STX OSV - Quality order book to withstand downturn (CIMB)

OUTPERFORM Maintained

S$1.23 Target: S$1.85

Mkt.Cap: S$1,451m/US$1,170m

Offshore & Marine

Trading close to trough

Reiterate Outperform. STX OSV’s share price has fallen sharply on concerns that tightening credit could slow down its order intake. We were the first to downgrade the O&M sector based on the same fears. We now reduce our earnings estimates for STX OSV for FY12-13 by 2-10% as we scale back order expectations by 20-23%. Our target price dips accordingly to S$1.85 (from S$1.89), still based on 11x CY12 P/E (5-year mean for small-mid-cap industrials). Notwithstanding this, we maintain our OUTPERFORM rating, believing in minimal cancellation risks for its quality order book and buffer to withstand a downturn. We continue to anticipate catalysts from strong quarterly results, 8% dividend yields (for FY11) and continued good project execution.

Still positive for now

Order intake concerns. As sentiment turns more negative, project negotiations have become lengthier. Some customers are adopting a "wait-and-see" attitude. However, underpinned by an uptick in the North Sea over this summer and heightened project inquiries, STX OSV stands by its belief in a stronger order momentum for 2H11. Further, orders are lumpy and are expected to be backend-loaded.

We remain confident that it can meet our FY11 order target. Including effective NOK3bn Transpetro contracts and a NOK375m PSV order from Island Offshore, STX OSV has met 60% of our order target of NOK13bn for FY11.

Cutting order expectations for FY12-13 by 20-23%. Nonetheless, a full-blown liquidity crunch is a worry. Tampering our bullishness further out, we cut our FY12 order expectation to NOK10bn (from NOK13bn); and FY13 expectation to NOK12bn (from NOK15bn).

Such expectations are realistic, in our view. Our FY12 NOK10bn target is in line with average orders secured over a boom-bust period (FY07-10). In addition, a 20% higher order intake for FY13 takes into account its new Brazilian yard, which is expected to increase its production capacity by 25%.

As a result of the drop in order expectations, our earnings estimates for FY12-13 have been reduced by 2-10%.

Quality order book should withstand downturn

Minimal order cancellations. Given STX OSV’s quality clientele and track record of no order cancellations, we believe there should be minimal cancellation risks for its order book. STX OSV’s customers are established Norwegian OSV operators such as DOF, Farstad and Island Offshore, with whom it enjoys close relationships. In addition, its backend-loaded payment structure does not stress customers during the construction phase and should help to reduce cancellation risks, in our view.

Sufficient order-book buffer. We estimate 1H11 order book at NOK15.3bn, to underpin 70% of our FY12 revenue projection. Such a buffer should be sufficient, in our view. An over-extended order book could actually erode STX OSV’s competitiveness - STX OSV’s edge lies in its ability to introduce new vessel solutions to its customers. If yard slots are booked too far ahead, it is unable to stay abreast of the industry’s changing needs.

Moreover, a bulging order book does not guarantee future performances. In FY07-08, the company secured over two years of forward revenue but still lost money. Part of the problem was capacity constraints at its own yards and an overheated supplier market which delayed the delivery of equipment.

We deem an order-book cycle time of 1.5 years as being optimal for STX OSV. This gives STX OSV the flexibility to meet customers’ needs and ensures it has enough resources to concentrate on project execution. Such has helped in its FY11 exceptional performance.

Valuation and recommendation

Trading close to trough. STX OSV is trading at 7x CY12 P/E, just above small-midcaps’ trough valuations. On average, Singapore’s small-mid-cap offshore stocks are trading at 6x CY12 P/E while Singapore rigbuilders are trading at 10x. The stock is trading roughly 18% above small-mid-cap offshore stocks but at a 30% discount to Singapore rigbuilders. Backed by its better capabilities and a quality order book, we believe STX OSV should trade closer to rigbuilders (although rigs are considered higher-spec than OSVs).

In addition, we deem the risk-reward trade-off favourable. Should the stock be derated to trough valuations, we see 18% downside. On the other hand, we see 51% upside should the stock be re-rated to mean valuations.

Reiterate Outperform with slightly lower target price of S$1.85 (from S$1.89), still based on 11x CY12 P/E (5-year mean for small-mid-cap industrials). Its recent correction provides an entry opportunity, in our view. We continue to anticipate catalysts from strong quarterly results, 8% dividend yields (for FY11) and continued good project execution.