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Morningstar | 2018 Will Be a Difficult Year for Sembcorp Marine, but Positive Outlook Ahead; FVE Cut to SGD 1.20. See Updated Analyst Note from 23 Jul 2018

Although we already assumed no-moat Sembcorp Marine, or SMM, would be loss-making in 2018, first-half 2018’s net loss of SGD 50.3 million versus net profit of SGD 42.2 million a year ago came in below our expectation. The disappointing earnings are largely attributable to the absence of disposal gain, decreased overall business activity, and the disposal loss of SGD 27 million from the sale of the West Rigel semisubmersible rig. However, we expect a sharp turnaround in 2019, when contributions from new orders kick in.  After fine-tuning our model, we reduce our fair value estimate to SGD 1.20 from SGD 1.26. The firm has decided to conserve cash, and it has declared no interim dividend versus SGD 0.01 a year ago. We think SMM remains overvalued, and Keppel Corp offers better value, especially after the latter’s share price drop due to concerns over Singapore’s recently introduced property cooling measures that we think will have minimal impact on Keppel’s real estate income.

Management guided that the firm will remain loss-making in the near term as key orders secured in 2015 are substantially completed while new orders secured since year-end 2017 are at early execution stage. In particular, new-build engineering, procurement, and construction, or EPC, projects have detailed engineering and construction planning phases that last six to 12 months. As such, there will be delays in revenue recognition and the firm will only reap the full benefits of its new orders in 2019. We note that the company’s operating losses have narrowed from SGD 45 million in fourth-quarter 2017 to SGD 29 million in second-quarter 2018.

There is no change in management’s guidance that the overall industry outlook remains challenging due to intense competition. Although capital expenditure has improved for the industry, it will take time to translate into sustained new orders, as the rig market remains oversupplied.

On a positive note, SMM indicates some initial interest in mid- and deepwater rigs, in line with Keppel Corp’s comments. SMM has secured SGD 730 million of new orders in first half 2018, but the pace trails our expectation of SGD 2.5 billion for full-year 2018. We reduce our projection to SGD 2.0 billion, given that new EPC projects for the production segment require significant time and effort in project codevelopment with potential customers before orders are secured. We expect new contract wins to increase to SGD 3.0 billion in 2019.

SMM’s net gearing ratio has further deteriorated to 1.28 times from 1.16 times in the previous quarter. Nonetheless, we expect it to improve gradually, given that the firm’s entire inventory of 10 rigs have been fully monetized and this should reduce liquidity risk going forward. In particular, the receipt of the remaining proceeds of about USD 1.0 billion from the 10 rigs sold should be able to support SMM’s working-capital needs.