STX OSV HOLDINGS (DMG)

BUY
Price S$1.19
Previous S$1.89
Target S$1.89

Offshore & Marine
STX OSV is a global shipbuilder of offshore support vessels (OSV) used in the offshore oil and gas industry.

Riding the upcycle for OSVs; re-iterate BUY

Order ou tlook improving; top pick in the mid-cap space. Our roadshow with STX OSV in Europe last week left us feeling positive on the company‟s ability to capture more new orders for offshore support vessels (OSV) and execute the projects well. Proper risk management is in place to avoid the problems faced in 2007-08 (which lead to losses) and we believe margins will stay relatively strong vs. historical trend of 8-9%. We made minor adjustments to our model: (1) we keep FY11F EPS estimate intact; (2) lower FY12 EPS estimate by 2% as initial billings from the new yard in Brazil could be slower than we expected; (3) raise FY11-12F dividends forecasts from S¢3.5 to S¢5.5 based on its minimum payout of 30% net profit. We also introduce FY13F numbers. We forecast +12% EPS CAGR over FY10-13F. Re-iterate BUY with an unchanged TP of S$1.89 based on 11x FY11F core EPS. Stock is now trading at 6.9x FY11F core P/E and offers 4.6% yield (new estimate).

Strong order book for the next two years. Based on our estimates, STX OSV has an unbilled order book of NOK17.5b and sufficient to keep the yards busy for the next two years. We think investors have not fully appreciated the improving business outlook for STX OSV given slow order wins in 1Q11. Order wins have picked up in 2Q11 with contracts for seven newbuilds vs. three in 1Q11 and we are positive that order flow will be stronger in 2H11 as vessel owners have turned more bullish on charter rates in 2013 and spot charter rates in the North Sea is rising. STX OSV is also well placed to win Petrobras-related newbuild orders due to its strong local presence in Brazil. Second yard in Brazil (50.5% owned) will start operation in 2H12 and will add 25% new capacity when fully developed in 2013.

Earnings outlook: We expect +12% EPS CAGR over FY10-13F mainly driven by higher topline while expecting EBITDA margin of 11.0-11.5% (1Q11:13.8%). Based on our sensitivity analysis, every 1% improvement in EBITDA margins vs. our base assumptions (FY11F:11.5%, FY12F:11.0%) will lift our EPS estimates by 9-10%.

Highlights from Europe Roadshow

Relationship between STX OSV and STX Group/STX Europe

What is the relationship between STX Group and STX OSV?
STX Europe, a wholly owned subsidiary of the STX Group, holds 69% stake in the company after the IPO in Nov 2010. Representatives from the STX Group have three seats on the Board of Directors out of the total six seats.

Why did the company choose to list in Singapore?
Management explained that the rationale behind the listing in Singapore was due to: (1) high number and attractive valuations of offshore & marine companies listed on the SGX; and (2) strong understanding of the offshore support vessel market.

Is the STX Group involved in day-to-day operations?
In its day-to-day operations, we understand that STX OSV operates independently from the STX Group. The executive management team is led by its CEO, Roy Reite, and has remained stable from before STX Group became an owner of the STX OSV group.

Cost structure, order book and margins

What is the cost structure of the vessel projects?
The main cost is the equipment cost which account for 55-60% of the total cost. Steel cost is marginal and only represents around 3-5% of the total cost.

What are the payment terms and currency of a typical newbuild contract?
Contracts for newbuilds are usually on fixed price basis and denominated in Norwegian Krone (NOK) except in Brazil whereby contracts are mostly denominated in US Dollars.
Payment terms are typically 20% during construction and 80% upon delivery. The 20% payment during construction is split into four payments of 5% each. Usually there is a risk contingency of 1-3% built into the newbuild contracts that will be released in the profits upon completion.

What is the order size and completion period for each type of vessels?
Pricing can be different for different risk assumed for the project and client profile. A typical platform supply vessel (PSV) contract can range between US$45-80m and a newbuild contract for an offshore subsea construction vessel (OSCV) can be worth more than US$200m.
For PSV, the construction period is the shortest at 13-14 months, followed by anchor handling tug and supply (AHTS) with construction period of 15-18 months and for OSCV, construction period could be more than 20 months.

What is the order outlook for high-end newbuilds?
Enquiries for newbuilds have improved significantly in the past three months. YTD, STX OSV has secured newbuild contracts for ten vessels – seven PSVs and three MRVs (Multi-Role vessels). MRVs are essentially similar to PSVs but may be equipped with other equipments to perform additional work such as limited seismic work, lifting capability (with crane) and remote operating vehicle (ROV) support.
In our view, the market appears to show renewed interest for AHTS and OSCV lately – in the mid-segment of the vessel market, ST Engineering has just won a S$171m (US$139m) contract for four deepwater AHTS from Swire Pacific while Ezra Holdings is looking to build a US$300m DP3 ice-class subsea construction vessel called Lewek Constellation. We believe STX OSV is well positioned to capture more new orders in 2H11. We estimate that STX OSV has an unbilled order book of NOK17.5b, sufficient to keep a high work level at its yards for the next two years.

Are the margins better for any particular segment i.e. AHTS, PSV or OSCV?
In general, no single product commands better margins. However, better margins can be attained when there is more customisation work involved.

Are the margins better for yards in Brazil, Europe or Vietnam?
STX OSV does not provide segmental breakdown for the yards in the respective countries. From our own understanding, we believe that the margins in Brazil and Europe are on fairly similar level given the yards in Europe have showed better execution due to optimisation of work split and seamless integration between the yards in Norway and Romania. We think margins for vessels delivered from Vietnam are lower than Brazil/Europe as the yard is still in the ramp-up stage but we believe the Vietnam yard has the highest upside potential for improvement due to lower labour cost.

What is the current yard capacity and future new capacity?
The company can deliver 24-25 vessels per annum but this is dependent on the type of vessels being built. From a revenue standpoint, STX OSV can generate around NOK12b revenue per annum and we believe that the company can squeeze out some incremental revenue from its existing yards. The Vietnam yard has the capacity to build 3-4 vessels per annum and is now running at 2-3 vessels run-rate. The second yard in Brazil (50.5% owned by STX OSV and 49.5% owned by Brazilian partners) will add 25% capacity when fully developed over the next two years.

Update on Brazil

Capital expenditure for the second yard in Brazil
The second yard in Brazil (50.5% owned by STX OSV and 49.5% owned by Brazilian partners) will cost US$105m and the yard investment will be funded by 25-30% equity and 70-75% debt. Based on 30% equity funding, we estimate that STX OSV‟s cash outlay for the new yard is estimated at US$15.9m. The financing for the new yard is backed by FMM (Merchant Marine Fund) and is expected to have debt tenure of 15-18 years with a USD-denominated fixed interest rate of 4-5%.

When will the second yard be ready for commercial operations?
The yard in Brazil is expected to start commercial operation in mid 2012. Environmental license was granted on 30 March 2011. As part of the new yard start-up, STX OSV has entered into an agreement with Transpetro to build eight LPG carriers for a total value of US$536m (NOK3b) which will be made effective after financing approval from Brazil‟s FMM.

Why did STX take on the contract for LPG carriers and will it have lower margins?
Management admit that the LPG carriers are outside the company‟s core expertise but are necessary to kick-start the investment in a new yard. They believe they have the necessary skills to complete the project given the complexity level is lower than OSVs. The contract will provide work for the yard in the initial years as the eight vessels are expected to be delivered between 2014 and 2016.

Will the LPG carriers come with lower margins?
Management believe that the LPG orders will not necessarily dilute the existing margins. Additionally, the client will take the risk of steel prices and the contract comes with elements of adjustment for labour cost.

Competition from other yards

Who are the main competitors?
Main competitors are yards in Norway such as Kleven Maritime, Havyard and Ulstein. STX OSV is the only high-end yard with global presence in four different countries.

How does STX OSV stay ahead of the upcoming yards in Asia?
Innovation is key to their ability to stay ahead of competitors. STX OSV is primarily focused on the high-end segment and has a knowledge driven culture to improve the design of a vessel from time to time and bring new products to the market. New vessels built today are not the same ones built five years ago. In our view, most Asian yards are generally pure shipbuilders without in-house design capabilities. We believe most of the high-end vessels constructed at Asian yards are few years behind in terms of new technology.

Will there be any sell down by the parent company?
Obviously the most common question posted to the management given rumours in the market that the parent company is looking to sell down more of its own stake.

On potential selldown by STX Europe?
STX OSV is not aware of any firm plans by the STX Europe to selldown their stake in the company. We believe that the STX Group will want to keep majority control of the STX OSV, and we would not rule out a further selldown of 18-20% stake by the parent company given STX OSV‟s share price has risen 51% from its IPO price. We think the concern over a potential selldown is overblown and improving fundamental in the high-end newbuild sector will continue to drive share price re-rating.

When is the lock-up period over?
The “First Period” lockup (six months from listing date) expired on 12 May 2011 and STX Europe can pare down its stake provided they get written consent from the sole global coordinator. The final lockup period will expire 12 months from the listing date (on 12 November 2011) and STX Europe can selldown without any restriction.