More than just rig builders

by VINCENT WEE (24 Nov)

LOOKING at the one-year price charts of SembCorp Marine, Keppel Corp and the benchmark crude oil grade, a close correlation appears.

Both SembMarine and Keppel Corp hit highs of $4.61 and $12.34 respectively on June 2, when the price of crude oil was on an unprecedented uptrend and just a month before it hit an all-time high of over US$147 in July.

When the oil price started sliding below US$100 per barrel after that high point, the stock prices of the two counters followed suit. And when oil prices briefly spiked back up above US$100, the stock prices of the two counters mirrored this movement, albeit on a much smaller scale.

With oil falling below US$50 last Thursday, the prospects for the two counters look poor if investors were to assume that the correlation will hold. However, the fundamental question that needs to be asked is if that rationale for the correlation was valid in the first place.

Firstly, new order announcements have slowed, not stopped, in the second half. Keppel Offshore and Marine managing director and chief operating officer Tong Chong Heong was recently quoted as saying that the group had 'not yet reached a point of panic' because most of its projects were properly funded and the yards had work all the way till about 2012 to 2013 with a net order book of $13 billion as at Sept 30.

Trying to pin down an oil price at which continued investment in new rigs will stop is at best an academic exercise. But the fact remains that demand for oil will continue to rise and so will the demand for rigs needed to find that oil.

According to a recent report by Ocean Shipping Consultants, even in a low case (price) scenario, offshore oil production is forecast to increase by 39 per cent between now and 2020.

The other key fact is that even as oil demand increases, the supply of rigs will not keep pace. Over 65 per cent of the global mobile rig fleet is over 25 years old and should be due for scrapping but owners have deferred this due to high current charter rates. New building orders account for just 20 per cent of the current offshore rig fleet.

Secondly, while both companies are known as rig builders accounting for more than two-thirds of global newbuilds and while it seems that the big rig deals with impressive headline numbers have tapered off, it should be realised that this is not all that they can do. For example, each of them are also recognised ship repair and conversion yards in their own right.

In fact, the margins on some of the other less attention-grabbing jobs they undertake are actually better than the rig jobs. Repair and conversion jobs see average margins of 25-30 per cent while the usual margin on a rig newbuild is no more than 10 per cent.

Nonetheless, contracts continue to trickle in and the type of jobs being secured seem to be indicating just such a shift.

Keppel announced several conversion and fabrication contracts worth a total of $340 million last week. SembMarine's most recent contract for the first in a series of LNG carrier life extensions was just last month.

DMG and Partners analyst Serene Lim notes in a recent report on SembMarine that 'the repair and conversion business division is counter-cyclical in nature'.

'In this weak credit market whereby we could possibly expect slowing new order momentum, we believe this non-rig building segment is likely to bring in relatively stable revenue stream.'

' We noted that historically, these combined revenue contributions from repair and conversion projects had been increasing through these years, $1.4 billion in FY05, $1.5 billion in FY06 and $1.9 billion in FY07,' she adds, maintaining her 'buy' call and a target price of $2.49.

OCBC Investment Research's Kelly Chia, meanwhile, resumed coverage of Keppel with a 'buy' call also and a fair value price of $5.20.

-Research Report by VINCENT WEE (24 Nov)