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.)

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KS Energy: Fixed charter rates lend visibility in an uncertain environment

Volatility persists in oil prices. The price of crude oil has risen more than 50% this year, hitting a high of about US$73/barrel on 12 Jun 09. The correlation between oil and equity prices has also increased significantly since the financial meltdown last September. With an unwinding of the Armageddon scenario and improving investor sentiment, global risk appetite increased. This and various concerns about the strength of the USD with the huge amount of quantitative easing underway led to a weaker dollar, fueling higher oil prices. However, crude oil price seems to be facing some resistance currently with fatigue in the equity market, falling to about US$68/ barrel two days ago.

Looking for a real demand for oil. Demand for oil ultimately depends on economic recovery, and economic indicators are showing more positive signs in general. OECD composite leading indicators point to a slower pace of deterioration in most of the OECD countries with possible troughs in countries like China and the UK. The US Conference Board leading index of consumer expectations also improved significantly from a low of 50.5 in February this year to 69.4 last month. However, a proportionate increase in the demand for crude oil and oil products seems elusive. Demand from OECD countries for oil products remains low (Exhibit 1), though some form of stabilization is expected, if leading indicators sustain their upward trend.

Fixed charter rates. Jack-up day rates have been affected by lower oil prices, but KS Energy's contracts are based on fixed charter rates, so lower spot rates are unlikely to impact the group adversely for now, unless oil prices trend significantly lower and customers negotiate for lower rates. Things should be looking better for the group's customers with the recent recovery in oil prices.

Maintain HOLD. 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. As the current level of oil price is still unable to induce a full recovery in overall E&P activity and markets remain relatively volatile, we maintain our HOLD rating and S$1.36 fair value estimate on the stock. However, the inventory restocking of commodities by China and possible oil speculation by institutions may contribute to higher oil prices despite soft fundamentals, which would lend support to the stock price.

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.