Offshore Sector (KimEng)

We reduce our price targets for Keppel Corp and SembCorp Marine (SMM), as the market becomes increasingly wary of the risk of these cyclical stocks. Although both companies have built up a substantial backlog of jack-up and other contracts to tide it through the current lull, new order wins remain the lifeblood for the performance of these stocks. While we fully subscribe to the argument that the long-term need for energy resources will be the main growth driver, the current uncertain economic climate offers no encouragement that rig owners will be placing orders with the yards in the near future. Fundamentally, we maintain our BUY call on both Keppel Corp and SMM, but the downside risk remains if market sentiment turns further bearish.

No impetus for new orders

While the argument that the offshore industry needs to invest into newer and better equipment to tap new resources is valid, there seems to be no pressing need to do so in the current market environment. Industry data also indicates that rig day rates and utilisation remain muted, implying that rig owners can still make do with what they have for the moment. Despite crude oil prices remaining firm, a global recession would likely send prices southward, and therefore reduce the profit incentive for the industry. The last downcycle for the yards was also exacerbated by a lack of financing for new rigs. For now, financial institutions are still willing to lend, but this could change substantially if they take a more cautious approach in a recessionary environment.

Keppel target reduced to $11.88, maintain Buy

We cut Keppel’s SOTP price target to $11.88 from $14.40 previously, as we reduce our FY11 shipyard earnings multiple to 13x, to reflect its weaker outlook. Our SOTP is also affected by our recent price target cut for Keppel Land. We also raise Keppel’s conglomerate discount to 10%. Keppel’s earnings are expected to remain firm on the strength of its offshore orderbook of US$7.2bn, but Property and Infrastructure earnings will be volatile.

SMM target reduced to $4.95, maintain Buy

While SMM’s earnings similarly looks solid for the next two years, based on its current orderbook of US$4.6bn with deliveries up to 2014, we expect this to start to taper down from 2013 barring new order flows. We lower our fundamental SOTP target to $3.95 from $6.66 previously, mainly on a reduced mid-cycle earnings multiple assumption of 13x for FY11. SMM’s healthy dividend payout is also at risk even if earnings hold firm, as these payouts are discretionary.