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.

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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.

Keppel - O&M core operations remain strong

Core above expectations. 2Q09 core net profit of S$318m (+6% yoy) was 27% above our estimate but in line with consensus, thanks to stronger-than-expected earnings from Offshore & Marine (O&M) and Property. 1H09 core profit of S$603m (+8% yoy) forms 58% of our FY09 forecast. 1H09 reported profit of S$1.02bn (+83% yoy) was below our estimate and consensus, due to a S$189m asset impairment charge for Infrastructure and O&M that offset its SPC divestment gain.

Strong O&M margins. 2Q09 operating margins of 11.8% were above guidance of 8-10%, thanks to better cost control from the execution of repeat rig orders. We believe the margin strength can be sustained into 2H09 and expect stronger revenue with 38 scheduled deliveries (1H09: 15 deliveries).

Order-cancellation risks reduced; hopeful on Brazilian order wins. O&M order book was S$7.7bn with S$330m of order wins to date. Management does not foresee more order cancellations and is cautiously confident of capturing some orders by end-2009. With its yard facilities in Brazil and track record with Petrobras semi-sub orders (P52, P51 and P56), Keppel is in a good position to capture Brazilian wins. We leave our order-win assumption of S$1.5bn for 2009 intact.

Conserving cash for growth. An almost unchanged interim dividend of 15 Scts (1H08:14 Scts) was declared, despite stronger earnings and cash of S$3.3bn (1H08: S$1.6bn). The excess cash could be used to fund expansion in Infrastructure or Property. However, we believe some special dividend could be announced in FY09. About S$2bn of the cash comprises deposits collected from O&M.

Earnings estimates raised by 6-9% for FY09-11, to incorporate: 1) higher sales and margin assumptions for O&M; and 2) our earnings upgrade for Keppel Land.

Maintain Outperform with higher target price of S$9.00 (from S$8.50), still based on sum-of-the-parts valuation. Our target price rises as a result of higher earnings assumptions for O&M and an increased target price for Keppel Land.

Rowan impact on Keppel

Rowan had previously placed newbuild orders for four Super 116E class Jackup rigs (EXL #1 to EXL #4) with KepCorp. KepCorp is proceeding with the construction of the first three jackups for Rowan with no change in schedule. The last rig continues to have a suspension of construction based on goodwill rendered by KepCorp to Rowan. KepCorp will resume the building of the forth rig in 3Q2009 (unless Rowan officially cancels the construction and pays penalties. Rowan's decision will likely be made during 3Q09 results). At this point in time, we have indications from KepCorp that they "think" Rowan will be resuming the construction.

Rowan has revealed in their investor communications that they are committing about US$273m for the rigs being built at Keppel for 2009. As we know it, all three Jackups have no contracts on hand. While this is a concern, Rowan has a significant number of assets (22 offshore jackups and 30 land rigs) that are operating and generating cash flows.

While 2009 might still show good performance in view of its previous year orderbooks, KepCorp has not won any newbuild contracts for its Offshore division for about 1 year. From our recent visit to KepCorp, management expects the gap to affect its 2010 earnings substantially.

We have a HOLD rating on KepCorp with a fair value of S$6.40. Entry at about S$6.10-6.20 can be explored if your clients are long term investors.

Keppel Corporation - Petrobras to bid out US$4 billion worth hull contracts by July-end; Keppel in the running

Petrobras to bid out US$4billion worth of hull contracts by July- end: Keppel Corp along with 4 other companies (namely Atlantico Sul, 10% Samsung owned, Engevix Engenharia SA and UTC Engenharia SA) are intending to bid for US$4 billion worth of Petrobras contracts to build hulls of FPSOs to be used in Brazil’s pre-salt oil fields (source: Bloomberg). The news article further adds that the companies are likely to submit the proposals between July 17 and July 24 and Petrobras is likely to open the offers on July 31. Petrobras aims to start operating the vessels in 2015 and 2016.

Potentially add S$4.2-6 billion to Keppel Corp’s new contracts versus JPM’s estimate of S$1 billion for FY09E: Assuming Keppel Corp successfully bids for these projects and takes a 70-100% stake within the order (70% is arrived at assuming Keppel successfully bids for Rio Grande wherein news reports (source: Upstream) suggest a 70% stake for KEP) it would add S$4.2-6 billion to the orderbook. Moreover assuming a 7-8% EBIT margin given its a hull contract (this may however be on the higher side for initial contracts given historic performance of ‘new projects’ by Keppel in Brazil), this would potentially add 11-12% to our FY10E / 11E EPS estimates and possibly S$0.30 / share (assuming a 2x on profit contribution). Do note however that our estimates already assume S$0.83 / share Petrobras option value (although this has been assigned only for new rig orders).

Still await news on Rio Grande shipyard purchase; would push Keppel Corp in to lead position for these orders: Given that Rio Grande shipyard has been identified for the assembly work of 8 hulls for the FPSOs, we believe Keppel Corp would be in a ‘leading’ position for the bids of these hulls for FPSOs in case it eventually does take the 70% stake in Rio Grande.

Keppel Corp - Now A Big One Up On Semb Marine

Business Times reported on Jun 27th that Keppel Offshore & Marine (KOM) may have out- maneuvered Semb Marine in taking a 70% stake in a new shipyard project in southern Brazil which could cost at least US$850 mln.

(The JV partner is W Torre Empreendimentos Imobiliarios, WTorre, a large and established group with expertise and capabilities in civil and engineering infrastructure development in Brazil. And the shipyard is located in the southern Brazilian city Rio Grande, which will have a dry dock that is to be the largest and the first purpose-built facility to be built in Brazil in 30 years.)

Semb Marine had on Oct 1st ’07 signed a MOU with WTorre to own and operate the yard. There has been no indication as to the status of this MOU.

The new shipyard project is particularly significant, given the imminent closing of Petrobras’ tender for the hull construction of 8 Floating Production Storage & Offloading vessels (FPSOs), as the massive Tupi oil field (with estimated 5-8 bln barrels of oil reserves) gears up to commence production. Brazil’s oil reserves stand at 12.6 bln barrels, ahead of Mexico, but well behind Venezuela in Latin America.

While the final outcome is still unclear, the latest news is likely to boost sentiment in Kep Corp shares, and unfortunately the reverse, at least in the short- term, for Semb Marine.

We have a BUY on both stocks. (Both companies count Petrobras as one of their key customers. In fact, Semb Marine, which has been in Brazil since 1997, has converted the most number of vessels for Petrobras: 6 FPSOs, I FPU and 2 FSOs. KOM, on the other hand, delivered the P-51 FPU to Petrobras in Nov ’08, the second after the P-52, and to be followed by P-56 that it is currently working on.)

Keppel Corp - Maintain Buy; Raise Target Price to S$7.60

Keppel Corp remains our top pick in the O&M sector. Keppel's long and established operating history in Brazil also suggests it is well positioned to benefit from Petrobras orders. We are also comfortable with Keppel O&M’s order book quality as the biggest customer overhang – Skeie Drilling and Production (est. 14% of order book) – has been removed: Skeie recently announced a successful restructuring plan to enable it to stay solvent and complete construction of all 3 jack-ups at Keppel.

Divestment of SPC has also strengthened Keppel's balance sheet to engage strategic M&A growth. We believe the group’s restructuring efforts will be geared towards revenue/earnings which are less cyclical (vs SPC refineries).Accretive acquisitions which can harness synergies with Keppel Land and/or KIE may provide further upside to valuations.

At the same time, Infrastructure prospects has room to improve further, on back of recent contract wins and demand for green technology.

Our S$7.60 target price is based on a marginal discount to our per-share RNAV estimate of S$7.64, applying a 15% discount to the value of Keppel's investments in M1 and K1 ventures as we see Keppel as a passive investor in these ventures. For the group's O&M business, we use a target Dec FY10E P/B of 4x, which is the historical average PB in the recent cycle. We use P/B as our valuation approach for shipyard value as shipyard earnings have become less visible in the face of a slower orders momentum. We use 2010E valuation for the O&M sector as the bulk of the existing order book will be recognized by 2010. For Infrastructure we use ~10x FY10E P/E, in line with the industry average as earnings is set to grow from a low base; and we value Keppel Corp's 53% stake in Keppel Land based on target price for Keppel Land of S$1.94.

Keppel Corp: Skeie Drilling and Production may face difficulties in paying for its three jackup rigs under construction

Skeie Drilling and Production may face difficulties in paying for its three jackup rigs under construction

1) Skeie Drilling & Production (SKDP) may seek company liquidation if no agreement with its bondholders were reached by 4 June 2009.

According to SKDP yesterday, there was to-date no agreement with a group of its secured bondholders on its financial and rig construction re-structuring proposal. Further negotiations have not been fruitful, with the bondholders' counter proposals rejected.

As a recap, SKDP's re-structuring proposal (initiated on 17 April 2009) has expired on 31 May 2009, including the possibility of extending the delivery schedule for rig construction contracts with Keppel Corp (KEP), and the underwritting commitment from SKDP's main shareholder, Skeie Technology and Wideluck, for possible US$85m equity fund raising.

2) SKDP is now behind its progressive payment schedule for Rig 1 (with US$37m milestone payment due on 31 May), and may miss the US$40m payment for Rig 3 on 4 June.

For Rig 2, SKDP's inability to raise US$18m of new equity by end May implies a breach under the Prodjack 1 bond loan agreement, as the jackup rig is still without a charter contract. Collectively, SKDP may also risk the termination of US$675m in bank loan commitment to finance the three rig construction with KEP, if the contractual breaches for these projects are not resolved.

3) SKDP's Board of Directors now believes SKDP is insolvent, and could be illiquid if no re-structuring agreement could be reached.

As a last step to avoid its filing for bankruptcy, SKDP's Board of Directors will now seek "irrevocable pre-acceptances from a qualifying majority (2/3) of the three SKDP secured bond loans and the convertible loan to the proposal as set out in the SKDP announcement dated April 17 and as described in the SKDP Company Presentation dated April 17 posted on the company's web-page www.skeiedrilling.com".

If these conditions can be met by 4 June 2009, and pending a follow-up formal votes from all bondholders, SKDP will then seek extensions to the agreements with its main shareholder and KEP as per the re-structuring proposal on 17 April.

4) SKDP is one of KEP’s top 3 customers.

SKDP currently has construction contracts for three N-Class Jackup offshore drilling rigs with Keppel FELS shipyard in Singapore. We estimate that the contracted value for the three orders were S$1.7b, with an estimated S$0.8-1.0b worth of contracts yet to be recognised (or 8-11% of KEP's current order book).

While there is a lack of information on the actual cash collected to-date by KEP for these three SKDP orders, we believe that the possibility for KEP to complete construction of the three rigs on its own is not high in the event of a default by SKDP, unless the total cash collected to-date is more than 50% of combined contract value. Maintain FULLY VALUED on KEP. Our fair value for KEP stays at S$5.13.

Keppel - Valuations still attractive

In the running for new FPS orders. Trade publication, Upstream, recently reported that Keppel O&M has jointly collaborated with J Ray McDermott to tender for a spar construction contract for work in Kodiak Field, Mississippi, Gulf of Mexico. Separately, we read that Keppel has also expressed keen interest for eight of Petrobras’ hull construction contracts. While we are unable to verify the status of the projects at the point of writing, we remain confident that these bids would translate to new orders momentum, given Keppel’s quality deliverables and strong track record. As such, we raise our new order estimates from S$2.2b/S$2.6b to S$3.0b/S$3.5b for FY09F/10F. Thus, our FY10F net profit is raised by 5%.

O&M customers’ concerns somewhat alleviated, except for Skeie Drilling. Skeie Drilling (of which Keppel owns 5%) is currently constructing three jack-up rigs at Keppel FELS, and the delivery deadlines have been extended by 4-6 months with the last jack-up due in Jun 2011. According to Skeie’s 17 Apr’s press release, Skeie requires a total capex and funding requirement of US$1.6b and would be seeking bondholder meetings to conclude this new capital raising by late May 09. While we remain cautious on customers’ non- payment in the near term, we expect fewer such events to happen as credit conditions improve, going forward.

Valuations below normalised levels, even after the recent share price rebound. Keppel O&M’s trading valuations at an implied 10.1x FY09F P/E and 12.3x FY10F P/E, are still lower than normalised levels, even after the recent share rebound. Given the more optimistic outlook and new order flow momentum, we have changed our valuation framework to P/E from P/B, applying 16x P/E on FY10F EPS for Keppel O&M. We have also updated DMG’s target prices and share prices of the listed entities, deriving a new target price of S$7.96 (from S$5.24 previously), representing an upside of 17.4%. Upgrade from NEUTRAL to BUY.

Keppel Corporation: Cash bonanza from sale of SPC; FULLY VALUED

Surprise proposed sale of SPC. Keppel Corp (KEP) announced that its entire 45.51% stake in listed SPC Ltd would be sold to PetroChina International (Singapore) Pte Ltd. This deal is conditional upon the approvals and consents from authorities in Singapore and China.

A good deal for KEP. The proposed sale will reap cash for KEP, amounting to S$1.47b or S$6.25 per SPC share (at 15.6x FY09 PE and 1.8x px to book). The cash proceeds are S$0.92 per KEP share, raising KEP's net cash to about S$1.6b. A special dividend payout is possible, and our assumed dividend payout ratio is raised to 90% for FY09, generating yield of 7.5%.

Don't forget the uncertainty from Rowan contracts. As a recap, Rowan has previously placed orders for four Super 116E class newbuild jackup rigs with KEP. This client is now seeking payment re-negotiation on all its four jackup rig orders, and may potentially cancel its fourth order with KEP. Assuming the remaining payments for all four jackup rigs to be payable upon deliveries, we estimate that KEP needs to self-finance US$430-550m of the construction costs.

Maintain FULLY VALUED on KEP. Our fair value for KEP is adjusted to S$5.13; due to the offer price for SPC, and the higher share price for listed Keppel T&T. KEP's current price remains expensive, as it implies 21x FY10 PE for its O&M. Maintain FULLY VALUED.

Keppel Corp divests SPC for S$1.47b

To sell 45.51% stake (234.5m shares) in Singapore Petroleum Company (SPC) to PetroChina International (S), a subsidiary of PetroChina Company Ltd for S$1.47b or S$6.25 per share in cash. The purchase consideration is at 24.0% premium to SPC's last closing price.

Keppel will realise a gain of S$660mm, thus increasing its NTA/share from S$2.84 to S$3.26.

PetroChina is required and intends to make a mandatory general cash offer for the remaining shares in SPC.

Assuming transaction is completed by end-09, our FY09 net profit would rise by 72% from S$920m to S$1.58m factoring in the S$660m gain. FY10 and FY11 net profit forecasts (indicative of operating earnings) would be reduced by 18% and 21% respectively to S$707m and S$590.7m. Revised EPS for FY09, FY10 and FY11 at 99.2 cts, 44.4 cts and 37.1 cts respectively with PEs at 7.0x, 15.7x and 18.8x.

Our revised sum-of-the-parts for Keppel is S$5.90/share, factoring in the S$1.47b selling price for its SPC stake. And also factored in a higher ex-rights target price of S$2.35 for Keppel Land (S$1.70 previously). Our previous SOTP was S$4.85/share.

Special dividend from the divestment proceeds is likely. Maintain SELL on Keppel as share price is significantly above our revised target price of S$5.90. With the divestment of SPC, Keppel will become a less compelling oil play.