 2010E P/E of 10x (previously 5x). Maintain OUTPERFORM.

Yangzijiang: A strong ship

Consistent earnings delivery albeit tough operating environment. Our conviction in Yangzijiang was raised with its better-than-expected 2Q09 results. The group’s net profit was RMB607m in 2Q09, vs. our expectation of RMB550m.

Improved earnings visibility in 2010. We have previously expected a sharp dip in 2010 earnings in anticipation of high cancellation/rescheduling of order book in 2009. As the jittery is soothed with no cancellation and relatively low deferment to date, we increase our 2010 delivery assumption from 30 to 40 vessels. Gross margin has also been lifted by 2.7ppt to 20% on better operational efficiency. As a result, our FY10 net profit estimate is raised by 50% to RMB1.8bn.

One of the few privileged yards supported by government’s stimulus package. Yangzijiang is one of the three private yards in Jiangsu province that is singled out under the government’s stimulus package. The funding access given to Yangzijiang and its foreign customers reduces ship owners’ default risk and enhances Yangzijiang’s financial capability to pursue M&A opportunities.

The listing of CSIC may provide potential price catalyst to Yangzijiang. China Shipbuilding Industry Co (CSIC), one of the largest shipyards in China, has obtained approval from securities regulatory to list in the A-share market last week. A successful launch of CSIC at good valuation could drive up the values of Chinese shipbuilders, which now trade at an average 16.6x FY10 PE. This could result in a re-rating of Yangzijiang.

Mercator Lines is currently valued at 4.25 times P/E

1Q FY2009 results. Mercator Lines (Singapore) Limited (“Mercator”) reported 1Q FY2009 revenue of US$35.5m (-31% yoy) and net profit of US$10.0m (-54% yoy). Revenue dropped because of the decrease in spot market day rates and the renewal of long term contracts at lower rates. Net profit fell due to lower revenue as well as higher voyage and depreciation expenses. The increase in expenses was the result of the acquisition of three vessels.

Earnings estimates for FY2010F to FY2012F. Due to the downturn in the shipping industry, we expect Mercator to report a much lower profit of US$45.4m in FY2010F. As the global economy is expected to recover in 2010, we anticipate that Mercator will report higher profit of US$48.1m in FY2011F and FY2012F.

Mercator is currently valued at 4.25 times P/E and 0.95 time P/B. Maintain HOLD with fair value raised from S$0.16 to S$0.42. We maintain our hold recommendation as the share price has risen rapidly in the recent rally and upside may be limited. However, we raise the target price of Mercator from S$0.16 to S$0.42, which works out to 1.0 time book value for FY2010F. The change is an increase from our earlier valuation of 0.4 time book value. This is because Mercatoris able to report a profit despite the difficulties faced by shipping companies. In fact, it benefits from having up to 70 percent of its revenue from long term fixed rate contracts of 11 months to five years.

Sembcorp Marine - Strong operating performance

Sembcorp Marine's 1H09 revenues were up 24% yoy to S$2,861m, while net income grew 17.6% to S$258m (about 53% of our full-year estimates). Gross margins were up from 9.9% in 2Q08 to 12.9% in 2Q09; on a half-yearly basis; they rose from 10.2% in 1H08 to 11.8% in 1H09. Operating profits surged 58% yoy to S$301m in 1H09 (up 50% yoy to S$167m in 2Q09). As valuations remain attractive, we maintain Buy.

As we have highlighted before, two key conditions are required for a sustained recovery of the sector: (1) improvement/stability in oil prices, and (2) easing of credit. At current oil prices, investments previously put on hold are now beginning to return. We also see incremental signs/examples that suggest substantial easing of credit in the O&M sector.

The alarming rate of decline of global oil reserves, as highlighted by the IEA, is prompting countries such as Mexico to aggressively step up spending within the industry to halt this decline. We expect more countries to follow suit in the long term. We believe SMM is well positioned to benefit from this trend, having built up its branding and execution track record over the years. SMM has announced a new S$160m FPSO conversion contract, bringing YTD new orders to S$1.12bn.

SMM has a strong net cash position of S$1.84bn (S$1.18bn in progress payments), which places it well for potential M&A activities. Our SOTP-based target price is S$3.80 (target multiple of 15x FY09E earnings for O&M business; market/implied values for Cosco). Risks: unexpected cost escalation, execution risks, foreign currency volatility, and a sustained plunge in oil prices.

SembCorp Marine - Above expectations: Strong margins, but order backlog falls further

Annualized 1H2009 earnings of S$258mn was 5% ahead of our expectation. The difference was largely due to the better-than-expected operating margin, which came in at 10.5% in 1H, vs. GS full-year forecast of 8.8%, reflecting strong operating efficiencies, especially with repeat rig orders. There were two negatives, though: 1) associate earnings were weaker, mainly due to Cosco Shipyard Group, and 2) there was a S$8m write-off on its small Petroprod investment, which recently went into liquidation. Separately, Sembcorp Marine won a S$160mn FPSO conversion contract on August 3, including previous wins; ytd new orders are now at S$1.1bn. This is helping to replenish order backlog, which has now fallen to S$7.9bn, vs. the previous quarter’s S$8.4bn. Sembcorp Marine remains positive on demand long term, though near-term conditions could be challenging. A S$0.05 interim dividend was announced.

We are raising our 2009E-2011E EPS by 4%, 3% and 6%, respectively, mainly due to stronger operating margins, and higher-than-expected new orders; we previously forecast US$500mn. We are rolling over our 12-m P/B-based price target to 2010, increasing our price target to S$1.15 (vs. previous S$1). We remain cautious on the medium-term outlook for offshore and marine prospects, especially considering the sluggish E&P spending globally and significant rig supply oncoming. Retain Sell. Key risk: Higher-than-expected oil prices, stronger new order momentum.

COSCO - Expecting lower 2Q09 shipyard margin

We are expecting a 20% qoq increase in shipyard turnover to S$792m in 2Q09 due to higher contribution from offshore and marine newbuild contracts. However, gross profit growth is expected to be eroded by high operating costs.

We forecast 2Q09 gross margin at 14% (1Q09: 15%) for the shipyard segment. This is lower than the 20-30% seen in 2007-08. This is mainly due to higher operating costs as the Group procured 400,000 tonnes of steel at Rmb6,000/tonne in 2008 compared with an average Rmb4364/tonne in 2007. This amount of steel can build up to 40 dry bulk vessels and the price has fallen by 33% to an average of Rmb4,000/tonne.

We estimate 2Q09 dry bulk shipping revenue to fall 33% qoq to S$28.6m (1Q09: S$42.9m) in view of a weaker dry bulk shipping market.

In 2Q09, COSCO (S) secured a US$80m FPSO conversion contract awarded by MODEC in May 09 and some shiprepair works. Ytd contract wins amount to US$80m (2008: US$1.1b). In 2Q09, 13 dry bulk carrier orders were postponed and eight were cancelled.

Currently, about 31 dry bulk vessels are under construction. COSCO (S) is targeting to deliver 15 vessels in 2009, one of which was delivered in 1Q09, but none was completed in 2Q09.

To date, 40-50% of COSCO (S)’s dry bulk orderbook has been cancelled or delayed. The Group’s current gross orderbook stands at US$6.7b (we estimate net orderbook at US$4.5b).

We believe COSCO (S)’s share price will continue to underperform in view of: a) poor shipbuilding execution at its shipyards, b) current low level of contract wins, c) potentially more order cancellations and delays and d) an uncertain dry bulk shipping outlook.

COSCO (S) trades at PEs of 22x for 2009 and 25x 2010. In view of its poor prospects, we maintain our SELL call on the stock with a fair price of S$0.95 based on sum-of-the-parts (SOTP) valuation.

Keppel - Robust 2Q09, higher interim dividends

Keppel’s 2Q09 net profit, including exceptional items, rose 147% y-y to S$739.5mn, and was up 6% y-y to S$317mn (excluding EI). Group EBIT grew 36.6% y-y to S$357mn, with O&M accounting for 75% of EBIT, property for 21% and infrastructure for 6.7%. 2Q09 group EBIT margins improved to 11.1%, mainly reflecting higher O&M margins. The group associate earnings declined 43% y-y to S$98mn, reflecting the earnings decline of recently divested Singapore Petroleum Company (SPC) (previously 45.5%-owned). SPC has since ceased to be an associate, after the stake was sold to PetroChina at S$6.25 per share or S$1.47bn in June 2009.

The group booked exceptional gains of S$621mn from the SPC divestment but this was offset by total impairment charges of S$189mn in the quarter, mostly reflecting asset write-downs at its infrastructure (S$113.8mn write-down) and goodwill write-offs (S$15.5mn) at its offshore & marine divisions. In 2Q09, the group’s property division EBIT gained 3.3% y-y to S$76.5mn while infrastructure EBIT rose to S$23.8mn from S$1.4mn previously.

Offshore & Marine 2Q09 EBIT rose 45.2% to S$267mn, with EBIT margins improving to 11.8% from 10.1% in 2Q08, and was also higher than the 10.4% achieved in 1Q09. While the group did not win any new O&M orders in 2Q09, management expects the group’s S$7.7bn orderbook to keep its yards busy, with deliveries into 2012. The group secured new orders totalling S$5.2bn in 2008.

We maintain BUY with a PT of S$8.57, which is pegged at a 5% discount to our SOTP value of S$9.03. We value the O&M division using DCF over a 20-year period, incorporating a cyclical downturn in earnings from FY10F, and a WACC of 7.5%. The group’s other businesses are valued at the current market prices.

Sembcorp Marine: Steady performance

Better than expected 2Q09 results. Sembcorp Marine’s (SMM) revenue in 2Q09 was S$1.5b, in line with our expectation for order book drawdown. SMM’s strong S$145m recurring net profit in 2Q09, vs. our expectation of S$122m, was due to higher EBIT margin of 11.1% (vs. our estimate of 9.8%). This was due to better-than-expected operational efficiency and relatively subdued margin pressure on variation orders.

Raising profit estimates. We have raised our recurring net profit forecasts to S$516m (+6%) in FY09 and S$553m (+5%) in FY10. These are due to the lower order cancellation assumption of 6% (-6ppt), and the higher EBIT margin estimate of 10.6-10.8% (+0.8ppt).

S$1.1b y-t-d order wins. SMM’s S$1.1b y-t-d order win has outpaced its peers, and is on target to reach our S$3b assumption. This includes SMM’s latest S$160m FPSO contract win from MODEC. Coupled with more spaced out order book drawdown, SMM’s order book of S$7.9b is now bigger than Keppel Corp’s S$7.7b.

Better quality of project enquiries. SMM guides that the quality of enquiries for rigbuilding/offshore jobs has improved. We expect the increasing seriousness of the bids as incentives for equipment suppliers to potentially moderate their prices lower to move sales.

Raising target price. Our target price for SMM is raised to S$3.70, as we roll forward SOTP valuation metrics to FY10 EPS on better margin visibility. Maintain BUY.

Cosco - 2Q09 earnings dragged by weaker gross margins

2Q09 results below expectations. While Cosco Corp reported 2Q09 revenue of S$719m that was in-line with our forecasts, core operating profit (excluding reversal of impairment of trade receivables) of S$34m was below our estimates. This was due to a decline in gross profit margin from newbuilding as well as lower revenue contribution from the sale of scrap materials. Net profit was affected by higher interest payments. Underlying FCF remained negative. No interim dividend was declared. We cut our earnings estimates as we take into account lower gross profit margins for FY09 and FY10. Hence, our target price is reduced to S$0.95 (from S$1.14 previously). Downgrade to SELL from NEUTRAL.

Positive highlights: 1. Reversal of impairment of trade receivables of S$26m, thus removing overhang on weak customer credit quality and customer nonpayments. 2. Management disclosed that they are currently in talks with three clients on offshore contracts which may translate to new order flow.

Negative spots: 1. Gross profit margin for newbuilding declined drastically from ~5% to ~1%, despite partial steel inventory write-down of S$89m in 4Q08 which would have possibly eased off some cost pressure. Nevertheless, this also reflected poor yard execution. 2. Cosco gained S$16.4m (-57% YoY) from the sale of scrap metals in 2Q09. Management noted that approximately 50 ships were repaired during the quarter (vs. an average of 106 ships per quarter in FY08). 3. Higher interest expense of S$12m (+637% YoY) on increased borrowings to fund yard expansion. 4. Free cash flow remained negative as revenue recognition was pushed back and capex had not scaled down. 5. Since Dec 08, 37 bulk carriers have been deferred while 13 others cancelled to-date, affecting 50% of the total order book.

Cosco is currently trading at 19.6x FY09 P/E and 2.5x FY09 P/B which looks expensive to us, especially when Cosco’s results once again suggested poor yard execution and deliverables. In the near term, the lack of new order flow, further potential order cancellations and more delays in ship deliveries could weigh down on this stock.

Sembcorp Marine - Waiting for Petrobras

Sembcorp Marine posted results that were slightly ahead of expectations, due to better strength in margins from improved execution. Net profit rose 7.6% YoY to S$138.0m on the back of an 8% pickup in turnover to S$1.5bn. Gross margins improved to 12.9% versus 10.7% in 1Q09. We expect this improved margin to be sustainable. SMM also declared an interim dividend of 5 cts per share (payable 1st Sept), equal to 1H08.

Rig-building continued to be the main driver of earnings, accounting for 69% of revenue, and was up 19.6% YoY to S$1.0bn. Ship repair typically showed softness in the current economic climate, with revenue down 11% to S$173m, where shipowners typically reduce its scope of work, resulting in lower average revenue per vessel.

Margin improvement resulted in a YoY 40% improvement in gross profit to S$193m. However, there was a 69% decline in associate earnings to S$12.0m, due to the woes of Cosco Shipyard Group (CSG). There was also a net loss of about S$6m on foreign exchange losses which were partially offset by hedges.

SMM’s orderbook stands at S$7.9bn, with additions of S$1.1bn this year, including a S$160m FPSO conversion for MODEC announced yesterday. At the current run-rate, most of this will be converted over the next 5 quarters. As for new rig orders, SMM says that it is still in negotiations with several parties. Notably, SMM is gearing itself up to bid for jobs from Petrobras, which is slated to spend over US$100bn for upstream projects. However, so is everyone else – the resulting competition is likely to put pressure on margins on contracts from Petrobras.

We are tweaking our FY09 earnings forecast up by 2.3% to S$508.5m to factor in improved margins. We also raise SMM’s price target to $2.91 from $2.73 previously, on the higher forecast and market value of Cosco shares in our sum-of-the-parts valuation. While 2-yr earnings CAGR is still 11.3% p.a., we expect turnover to taper off from 2011 onwards. While we do expect the rig market to pick up, we are unlikely to see the same strength as the last boom cycle between 2005 and 2008. Maintain Hold.

Cosco Corporation: Not out of the woods yet

Cosco Shipyard Group disappointed again. Group sales dropped 31% yoy to RMB 719m due largely to 40%-50% yoy dip in offshore, ship-repair and conversion revenue. Coupled with lower margins across shipping and shipyard operations, net profit plunged 71% yoy to S$37m. Stripping out the write back of receivables amounting to S$13m (after MI), bottomline would have been even lower at S$24m (-81% yoy). While offshore, ship-repair and conversion business maintained its gross margins, newbuild operations remained in the red. The only saving grace was the better-than-expected shipping earnings on stronger charter rates in 1H09.

No sign of recovery in 2H09. We have previously expected Cosco¨s newbuild segment to turn profitable in 2H09. However, we now believe it would remain in the red due to: (i) delivery on its lower-priced contracts for parent company; and (ii) weak margins for current projects on poor execution. Gross margins of 1% is unlikely to improve and shipbuilding will continue to incur losses in 2H09. Outlook for shipping, shiprepair and conversion remain weak.

Cut 2009/2010 earnings by 25%. We cut our 2009 earnings by 25% to adjust for higher shipping day rates (up from US$18k per day to US$20k), but offset by lower contributions and margins from shipbuilding and shiprepair. We have also rolled over our valuation to FY10F, our target price raised to 96cts, based on 13x its shiprepair/conversions profits, 9x its shipbuilding/offshore profits. However, stock remains expensive, at 17.3x FY10F, its PE is the highest in the sector for a company suffering from order book vulnerability and execution problems at its yard.

Ezra - The subsea rises

Ezra's recent new growth strategy announcement on the subsea market marks a strategic and transformational move to focus on one of the fastest growing segments of the O&M sector, and we expect earnings to benefit. At 7.1x FY2010E PER, with an EPS CAGR of 41%, and trading towards the lower end of its historical range, we believe valuations are attractive. Initiate with a Buy.

Our FY2011E earnings estimates are around 50% above the market’s and we expect Street forecasts to rise over the coming year as Ezra’s plans begin to materialize. The group has a good execution track record over the years and we believe there is plenty of room for a positive re-rating as their earnings accelerate, moving them up towards the O&M mainstream names.

Global subsea spending in the next five years should rise >70% over the previous five years. Subsea spending should total about US$160bn from 2009 to 2013, and 3,222 subsea trees are due to be installed during this period. With its upcoming high specification vessels, enhanced know-how and expertise, and good execution track record, Ezra should be in a strong position to benefit.

We have set Ezra’s target price at S$2.50, which is derived by averaging the estimated values of the PEG and Gordon Growth model methods. Risks include vessel delivery delays, execution, any unexpected offshore mishaps, a sustained plunge in oil prices, and any unexpected departures of key executives.

Cosco - Still in the doldrums

COSCO Corp (S) (COSCO (S)) reported 2Q09 net profit of S$37.0m (- 71.2% yoy; +11.7% qoq) due to lower shipyard revenue, weaker charterhire rates and higher operational costs.

Shipbuilding revenue rose 22.6% yoy to S$299.8m (+55.6% qoq) while revenue for the ship repair, conversion and offshore segments fell 39.4%, 52.0% and 30.4% respectively. According to management, dry bulk shipping earnings totalled about US$20m for 1H09 (1H08: US$55m). This translates into a net margin of 38% (1Q09: 40%).

Management guided that 2Q09’s shipbuilding gross margin was only 1%. This was mainly due to higher operating costs as COSCO (S) procured 400,000 tonnes of steel at Rmb6,000/tonne in 2008 compared with an average of Rmb4,364/tonne in 2007. This amount of steel can build up to 40 dry bulk vessels. Steel price has since fallen 33% to an average of Rmb4,000/tonne.

Total borrowings rose from S$656.6m in 1Q09 to S$1.2b in 2Q09 to fundshipyard expansion. COSCO (S) had net cash of S$672.2m as of end- 2Q09.

Gross orderbook stands at US$6.8b (we estimate net orderbook at US$4.5b). Of the 100 dry bulk carriers in its orderbook, 39 are under construction. The Group is targetting to deliver 12 vessels in 2009, one of which was delivered in 1Q09. Twenty-nine vessels are scheduled for delivery in 2010 and 48 in 2011. Eleven dry bulk vessels will be on sea trial from now to end-09. To date, there have been 37 delivery delays and 13 order cancellations.

The contract for Sevan Driller 2 is still pending finalisation although Sevan Marine has announced it has secured equity funding for the drilling unit. If this contract materialises, it will be COSCO (S)’s first contract clinched in 2009.

We estimate COSCO (S)’s shipyard turnover to fall 5% yoy to S$3.0b in 2009 (2008: S$3.2b) due to lower ship repair and conversion revenue. Shipping turnover is forecast to halve to S$128.7m in view of a weaker dry bulk shipping market.

We believe COSCO (S)’s share price will remain in the doldrums in view of the following: a) poor shipbuilding execution at its shipyards, b) current low level of contract wins, c) potentially more order cancellations and delays, and d) an uncertain dry bulk shipping outlook. That said, should the Sevan Driller 2 contract materialise, share price could see some short-term strength.

COSCO (S) trades at PEs of 22x 2009 and 25x 2010 earnings. In view of its poor prospects, we reiterate our SELL call with a fair price of S$0.95 based on sum-of-the-parts valuation.

Yangzijiang Shipbuilding - summary and update

YZJ reported 80% yoy increase in 2Q09 PATMI of Rmb607.4m (+26% qoq; 1Q09: Rmb483.3m).

This is mainly due to an improvement in productivity from the new yard and higher profit recognition from three high margin vessels delivered in 2Q09.

Eleven vessels were delivered in the quarter as compared to six in 2Q08.

Orderbook stands US$6.1b comprising of 139 vessels or 2.54m CGT (66 containerships, 73 dry bulk carriers)

Excluding restricted cash of Rmb3.2b, YZJ has a net cash of Rmb4.8b.

Till date, YZJ has not received any order cancellation of vessels.

Eighteen vessels will be rescheduled by five to 24 months after the Group has received 40% prepayment in cash.

A total rebate of US$38m was provided for eight high margin vessels (GP margin >30%) in which the amount accounts for 5% of vessel costs.

Out of the eight high margin vessels, three have been delivered in 2Q09. The rest will be delivered by 2010.

In view of the numerous enquiries on multi-purpose cargo vessels from customers, YZJ has begun construction on two 92,500 dwt vessels.

The new shipyard is currently operating at 50% capacity utilization rate while the old yard is at full capacity.

YZJ plans to deliver 40 vessels in 2009, 45 in 2010 and 45 in 2011.

Based on consensus forecasts, YZJ is trading at 10.2x 2010 PE (9.5x 2009 PE) and 2.3x 2010 PB (2.8x 2009 PB).

SembCorp Marine - Much hope is pinned on Petrobras’ capex

Sliding orderbook, but SMM has fared better than Keppel Corp. SembCorp Marine’s (SMM) orderbook (excluding shiprepairs) was S$7.9b as of 4 Aug 09 compared with S$8.4b a quarter ago. SMM has secured S$1.1b worth of new contracts ytd, which is on track to meet our S$2b estimate for 2009.

Much hope is pinned on Petrobras’ capex, as enquiries from other customers remain low. Petrobras will need 28 more drilling rigs (semis and drillships) over the next five years (5-6 p.a.) as part of its expansion. Competition will be intense. Of the 12 rig contracts awarded by Petrobras in 2008, only one was secured by Singapore. South Korean shipyards benefitted the most as most of the contracts were for drillship newbuilds. Lower margins. Petrobras is now preparing to issue tenders in 3Q09 requesting the provision of as many as 7-8 newbuild floaters for contract start-up from 2013, according to ODS-Petrodata. We estimate shipyard contracts could total US$5b-6b (S$7b-9b). However, history has shown that for shipyards, Petrobras projects typically have lower margins than projects for other customers.

No change in target price and earnings forecasts. Our fair price of S$2.60 is pegged to our sum-of-the-parts (SOTP) valuation of S$2.56/share. Our SOTP valuation is premised on the following: a) SMM’s sustainable contract wins level of S$3b p.a. in the longer term, translating into an annual net profit base of S$235m, b) SMM’s own shipyard is valued at a PE of 15.0x (i.e. preoffshore oil & gas boom valuation for large shipyards), and c) SMM’s 30% stake in CSG is valued at a PE of 8.0x (i.e. pre-offshore oil & gas boom valuation for large shipyards) of its earnings based on long-term sustainable contract wins of S$2.0b p.a.

Keepl - await the Petrobras 'order-train'

Upgrade Keppel Corp to OW: We upgrade Keppel Corp from Neutral to Overweight and raise our PT to S$9.50, representing 21% upside from the current share price. Three key reasons for our upgrade are: (a) better than-expected 2Q09 earnings driven by O&M segment’s margin expansion (11.8% for 2Q09 versus 10.1% for 2Q08); (b) recent steps taken by management to streamline its business (SPC sale, KPLD rights issue) resulting in ‘clean net cash' position of S$200 million (from ‘clean net debt’ of S$835 million); and, most importantly, (c) potential new orders from Petrobras with near-term focus on (i) eight FPSOs hulls bid out by Aug'09, and (ii) next round of 7-11 deepwater rigs.

O&M segment surprises on margins; we raise FY09E/10E/11E EPS by 12%/14%/17%: Keppel reported a 2Q09 recurring net income of S$317 million versus J.P. Morgan’s estimate of S$270 million, 17.4% better than expected. The key reason for the variance was the stronger than-expected performance by the O&M segment due to steep expansion in the EBIT margin from 10% in 1H08 to 11.1% in 1H09.

Petrobras orders remain the big driver for offshore sector; three ‘potential’ near-term opportunities for Keppel: While the upcoming round of 7-11 rigs (7 PBR-owned and the rest being chartered out) remains the key opportunity for Singaporean/Korean yards, in the near term we see additional potential catalysts for Keppel, namely (a) potential US$4 billion order for the eight FPSO hulls (the entire set of eight hulls is likely to go to a single winner), alongside (b) news flow of Technip being a leading candidate for P-58 and P-60. Given Technip and Keppel’s close working relationship for P-51, P-52, and P-56, Keppel may benefit if these two assets are eventually awarded to Technip.

Price target, valuation, key risks: As a result of our raised estimates and new timeframe of Jun-10, our PT increases to S$9.50. This implies 14x 2009E earnings and a 3.7% dividend yield. We believe the key risk to our PT is a continued global slowdown leading to worse-thanexpected new orders.

Ezra - Sub sea journey

By adding new specialized equipment and functions to assets it already has under construction, Ezra is increasing their market value. These assets will be destined to support deepwater sub sea services (the company’s new area of growth) instead of exploration services. Our FY11 EPS estimate rose by 11% after taking conservative estimates on the new assets, but could rise by another 20% in a blue-sky scenario. At 7.7x FY10 PE the stock is cheap. Maintain BUY. New TP holds 54% upside.

Ezra’s new growth strategy is focused on the drilling market (support of oil production activity) instead of the exploration market. This is the market where oil majors are spending their additional capex dollar. Ezra plans to grow through the addition of highly specialized vessels that perform installation and maintenance work for drilling projects in the deepwater sub sea segment. While the long term chartering of its current fleet of 25 AHTS vessels, which support exploration rigs, will provide a stable earnings source.

By adding new specialized equipment such as drilling towers, ROVs and moon pools to assets that it already has under construction and by providing a highly qualified team of engineers, Ezra is able to bid for contracts in the deepwater sub sea segment that could obtain significantly higher charter rates than if the assets were to be used to in the exploration segment. For example, after converting a pipe-laying barge into a DP3 sub sea construction vessel, Ezra could potentially obtain charter rates of US$250-300,000/day instead of the US$130,000 we had factored in.

After taking conservative estimates on the DP3 and 2 MFSV assets that Ezra will use for the sub sea segment, our FY11 earnings estimate rose by 11%. In a blue-sky scenario, our FY11 EPS estimate could be another 20% higher than our new estimate. Besides this the company has signed an agreement with a third party to market and operate their support vessels in return for a share in their profits. This could add another US$8-10m in earnings annually.

Based on our new earnings estimates, Ezra is trading at 7.7x FY10, more than one standard deviation below its long term average. We value the stock at S$2.10/share, based on our DCF-derived target price, 11% above our previous target. Risks remain on the FPSO for which Ezra has yet to be paid.

MARCO POLO Marine - Ship Repair Expansion To Offset Shipbuilding Downturn

Marco Polo Marine Ltd (MP) is an integrated shipping group principally engaged in: a) ship chartering, which includes the provision of chartering, re-chartering and transhipment services of tugboats and barges and b) shipyard operations, which include the provision of building, repair and broking services of tugboats and barges. As of end-1HFY09, the Group had a shipbuilding orderbook of S$51.9m, excluding S$29.8m shipbuilding projects meant for its own ship chartering business. MP currently operates a fleet of 55 vessels.

Stable and constant ship chartering revenue. The ship chartering rates for most offshore support vessels (OSV) have fallen by 20-40% from their peaks but the rates for tugboats and barges have remained stable, according to MP’s management. MP is also the exclusive supplier of chartering services of tugboats and barges to BRJ, a major customer controlled by the Lee family. The products transported for BRJ and other Indonesian customers are mainly mining products such as granite and aggregates mined in Indonesia, mainly for the construction, infrastructure, property development and land reclamation industries in Singapore and, to a lesser extent, Indonesia.

Recurring earnings through JV with Glencore International AG, one of the world’s largest suppliers of a wide range of commodities and raw materials to industrial consumers. The 50:50 JV (MPST Marine Pte Ltd (MPST)) is to jointly own and operate a fleet of tugboats and barges for the provision of transhipment services of cargoes for Glencore and/or its related corporations and affiliates. MP will procure shipbuilding and supply of an initial fleet of 24 vessels, out of which 10 were delivered and 14 are scheduled for delivery by end-09. MP expects recurring contributions to its earnings through the share of profits in the jointly controlled MPST.

Ship repair expansion to offset shipbuilding downturn. The management expects its ship repair business to contribute significantly to its shipyard operations once the second dry dock (currently under construction) becomes operational. Ship repair business tends to generate higher gross profit margin of 35-50% than shipbuilding (15-18%) and it is less cyclical given the recurring need for maintenance and repair of vessels. Management guided that each of the two dry docks has the capacity to repair six to eight vessels per month at a cost of S$150,000-S$300,000 per repair work. MP is currently trading at 1.9x P/B and 8.9x PE. The hybrid OSV sector that MP falls under is trading at 1.3x P/B and 6.3x PE.