Sembcorp Marine has terminated one contract with Petroprod

Sembcorp Marine has terminated its contract with Petroprod D&P I Ltd for the construction of a jack-up rig, as milestone payments due under the contract have not been received. The jack-up rig is a harsh environment drilling rig and is one of the world’s largest jack-up rigs. SMM says that there are alternative buyers who are interested in this rig, and they are confident that it will be able to receive all amounts it should have earned with the sale of this rig.

The rig was contracted in 2007, is expected to be completed in mid-2010, and has a value of US$442m. Petroprod is a member of Norway’s Larsen Group, and we understand that it is being put in liquidation. We also understand that Petroprod has one other order with SMM, for the conversion of a tanker to an FPSO.

On June 8, SMM had announced that it had sold the semisubmersible PetroRig I to Diamond Offshore in order to recover monies due to them following the non-payment by the customer, Petromena. Petromena similarly has ties to the Larsen Group. Petromena also has two more semi-submersibles under construction with SMM.

This latest development is indicative of our ongoing concerns for potential cancellations and defaults that SMM faces. Although SMM has so far been protected via progress payments and still-buoyant pricing for rigs, the elevated risk is one of the reasons for our muted outlook on the stock. We are keeping tabs on more potential cancellations, and maintain our Hold recommendation to target price of S$2.91.

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SembCorp Marine - The tide is rising

Investors appear impressed by the strong operating margin (10.5% for 1H09). SMM feels confident it will be able to maintain this level of margin and pointed out that profit contribution from orders negotiated at better pricing could even see margins inch up. We forecast 10.6% for FY09 and 11.2% for FY10 and note upside risk to our forecast as it is still a builders’ market.

Not surprisingly, Petrobras’ plans for 28 drilling rigs and 8 FPSO units merited lots of attention. While agreeing that Petrobras would indeed be one of the larger potential customers, the company took pains to point out that current oil prices will likely result in orders from the Middle East (Saudi Aramco, Iran NOC) & North Africa (Egypt), China as well as Mexico (Pemex). High levels of drilling activity in West Africa will also generate incremental demand for deepwater rigs and production units.

Asked about their plans for the S$1.8bn net cash balance (S$600m excluding S$1.2bn customer advances) and low gearing, SMM hinted at a “near customer” strategy, which we believe points towards asset acquisition/equity partnership in Brazil. In the medium to longer term, consolidation of the yard network is likely, with a focus on efficiency gains and streamlining of operations.

Our target price of S$3.25 would increase to S$3.43 if we took Cosco Corp’s current share price into account, pointing to 11.2% upside. At 8.9x FY10 PER, the stock is trading below its 5-year average PER of 13.5x despite continued strength in execution and strong balance sheet. Further, we expect 2010 to offer more promise as regards order wins. Maintain OUTPERFORM.

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.

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.

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.

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.

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.

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.

SembCorp Marine - Price target maintained at $3.22

Our price target is S$3.22 based on our sum-of-the-parts (SOTP) valuation comprising a DCF valuation (over a 20-year period and incorporating a cyclical downturn in earnings from FY11) of the group’s shipyard businesses, which includes the three Singapore yards, as well as earnings from overseas yards including Cosco Shipyard Group, and its remaining 5% stake in Cosco Corp. Our WACC assumptions remain unchanged at 7.5% and zero terminal growth.

With FY09/10E P/E of 12.3x and 12.1x, SMM still trades at the lower end of its historical P/E band of 7x and 28x. FY09/10F ROEs of above 31.6% and 26.8% are creditable for a shipyard group, in our view, and we expect dividends to be maintained for FY09F and FY10F, giving dividend yields of 4% which as attractive relative to peers.

SMM holds net cash of S$1.8bn as at March 2009, of which S$1.2bn are WIP payments, with steady cashflow seen from progressive recognition from its S$9bn order-book. Given that capex requirements can be met from its operating cashflow, we believe the group is unlikely to need to raise capital in the short to medium term Risks to price target: Our price target could be negatively affected by extensive cancellations of the group's O&M orderbook, or by significant losses incurred on these O&M projects, or more associate losses.

Sensitivity analysis. If we assume a 10% cancellation of the group’s offshore rig contracts from its current orderbook, our FY09/10/11 earnings estimate will fall by 8.3%, 7.2% and 6.8%, respectively. Our current earnings forecast already takes into account all announced cancellations and delivery postponements.

Sembcorp Marine - Secures second SeaDragon US$237 million rig order; crystallization of April '09 option

SMM secures 2nd rig order from SeaDragon worth US$237.3 million; crystallization of April’09 option: Sembcorp Marine has secured a 2nd SeaDragon rig order (first rig order was reported in April 2009) to complete and deliver a Moss Maritime Fully Dynamically Positioned (DP-3) semi-submersible drilling unit. The contract is worth US$237.3 million excluding equipment supplied by owner with the hull having been built in a Russian yard (which arrived at Jurong shipyard in early June 2009). While the first rig (order win in April 2009) is contracted with Pemex for five years, this recent rig is un-contracted for now.

Why is contract value only for US$237.3 million versus new build of US$500-600 million?: Given that the hull has been constructed at the Russian yard and transported to Jurong and the rig contract is on an ex-equipment basis, the contract value is only at US$237.3 million versus a usual price tag of US$500-600 million for a new build semi-submersible.

Year to date "new contracts" stand at S$954 million versus JPM estimate of S$1 billion for FY09E; steady recovery of order-book momentum? Sembcorp Marine has achieved in total, new contracts worth S$954 million versus our FY09E estimate of S$ 1billion. Moreover we believe we could see S$500-800 million upside risk to our current estimate of new contracts as we'd expect to see additional orders in 2H09; however more related to conversion work as against 'new build rig’ orders.

Petrobras still the ‘clearest & biggest opportunity’; SMM willing to consider drillships? During the 1Q09 conference call, management had indicated that they would be willing to consider drillship orders and highlighted they have been approached in the past in this regard. PBR’s 1st batch of 5-7 rigs (out of 28 rigs) is likely to bid out in 2H09.

SMM recovers amounts due from PetroRig I

With the resolution of the PetroRig I sale, we are raising our recommendation on Sembcorp Marine (SMM) to a Hold. However, the outlook for rig newbuilds still remains muted at this point, and we remain unexcited over the medium term.

On June 8, SMM had announced that it had sold the semisubmersible PetroRig I to Diamond Offshore in order to recover monies due to them following the non-payment by the customer, Petromena. Diamond has disclosed a price of around US$460, of which SMM will receive its outstanding amount of US$200, plus administrative costs. The balance of the amount will be returned to the original bondholders of the project.

With the healthy reported selling price of US$460m, this assuages concerns of SMM’s other 2 rigs being built under the same specifications for Petromena. SMM has collected 50% of these contracts amounts, and believes that it would be able to dispose of the rigs in a similar manner at no loss if Petromena should once again default on payment. The sale also indicates that demand for such deepwater rigs remains healthy, and that SMM is able to protect itself against such default contingencies.

However, despite continued interest in the deepwater segment, we do not see this translating to significant orders, despite an improving credit environment. SMM’s last reported orderbook stood at $8.4b stretching to 2012, and has since announced orders worth S$230m for an offshore platform contract for SMOE, as well as US$237m outfitting and completion order for a semisubmersible.

We are raising SMM’s price target to $2.73 from $2.31 previously, on higher shipyard multiples in our sum-of-the-parts valuation. Our FY09 net profit forecast of $497m remains unchanged. While 2-yr earnings CAGR is still a healthy 12.7% 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 in the last boom cycle between 2005 and 2008. However, given its respectable earnings visibility and decent dividend yield, we raise the stock to a Hold.

Sembcorp Marine: Offers better risk/reward now

Upgrade to BUY. The risk/reward is more attractive now on potential price catalysts in 3Q09, and we upgrade SMM to BUY. Our fair value is raised to S$3.25, using mid-cycle valuation, and rolling forward to blended FY09/10 EPS on improved margin visibility.

Price catalysts in 3Q09 We see the on-schedule receipts of the next milestone payments for Petroprod's jackup rig (before mid-July 2009), and Seadrill's semi-submersible rig (estimated by end 3Q09) as catalysts for the eventual removal of our S$1.1b order cancellation assumption. This could potentially add >5% to our fair value for SMM. SMM's confidence on contracts execution in 1H09 has also mitigated our concerns on margin pressure for variation orders, we have raised our EBIT margin assumptions for FY09 and FY10, to 9.8% and 9.9% respectively and expect a good set of 2Q09 results to be another price catalyst.

Expect new order wins in 2H09, our assumption unchanged at S$3b. We caution investors against expectations that any SMM's new order win is the start of an uptrend. We maintain our view that an uptrend in new order wins require : 1) An easing of credit crunch through a reduction in credit spread and equity funding requirement, and 2) A lowering of still high construction costs. These pre-conditions are currently not met yet.

SembCorp Marine - Maintain Hold; TP S$3.00

We keep our earnings estimates unchanged, but raise our target price to S$3.00 from S$2.30 based on a sum-of-the-parts valuation. For the core O&M business, we use a target Dec FY10E P/B of ~4x (raised from 3x), which is the average PB multiple in the recent cycle.

Our earlier upgrade on SMM from Sell to Hold was partially driven by our view customer cancellation risks have already been priced into the stock. Financing issues remain for a few selected customers, and could likely lead to selling pressure, but we like SMM's strong footing in fixed production platforms. The acquisition of SOME has established itself as a strong beneficiary from the strength in the production cycle.We see upside risks to our earnings forecast.

We value SembCorp Marine on sum-of-the-parts valuation, giving us a target price of S$3.00. For the core O&M business, we use a target Dec FY10E P/B of 4x, which is the historical average PB multiple of 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. We derive our fair value estimate for SMM's 30% stake in Cosco Shipyard Group based on our valuation for COS's shipyards. We value SMM's 5% stake in COS based on our COS target price of S$1.20.

SembCorp Marine sells PetroRig I semi-submersible rig to Diamond Offshore

SembCorp Marine (SMM) says its subsidiary Jurong Shipyard has accepted the bid by Diamond Offshore Services Company, a related company of Diamond Offshore Drilling Inc to purchase the PetroRig I semi-submersible rig . The sale is expected to be completed by end-June.

SMM has not disclosed the purchase price, but we think it should be higher than the last offer price of US$450m made by an international drilling contractor to PetroRig I Pte Ltd in Mar 09.

The sale proceeds should cover the unpaid sum (50% of US$423m shipyard contract) due to Jurong Shipyard.

SembCorp Marine - Sustained margins and high ROE are positives

PetroRig I – twist in outcome, but SCM maintains confident to sell rig. SCM is currently in the midst of selling PetroRig I, though there appears to be some difficulties as SCM’s wholly owned subsidiary, Jurong Shipyard (JSPL) received an injunction to proceed with the sale. Nonetheless, we believe JSPL is able to recover the final payment through the sale of PetroRig I, though this may take a while longer than expected.

Better-than-expected margins. SCM turned in better-than-expected operating profit margin in 1Q09 for the third consecutive quarter. We opine that this ascertains SCM’s capability and efficiency for rigbuilding as the first quarter is a seasonally slow quarter for higher-margin shiprepair and thus, the revenue profile for the first quarter is skewed towards rigbuilding. We expect subsequent quarters to record better profit margins than 1Q09. Increasing ROE track record. SCM’s ROE has consistently trended up from FY02. We believe this demonstrates its commitment towards delivering returns.

SCM is currently trading at a P/E of 11.0x/11.7x on FY09F/FY10F EPS. Given the slightly clearer outlook ahead, SCM’s trading valuation looks inexpensive, compared to its mid cycle historical P/E band of 16x, backed by its record backlog orders and quality deliverables. We derive our target price of S$3.04 (from S$3.02 previously) based on sum-of-the-parts valuation. We value SCM based on

• P/E of 16x FY10F earnings for its niche rig building/repair business sector
• SCM’s 30% stake in Cosco Shipyard Group (CSG)
• 4.98% equity interest of Cosco Corp’s share at Cosco’s Target Price of S$1.14. (based on our revised fair value estimate for Cosco)
• Applying a 15% discount, considering the near term risk from its customer.

Maintain BUY.

Sembcorp Marine: Unaware of legal proceedings

SCM unaware of legal proceedings brought upon by PetroRig I. Sembcorp Marine (SCM) made a press release last evening, expressing that its wholly-owned subsidiary, Jurong Shipyard Pte Ltd (JSPL), was not aware of an action by PetroRig I Pte Ltd against Jurong Shipyard over the termination of the construction contract for PetroRig I. JSPL added that it had not received any official notice of such US proceedings. Even if there was such an action, JSPL would firmly defend it as it believes it had acted properly under the terms of the construction contract. JSPL maintains that it would proceed with the sale of the semi-submersible, PetroRig I, as advertised, with the bids closing at noon on 20 May 09.

SCM remains confident it is able to sell PetroRig I. As we recall, SCM is currently in talks with three potential international drilling contractors for the sale of PetroRig I. While we believe JSPL is able to recover the final payment through the sale of PetroRig I, we remain concerned over the remaining instalments amounting to US$505m for PetroRig II and PetroRig III. We think the relationship between SCM and PetroMena may be strained as a result of this incident.

Nevertheless, SCM’s healthy balance sheet is able to take on the remaining capex. SCM is in a healthy net cash position of S$1.9b, of which S$1.2b is progress billing in excess of work-in-progress. Assuming a gross profit margin of 14% and outstanding work of 40% and 60% on PetroRig II and PetroRig III respectively, SCM requires cash of US$435m (S$653m) to complete the remaining works. We believe SCM’s healthy balance sheet will be able to take on the remaining capex on these two semi-submersibles. Maintain BUY, Target S$3.06.