SembCorp Marine - High expectations

We have revised up our FY10 and FY11 net-profit forecasts by 11.4% and 7.6%, respectively. We believe our new FY10 and FY11 non-rig-building revenue assumptions now better reflect that business’s relatively steady order-flow nature.

We maintain our 4 (Underperform) rating on the stock, and DCF-based six-month target price of S$2.06, as we believe that expectations in the market are too high and the stock is vulnerable to an FY11 earnings disappointment. We think the first catalysts would be two Petrobras orders: one for an eighthull winner-takes-all FPSO order and the other for six-to-eight semi-submersibles, both expected to be placed by the end of 4Q09. This catalyst may be a significant positive or negative, depending on if SembMarine wins any of these contracts.

SembMarine’s share price is up by 127.4% since 9 March 2009, compared with a 78.3% rise in the FSSTI and a 44.6% increase in crude-oil prices over the same period. While economic and market conditions have improved since 9 March 2009, we think that expectations in the market are too high for continued record-level earnings at SembMarine, and that the stock is vulnerable to an earnings disappointment.

Our key thesis is that we believe new rig orders will not come in fast enough and in large enough numbers to prevent idle capacity from having a significant negative effect on earnings in 2011. So how did we come to the conclusion that SembMarine’s revenue and earnings would be much worse than the market expects?

We continue to use a DCF analysis to derive our six-month target price, which is unchanged, at S$2.06. We use a WACC of 11.9% and a terminal growth rate of 1.2%.

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Sembcorp Marine: Cancellation of contract – Not a surprise

Cancellation of Petroprod’s contract. Sembcorp Marine (SMM) announced yesterday that its subsidiary, Jurong Shipyard has terminated its contract with Petroprod D&P I Ltd for the construction of a jack-up rig as a result of customer non-payment. We are not surprised over this cancellation. Our only concern is the amount that this jack-up would fetch in an impending sale, especially when the initial contract value of this jack-up is twice the cost of a typical jack-up at that time. Our ground checks indicated that the current value of a typical jack-up has fallen by at least 20% YoY. We are leaving our earnings unchanged as we have already factored in this cancellation in our earnings model. Our target price of S$3.74 based on SOTP valuation remains. Maintain BUY.

We are not overly surprised at this cancellation as SMM has previously hinted that it is not recognising the revenue of this jack-up even though work has commenced. In addition, SMM made an impairment charge of S$7.5m for its 3% stake in Petroprod in the recent 2Q09 results, implying signs of an amicable end to its contract with Petroprod. Our only concern is the amount that this jack-up would fetch in an impending sale. We recall that when this newbuild jack-up was first awarded in May 07, it was touted to be one of the world’s largest jack-up rigs to drill in harsh environment. The cost of this jack-up was a hefty US$442m, which was twice the cost of a typical jack-up then. Through our ground checks, we believe the current cost of a typical jack-up rig has fallen by at least 20% YoY. SMM stated in the press release that there are buyers who have shown interest and is confident that it will be able to receive all amounts it should have earned upon the sale of the jack-up.

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).

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 sumof- the-parts valuation methodology.

Sembcorp Marine - On-time deliveries puts stamp on track record

Sembcorp Marine has delivered a total of four jack-up rigs to its customers from December last year to June this year, all on-time or ahead of time, putting a stamp on its execution track record. This follows the seven jack-up rigs delivered last year (excluding December). On the semi-submersible front, following the delivery of the PetroRig1 to new owner Diamond Offshore, the group remains on track to deliveranother semi-submersible this year, with another three units per year in 2010 and in 2011.

On July 1st, the group announced that SeaDragon Offshore had awarded SMM’s Jurong Shipyard its second rig order, to complete (from a Russian-built new bare-deck hull) and deliver a Moss Maritime dynamically positioned (DP-3) semi-submersible drilling unit for US$237.3mn. This comes just three months after the group won its first US$247mn SeaDragon Offshore rig finishing contract. The second SeaDragon contract brings the group’s new orders to-date to S$964mn. However, management remains confident that more offshore rig and conversion contracts are in the pipeline, not just from re-directed rigs but also from national oil companies that are keen to exploit offshore territorial waters, based on the level of enquiries the group has seen. Petrobras in particular has been making active enquiries at the shipyards (in Singapore and in Korea) for new semi-submersibles and drillships for the Brazilian national oil company’s large deepwater finds in the Tupi and Jupiter fields. According to the group, Petrobras is still seeking to charter and tender for 28 new offshore rigs, whether semi-submersibles or drillships.

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%, with a zero terminal growth.

With FY09F and FY10F P/Es of 11.3x and 11.0x, SMM still trades at the lower end of its historical P/E band of between 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 4.4%, which are 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.

Sembcorp Marine - Sale of Petrorig-1 to Diamond Offshore

SMM confirms sale to Diamond Offshore Services Company; no price-tag announced: In a press release published after market hours, SMM confirmed the sale of the semi-submersible (Petrorig-1) to the highest bid, which was made by Diamond Offshore Services Company, a related company of Diamond Offshore Drilling. However, no details have been provided on the agreed-upon price, with sale expected to be completed by end-June 2009. As we have highlighted earlier, we expected limited risk with regards to SMM’s outstanding proceeds on Petrorig-1.

Cash-flow positive event although minimal incremental EPS impact: Given that SMM has outstanding of approximately US$220-230 million versus anticipated sale price of US$400-450 million, we'd expect SMM to easily recover its entire costs outstanding, profit margin on the asset construction as well as incidental costs incurred due to the bidding process. While this would be cash flow positive, we would expect to see minimal incremental impact on earnings as the company would have followed the percentage of completion, and we believe close to 90% of related project would have been booked as earnings till date.

Can we expect the same outcome for Petrorig-2 and Petrorig-3 in case PetroMENA is unable to pay outstanding proceeds? : With the sale of Petrorig-1 now largely complete, we believe the concerns relating to Petrorig 2 and Petrorig-3 should largely abate, even if PetroMENA is unable to meet the outstanding payments on both these rigs. While the Petrobras contract associated with Petrorig-1 may be renegotiated (as we understand the Petrobras rig contract at day rate of US$390k does not stand with the sale of the asset), we believe the current sale provides confidence of DO maintaining or possibly increasing day rate.

SembCorp Marine : Good Results but Catalysts Already in the Price

1Q09 results — Revenue reached S$1.4bn, (-16% qoq, +49% yoy), underpinned by strength from ship conversion/offshore (-25% qoq, +80% yoy) and rig building (-12% qoq, +57% yoy), thanks to a record delivery schedule this year. Ship repair was flat yoy while net profit reached S$120m, accounting for ~26% of our FY09 estimates. Gross margin was largely flat yoy despite an increased mix of offshore conversion projects during the quarter. SMM benefited from S$15m forex gain in 1Q09 (vs $6.3m losses in 1Q08).

Balance sheet — Net cash stood at S$1.9bn but operating cash flow deteriorated and reached $93m (vs. S$857m in 1Q08) due to higher working capital requirements. Capex commitment reached $26m and should increase to S$100-150m by end of the year.

Prospects — SMM now has S$8.4bn of orderbook to deliver till early 2012. Although macro outlook remains challenging, SMM does not rule out potential contract wins with Petrobras, particularly production units (fixed and floating). SMM is also targeting to forge more alliances to perform ship repair work with international shipping names (e.g., oil tankers). Currently, ~80% of ship repair revenue is generated from alliances.

Maintain Hold (2M) – SMM had executed well, capitalizing on the up-cycle, improving margins and visibility with record orderbook. However, the extent of the current downcycle and concerns over customer financing will continue to weigh on the stock.

Sembcorp Marine Ltd: Pricing for Hope

Good results. Sembcorp Marine Ltd (SMM) reported its 1Q09 results with topline came in at S$1.36b (+49% YoY, -16% QoQ). PATMI registered S$120.2m (+32% YoY, +73% QoQ). SMM did well when compared to a weak 1Q08 which had project revenue recognition timing issues. The group also experienced a better gross margin this quarter as it started reaping from the better priced contracts signed during the peak 2007-2008 phase. The group's net cash position stood at S$1.89b while order book stood at S$8.4b.

Repair activities seem peak-ish. SMM's ship repair activities seem to have come to a plateau with a net change in ships repair growing in the high single digits this quarter. While SMM iterates that a base load (~80%) of its repairs consists of exclusive agreements with major shipping/oil companies that are regulars at its docks, we are waiting to see if this should tail off as companies anchor vessels as demand for goods and raw materials slows down. A slew of LNG tankers coming on stream could affect SMM's repair of this vessel class as the recession takes demand off fuel.

No clarity with Petrobras… yet. Management has indicated that discussions with Petrobras are ongoing and are confident of some positive newsflow in the future. With about half of the 28 drilling assets slated to be semi-subs, it translates to about US$7.7b worth of orders (14 x US$550m). However, there is no clarity on the quantum and timing of contracts being discussed. The bug-bear issue with Petrobras is its requirements for the use of "local content" to sustain employment in Brazil's yards. SMM's jointly operated MacLaren yard is its only presence in Brazil. MacLaren is currently building a new dock (ready 2H09) capable of drydocking the largest of semi-submersible rigs.

Pricing for hope. We have upped our estimates in view of a more aggressive recognition of higher valued projects from FY07/08. However, SMM still has another S$1b worth of wins to catch up with our forecasts for FY09. Oil prices have run up in tandem with equity markets and we bump up our valuation peg to 13x FY09F PER (prev. 11x). While our fair value is now raised in tandem to S$2.65 (prev. S$2.02), we find the hope of the sustained oil price rise of the recent magnitude to lack fundamentals. As such, we are maintaining our HOLD rating.

PetroRig I acts to block rig sale by Jurong Shipyard

Jurong Shipyard's planned sale of a disputed rig could hit a roadblock after PetroRig I Pte Ltd filed an application before the bankruptcy courts in New York yesterday. The application is seeking a preliminary injunction restraining Jurong Shipyard, a unit of Sembcorp Marine, from selling the rig, and comes just hours before today's noon deadline for interested parties to submit their bids. In a brief statement issued to the media, SembMarine said the application was fixed for hearing yesterday at 10am in New York (10pm Singapore time). 'Jurong Shipyard has sought and obtained legal advice and will vigorously resist the application filed for hearing in New York. Jurong Shipyard has also received a copy of the complaint filed by PetroRig I seeking protection under US Chapter 11 procedure,' it said. SembMarine added that Jurong Shipyard was advised that the application is 'without merit' and that it will resist the action on various grounds, including the jurisdiction of US bankruptcy courts over a company incorporated in Singapore'.

This latest twist in an increasingly complicated saga comes just after SembMarine said on Monday that it was unaware of 'any injunction of any kind' restraining Jurong Shipyard from proceeding with the rig sale. SembMarine also said then that it was unaware of a lawsuit filed against Jurong Shipyard by PetroRig I over the termination of a rig construction contract. PetroRig I sought bankruptcy protection on Sunday and was said to have launched a lawsuit against Jurong Shipyard, which it had hired to manufacture its US$464 million oil rig. PetroRig claimed that the shipyard attempted to deliver an 'incomplete and inoperable' rig. On April 29, SembMarine said Jurong had terminated the contract with PetroMena - an oil services group in Norway - because the final payment had not been made and planned to sell the rig to recover money owed.

PetroMena's three Singapore subsidiaries - PetroRig I, II and III - entered into agreements to build three ultra-deepwater semi-submersible drilling with SembMarine. The rigs were scheduled for delivery from Jurong Shipyard in April 2009, September 2009 and January 2010. PetroMena has since struggled to come up with adequate financing to complete construction of the rigs, which have previously been assigned five-year drilling contracts. In its earlier statement on Monday, SembMarine maintained that Jurong Shipyard was confident it would be able to sell the rig and to recover all outstanding amounts owed to the shipyard. As for what happens next, SembMarine said things would have to wait until the hearing in New York is over. 'Sembcorp Marine will make the necessary announcement at the appropriate time of the development of the proceedings.'

SemMar - Offshore remains strong, on established orderbook

SMM posted 1Q09 profit of $S$120.2m, up 31.6% versus 1Q08, on the back of a 48.8% rise in turnover to S$1.36bn. This strong showing was despite the shortfall in associate contributions from Cosco Shipyard Group, which reported disappointing earnings earlier in the week. Despite this, SMM’s operational results were in line with expectations.

Revenue was driven by the rig-building segment, which posted a 56.9% increase to S$759.5m. Offshore and conversion also rose 80.4% to S$401.0m. Both segments reflect SMM’s strong orderbook for offshore oil and gas. EBIT margin at 10.7% was flat versus 1Q08, but weaker versus FY08’s 12.9%. This is in line with SMM’s portfolio of higher value turnkey projects, as well as recognition differences, but is still extremely healthy.

SMM’s current orderbook stands at S$8.4bn stretching to 2012, lower than the S$9.0bn as of end-FY08. SMM only secured S$378m in new orders for the quarter, in line with the uncertain credit and economic environment. We do not expect a quick resumption of orderbook growth, despite an improving credit environment. In fact, we expect customer risk to increase further, as evidenced as by the recent bankruptcy of Petroprod and the non-payment by PetroMena.

We are adjusting our FY09 net profit forecast down by 4.8% to S$497.0m from S$522.0m previously, to factor in the weaker contributions from CSG. While 2-yr earnings CAGR is still a healthy 12.7% p.a., we expect turnover to taper off from 2011 onwards, and the risk of more orders being delayed or cancelled. Despite continued interest in the deepwater segment, we do not see this translating to orders in the near term.

We are adjusting our price target to S$2.31 from $2.07 previously, based on higher shipyard multiples in our sum-of-the-parts valuation. However, we believe that valuations have run ahead of fundamentals in this current liquidity-driven market rally. We are reducing SMM to a Sell, as current share price exceed our target by 19%. With a less attractive dividend yield of 4.7%, shareholders are not fully benefiting from SMM’s current earnings strength.

SembCorp Marine: Not a one-way street yet

Margins held up well in 1Q09. SembCorp Marine’s (SMM) EBIT margin rose 2.2ppt y-o-y to 9.9% in 1Q09, resulting in S$134.6m EBIT (+69% y-o-y). SMM’s net profit in 1Q09 was US$120.2m (+32% y-o-y), in line with our expectation. The lower net profit growth was due to smaller contribution from associates, as Cosco Shipyard Group’s (CSG) net profit dipped 58% y-o-y to S$13.3m. Our FY09 net profit is cut by 2% to S$468m, due to lowered projection for CSG’s earnings.

Sale of Petrorig 1 is going on smoothly. SMM guides that there were active enquiries on its sale of Petrorig 1, despite the requirement for each bidder to put US$15m deposit before proceeding further with the bids. The potential selling price for the rig is US$450m, and we believe that the results may be known by late May.

Downgrade to HOLD. SMM’s share price has also done well (+28%) since we commenced our 3-week Asia roadshow on 22 April, outperforming Keppel Corp [FULLY VALUED, S$4.41] by 10ppt. We now believe that even SMM’s share price is no longer cheap, despite: 1) Our contrarian view that order cancellation risks are dissipating, and 2) Our earnings model having factored in one of the highest new order win (S$3b) in the streets. We downgrade SMM to HOLD. Our new fair value is S$2.61, factoring in higher share price target for Cosco Corp [FULLY VALUED, S$0.85] in our SOTP valuation metric for SMM. The key catalyst for future upgrade remains the lifting of credit crunch, which would release the lid on the new orders for floaters.

Sembcorp Marine Ltd: PetroMena defaults on final payment for first rig

Customer crumbles under financial pressure. Sembcorp Marine's (SMM) customer, PetroMena, has defaulted on the final payment of US$228m for its 6th-generation semi-sub PetroRig I. PetroMena, largely controlled by Larsen Oil & Gas, has been under pressure to obtain financing to pay for its large capex outlays that it placed when the economy was in its bull run and oil prices were rapidly rising. With the default, SMM now owns the rig and has announced that it will sell the rig in the open market. However, SMM is contractually only entitled to what is equitably theirs (ie. contract value of rig + misc), and not to the entire proceeds of the sale.

Confident of a buyer. We are confident that the rig will find a buyer because: 1) The rig is immediately available (has MOU for offer at US$450m) and possesses >10,000ft drilling capability. Typical semi-sub build times range from 2-3 years and have a plethora of risks like equipment delays etc. 2) Rig prices are still high - current 6th-gen deepwater semi-subs are still changing hands at ~US$650m (source: ODS-PetroData, Mar 09). Even if SMM sold the rig at a discount, we believe it would be able to cover costs and make a profit. 3) Petrorig I is non-speculative - operators who are keen on deepwater operations will be able to reap immediate benefits as the rig comes with a 5-year contract from Petrobras with day rates of US$395k/ day.

What about the other two rigs? SMM is still constructing Petrorig II (delivery: Sep 2009) and Petrorig III (delivery: Jan 2010). As payments for these two rigs are not in default, SMM is still obliged to continue building them and will endeavour to deliver on time to prevent any reason for cancellation. Payment defaults (like for Petrorig I) are effected when payments are not received two weeks after contract completion. There is an MOU between a buyer and PetroMena for the sale of Petrorig III at US$540m. The depressed prices offered for these brand new 6th-gen rigs are much lower than usual in view of the distressed situation that PetroMena is in (see exhibit 5).

No losses expected for SMM. When the rigs are finally sold, SMM will take the portion due to itself and remit the rest back to the bondholders of the rigs. As such, we do not expect changes to the original estimates that these rigs will bring to SMM. We are maintaining our HOLD rating and fair value of S$2.02.

SembCorp Marine: Concerns overblown

Downside risks from Petromena protected. SMM has terminated the contract for PetroRig I as Petromena has failed to fulfill its final payment. We believe downside risk is limited as SMM is confident of selling the rig given that a) the rig is a proven design b) about 50% of the payment has been collected c) there are 3 ready buyers for this rig with an MOU signed for US$450m. As for Petrorig II and III, risks for these contracts are cushioned by the fact that they are backed by charter contracts and Petromena has signed an MOU for Petrorig III at US$540m, above Petrorig III's contract price of US$524m with SMM.

Petrobras expected to hand out contracts soon? Petrobras awarded contracts for 12 rigs last year, but still needs 28 more deepwater units over the next 5 years to help it meet its ambitious production targets of 2.7m bpd by 2013. We have assumed new contract wins of S$3bn this year, which we believe is achievable, on the back of credit crunch easing from 2H09, as well as uncompleted contracts from other shipyards facing financial difficulties.

BUY Maintained. Maintain BUY rating on SMM, target price maintained S$2.57, using normalized early cycle FY09 PE of 13x for ship repair and 11x for offshore construction and 3x trough valuation PE applied to Cosco Shipyard Group's business. SMM remains our top pick in the oil and gas sector, a key beneficiary of the frimer oil price with potential for earnings upgrades.

SembMar - Customer defaults on final payment for semisubmersible

Sembcorp Marine has announced that it has terminated the contract for the recently completed semi-submersible rig, PetroRig I, originally built for PetroMena, as final payment was not made under the construction agreement. In accordance to its rights under the contract, SMM will now proceed to sell the rig in the open market.

The rig is a 6th generation ultra-deepwater semi-submersible rig, capable of operating in 3,000 metres water depth and harsh environment drilling conditions. The contract was originally secured in October 2005 and was valued at US$423m. We understand that the final payment outstanding amounts to around US$200m.

SMM says it is confident that it will be able to sell the rig and to recover all outstanding amounts owed to the shipyard, and that the event will not have any material impact on SMM. We believe that SMM will be able to secure a good price for the rig, as demand for deepwater assets still remains relatively buoyant. We estimate that the rig would be worth around US$550m, in the current market.

We also clarified with SMM that if it is able to secure a better market price for the rig, it will not be entitled to an extraordinary gain – it is only allowed to recover its contract value as well as administrative and legal costs, with the surplus to be returned to bondholders who are financing the rig building.

In addition to this rig, SMM had subsequently undertaken another 2 semisubmersibles newbuild contracts from Petromena, with the same specifications as PetroRig I. These are due to be delivered in September 2009 and January 2010 respectively. The second contract was secured in March 2006, with a value of US$480m, and the third was secured in Jan 2007 for US$524m. However, despite the default on Petrorig I, SMM is obliged to continue construction work on these other 2 projects, as these contracts itself are not in default. Essentially, the non-payment on the first rig by the same customer has no legal bearing on these contracts, as they are considered separate. SMM has already secured a 50% payment for the two rigs, and will be entitled to dispose of these rigs in the same manner as the first rig, in the event of non-payment. We will keep tabs on the progress of these two other rigs.

While this incident demonstrates that SMM has protected itself against payment defaults, the situation still increases the risk burden on SMM, as it is now subject to market pricing of these assets in order to secure payment. This incident reinforces our cautious outlook on the offshore sector. We are maintaining our Hold recommendation on SMM, with a target price of S$2.07.

Sembcorp Marine - Rig order from start-up SeaDragon, increasing order book risk

Sembcorp Marine secured a US$247m semi-submersible drilling rig order from start-up UK-based SeaDragon Offshore. The rig hull, which has been built in a Russian shipyard, will be shipped to Sembcorp Marine’s shipyard by this month, and Sembcorp Marine will complete the topside rig construction by end-2010. The SeaDragon Offshore I semi submersible rig (SDO I “Oban B”) had been chartered to Mexico’s national oil company, Pemex for a period of five years, now delayed vs. the original target starting 1Q10.

According to our industry checks, Tees Alliance Group was supposed to construct the topside in Haverton Hill shipyard in Teesside, UK, with the support of international drilling contractor KCA Deutag (part of The Abbot Group). The order by SeaDragon was significant for the UK, as it would have been the first rig to be constructed there after many years. However, despite the consortium completing a quarter of the rig already, industry independent news provider Upstream reported that SeaDragon apparently pulled the contract in favor of Sembcorp Marine after a UK bank withdrew its asset funding. While the market may view the order win favorably, especially given that Sembcorp Marine had none in 1Q, we remain cautious. Little is known about the start-up SeaDragon, other than its rig contract win by Pemex, as well as another rig hull under construction; Bloomberg also reported in early Sep 08 about an aborted sale of SeaDragon to Indian-listed Great Offshore. We are concerned about order quality, as we see potentially higher order book risk with the start-up order win and believe that financing could be an issue.

Retain Sell (on Conv list); our 12m P/B-based TP of S$1 implies 53% downside. Valuation appears rich at 2009E P/BV of 2.9X, vs. historical avg of 2X, trough of 1X, and est. forward 3-year earnings CAGR of -12%. We remain negative, as we see sharply lower new orders this year (forecast US$500m), given weaker industry fundamentals. Key risk: Higher oil prices and new orders.

Sembcorp Marine Ltd: Wins first new build contract

US$247.m new build contract win. Sembcorp Marine (SMM) has secured a rig order from Gander Drilling Limited, a wholly-owned subsidiary of SeaDragon Offshore Limited, to complete and deliver a Moss Maritime Full Dynamically Positioned (DP-3) Semi-submersible drilling unit with an option for an additional unit. SMM will complete the build after the bare-deck hull arrives (latest by Apr 2009) from a Russian shipyard which constructed the hull. SMM has experience with bare-deck hulls from a similar contract with Noble Drilling in May 2007. This semi is scheduled for delivery by end 2010.

Financial reasons to like it. This contract is not a speculative build as it comes with a US$958m five-year contract with Mexico's National Oil Company, Pemex. A check with industry research site, Rigzone, indicates that the rig has full asset financing arranged by Lloyds TSB Bank. Moreover, SMM has received a deposit for the rig as well as a "favourable schedule" of regular payments. This reduces the risk of bullet payments and will smoothen out the contribution to SMM's earnings.

Operational reasons to like it. Rigzone has also indicated that the original yard slated to finish the work was to be the Haverton Hill Yard. In obtaining this contract (and its option for the second rig) from Haverton Hill, SMM effectively authenticates its strength as one the leading rig yards in the world, providing on-schedule, on-budget deliveries of new generation rigs. While SMM has not constructed this particular rig design, it has experiencewith finishing bare-hulled jobs, evident from its May 07 contract with Noble Drilling. Completing this project will add another feather to its cap for building experience in an array of rig models. To top it off, SeaDragon is a new customer.

Better sentiments but remain cautious. This win puts some ease into our estimates but SMM still has another S$1b worth of wins to catch up with our forecasts for FY09. We have bumped up our valuation peg to 11x FY09 PER (prev. 10x) as positive sentiments on the Oil and Gas sector have somewhat returned. While our fair value is now raised in tandem to S$2.02 (prev. S$1.85), we remain cautious on the 68% rise in share price since its low on 3 Mar 09. As such, we are downgrading our rating to HOLD, purely based on valuations. Sustained rise oil prices along with an accelerated pace of contract wins will incentivise us to nudge our valuations upwards.

Sembcorp Marine Maintain UNDERPERFORM on First contract win for the year meets 12% of our FY09 new contract win forecast

Sembcorp Marine has secured a US$247.3 mn (S$371 mn) order to complete topside integration and commissioning of a semi-submersible drilling rig for SeaDragon Offshore.

This is a re-award of SeaDragon’s 2006 contract with Haverton Hill yard in the UK. While this re-award acknowledges Jurong’s rig-building expertise, it is not necessarily an indicator of a recovery in rig-building demand.

This is the first offshore rig contract for the Singapore yards this year. Although encouraging, it only fulfils 12% of our S$3 bn new contract wins assumption for Sembcorp Marine.

The project, expected to be completed by end-2010, has shorter duration than 36-40 months for a typical semi-sub contract. As a result, our FY09 EPS estimate is revised up by 3% while FY11 estimate is lowered by 2% on higher shorter revenue recognition.

There is no change in our target price of S$0.95 (2008 P/B 1.5x) or our UNDERPERFORM rating. SMM’s premium to peers’ P/B valuation is not supported by its weak customer profile and demand outlook.
Cayman Island-based SeaDragon was founded in 2006, its principal asset comprising two semi-subs under construction. The hulls for these rigs are being built in Russia. Topside integration was to be completed at Haverton Hill yard in the UK but SeaDragon has now re-awarded the contract for Rig 1 to SMM, with an option for Rig 2. Rig 1, managed by Vantage Drilling, has a five-year charter contract with Pemex at approximate day rate of US$503,000, with total contract valued at US$920 mn in revenues. Rig 2 is a speculative build. There is no financial information available on SeaDragon. The hull of the vessel, built in a Russian yard, will be delivered to Jurong by April 2009 and the completed unit is scheduled for end-2010 delivery.

This is the first major win for SMM and the only rig contract win for the Singapore yards this year. While the re-award of this contract testifies to Jurong’s rig-building expertise, it does not necessarily represent a recovery in rig-building demand. In any case, the S$371 mn contract represents 12% of our S$3 bn new contract win assumption for SMM. Another S$2.63 bn in new contract wins is needed to meet our current estimates.

Our 2009 revenue and earnings estimates are raised by 3% due to shorter completion of this project relative to SMM’s typical rig-building contract duration. Our 2011 estimates are lowered by 2% because of the earlier revenue recognition on this project.

Fundamentally, there is no change in our view on SMM or the sector outlook although this may be short-term positive for sentiment. We believe that SMM’s valuation premium on P/B is not supported by its weak customer profile (cancellation/default risk) and demand outlook.

SembCorp Marine - Sell: Some Signs of Relief against Order Book Capitulation

Another proposed rig sale — SMM customer Petromena (PM) signed an MOU with an undisclosed international drilling contractor to sell PetroRig 1 (PR1) for US$450mn (20% discount to contracted build price of US$562mn). This news came on the back of recent disclosure that PM received a US$540mn conditional bid for Petrorig 3 (PR3), a 14% discount to contracted build price of US$627mn. PR1 and PR3 have underlying charters to Petrobras (US$390k/day, 5 years) and Pemex (US$515k/day, 5 years) respectively.

Financing woes — By selling PR1 at 20% discount despite the attractive build price secured in Aug-05 (mid-phase of the rig up-cycle), PM is clearly facing difficulties in the market. This sale could also be triggered by PM failing to meet a bond loan agreement requiring it to raise another US$50mn of equity by 13-Mar-09 (source: Oslo Bors), for which grace period has been extended until two days' written notice is served, as PM assesses its funding options.

Funding woes may ease — Our Feb-16 report highlighted that Petromena’s funding shortfall of US$300mn for three semi-subs may be plugged if PR3 is sold, as this would free up ~US$228mn additional cash, which is sufficient to plug the funding gap for all the three semi-subs under construction. So far, there has been no update on the status of the offer for PR3. Alternatively, if PR1 is sold, funding woes will ease though shortfall of ~US$55mn remains.

PetroProd Bond “Event of Default” — In a separate announcement on Oslo Bors, PetroProd (PP), another SMM customer related to PM, failed to meet a bond loan agreement requiring it to raise another US$45mn of equity by 13- Mar-09 (including grace period), triggering an "Event of Default" under the agreement. PP has outstanding orders at SMM consisting of 1 FPSO conversion (which has been sold) and one harsh environment jack-up rig (without charter). Outstanding capex on the jack-up is US$258mn with expected delivery in 3Q10.

Sector indications — The start of de-leveraging among cash strapped players exiting the market could have mildly positive implications on rig builders: in our view, transferring rig assets under construction to owners with stronger balance sheet strength could protect order book and earnings, and mitigates the extent of potential order book capitulation. We believe more distressed sales will follow, but limited to rigs with charter contracts.

Sembcorp Marine - Disappointing dividend payout ratio

SMM recorded a FY08 profit of S$429.9m, which was below our and market expectations of around S$440m. While headline earnings indicate a 78.4% jump, stripping out a charge of S$44m and FY07’s S$303m charge, (both related to the forex transaction losses), earnings was still up an impressive 31%.

SMM’s turnover grew 21%, with rig building up 14%, and conversion up 20%. Gross margins reached a record of 16.2% in 4Q, and 12.9% for the full year, resulting in gross profit growth of 59.2%. However, in addition to the expense mentioned above, SMM also took a mark-down its Cosco shares and adjustments on foreign currency forward contracts, totalling over S$50m. Associate earnings also posted a loss of S$42.5m in 4Q, due to the weak performance CoscoShipyard Group.

The most disappointing aspect of these results is SMM’s decision to limit its final dividend to 6 cts per share (11cts for the year), despite the rise in earnings, thereby reducing its payout ratio to just 50%, versus 75% in FY07. SMM explained this as prudence in current economic conditions, and conserving cash for potential acquisitions, without being specific. SMM’s current net cash position stands at S$1.8bn, of which we estimate S$1.4bn is customer deposits.

Going forward, SMM will continue to convert on its current orderbook of S$9.0bn stretching to 2012, with good margins. While earnings 2-yr CAGR is a healthy 11% p.a., we expect turnover to taper off from 2011 onwards, with order momentum slowing, and the risk of some orders on hand being delayed or cancelled. SMM has attributed the lack of new orders to the tight credit market, with offshore’s fundamentals being intact. However, we are less sanguine on the health in demand.

We are cutting our price target to S$1.74 from S$2.40 due to the lower dividend payout, which effectively cuts FY09 yield from 13% to 9%. With a cyclical downturn expected to impact growth past 2011, the reduced payout means that shareholders are not able to at least fully benefit from SMM’s current earnings strength. We maintain our Hold recommendation.