Published December 6, 2008

Sector In Focus
Yards in rough waters...

Contrary to optimism, cancellations and order reviews begin to surface as downturn bites. By Vincent Wee

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SOMETHING'S gotta give - and it did, despite the constant refrain from many shipyards that they saw no order cancellations on the horizon. Keppel Corporation got the ball rolling last week by announcing some $1.2 billion worth of orders worth 9.6 per cent of its order book was 'under review'.
BULK CARRIER
While some bigger China yards are trying to move into the higher value added offshore and marine sector, most are still involved in the dry bulk carrier market

China-based yards JES International and Cosco Corp (Singapore) followed in quick succession earlier this week. JES on Monday said it had written to South Korean customer Parkroad Corp to check on the status of deals signed to build four dry bulk vessels after news reports on the Korean company's financial position. On Wednesday, Cosco reported that its Cosco Dalian unit had received order cancellations for two out of an original order for five bulkers signed last July.

The two other major listed yards that have maintained an ominous silence are Sembcorp Marine (SembMarine) and Yangzijiang. Sentiment was hit not so much by the announcements themselves but by the fact that after so many months of denials by shipyards, it now appears their position is not as secure as they made it out to be.

Right up to the last round of third-quarter results briefings, companies were staunchly defending their order books, chiming the familiar refrain of 'good clients' in some shape or form.

All this against the backdrop of what analysts and other industry watchers knew was happening on the ground was an exceptional blow to shipyards' confidence when something really did give as it had to ultimately. For example, with SembMarine sharing a massive Sea Drill order tranche with Keppel in June, it must be plausible that if Keppel's orders with this client are hit, SembMarine's should shortly follow.

The market's reaction was swift. Last Friday, Keppel shares lost 60 cents or 12.5 per cent in the wake of the news and by yesterday it had lost a further 39 cents or about 9 per cent more from that level to close at $3.81. SembMarine fell 17 cents or nearly 10 per cent last Friday and closed 14 per cent lower from that level again at $1.37 yesterday.

Before analysing the likelihood of any actual cancellations and the future impact on the companies, it is important to differentiate between the sectors they are involved in. A distinction must be drawn between predominantly oil and gas industry-linked Keppel and SembMarine and the rest.

Although they have recourse to other revenue streams, the market perception is that the former two's fortunes are expected to mainly rise and fall with that of the oil industry because the headline numbers of the contracts are so large. This being so, the sliding oil price and the prospect of the loss of these potential revenues are especially worrying to investors.

Citigroup yesterday cut its rating for Keppel to a 'hold' from a 'buy' and lowered SembMarine to 'sell' from 'hold'. Citi said a 10 per cent drop in orders will lead to a decline of between 4 and 6 per cent in 2010 earnings. 'A sharp decline in oil prices, higher funding costs, difficulties in obtaining financing, and the influx of additional supply from the recent rig building boom will continue to result in sharper-than-expected exploration and production cuts,' Citi's analysts said.

DBS Research meanwhile in a report released last Friday has a slightly more optimistic view of the market and makes a distinction between the two big rig builders. 'We see the re-scheduling of payment structure or vessel delivery dates as more likely scenarios, as they address the cash flow issues faced by clients,' DBS said.

Diversified customer base

In addition, it sees Keppel as having a more diversified customer base, with 44 per cent of total secured orders for delivery after year-end exposed to its top three customers while the corresponding figure for SembMarine is 55 per cent. The order portfolio is also seen making a difference, with DBS seeing 34 per cent of Keppel's secured orders being exposed to delivery delays with SembMarine's probable delays being around 43 per cent. This is based on DBS' view that jackup rig deliveries from the second half of 2010 and semi-submersible rig deliveries from the first half of 2011 have a higher probability of being delayed, with an estimated less than 30 per cent of cash flow per contract collected by end-2008.

DBS has downgraded Keppel to 'fully valued' with a fair value of $3.58 and SembMarine to 'hold' with a fair value of $1.90.

The picture with the China yards is somewhat different though not particularly bright either. While some of the bigger ones such as Cosco are trying to move into the higher value added offshore and marine market, the majority of them are still plugging away at the entry-level dry bulk carrier market.

With dry bulk freight rates already down more than 90 per cent from their highs earlier this year and forecast to stay at current low levels last seen during the Asian Crisis, Cosco's order cancellations are unlikely to be the first or the last seen in the months ahead. The tremendous oversupply caused by imprudent over-ordering of ships during the dry bulk boom earlier this year combined with the deepening credit crunch which has all but frozen the flow of commodities will inevitably cause the closure or restructuring of many dry bulk players.

This will continue to weigh on the yards as the shipping downturn bites. But because negative sentiment on S-chips (stocks of China companies listed in Singapore) has already taken its toll on the valuations of these counters, the impact on the yards' stock prices seems to be limited for now. In fact, Cosco rose nine cents to 85 cents after releasing its cancellation announcement and yesterday ended the day at 87 cents.