Sembcorp Marine - Risks Priced In After Difficult Fortnight

SembMarine had a tough fortnight with a jack-up rig cancelled (on build quality concerns) and a semi-sub on “standstill” (we view it effectively a non-delivery/cancellation) – a newbuild contract was the only positive. While a 4Q15 profit warning was issued and we cut FY15 earnings by 33% to factor in the cancellations, we upgrade to NEUTRAL on valuation grounds with a SGD1.81 TP (from SGD2.00, 4% downside) as the stock has fallen 26% since our downgrade and trades even below 2008 levels now.

Quality dispute details emerge
Marco Polo Drilling (I) Pte Ltd (MPD) stated there were 70 cracks found on all three legs after the first full jacking test, “including cracks on the parent material, with a majority of the cracks detected at or near the weld joints on both the internal and external surfaces of the spud cans.” Subsequently, >180 cracks were found even after one round of repairs and after a second partial test that involved only a full preload but no full-length jacking test. PPL Shipyard Pte Ltd (PPLS) is of the view that “the purported termination by MPD is to avoid its obligation to pay the second 10% disbursement of the contract price”. MPD pointed out that PPLS’ 25 Nov announcement to “affirm” the contract after the 18 Nov one to “terminate the contract” was “inconsistent”. We note that PPLS served a termination notice on 1 Dec, after the 30 Nov schedule for payment of the second disbursement.

Profit warning on recognition reversals
With the MPD cancellation and the semi-sub rig “standstill” agreement with North Atlantic Drilling, profits recognised on both rigs have to be reversed. We estimate these to be c.SGD39m and c.SGD90m respectively, leading Sembcorp Marine (SembMarine) to post its first profit warning ever. Additional provisions on the Brazilian drillships, if taken, could lead to a worse-than-expected 4Q15 result. We slash FY15F/FY16F earnings by 33%/12% respectively to factor in the profit reversals and additional rig delivery delays.

Technical Analysis
Daily Chart
Negatives do appear priced in
Even though the news has been negative, we note that SembMarine now trades at 1.38x P/BV, below the 2008 low of 1.9x and nearing the -2SD mark (Figure 1). Our SGD1.81 TP is based on 12x blended FY15/16F P/E and implies 1.33x FY15F P/BV. As the stock has fallen 26% since 23 Oct and now trades at unprecedented P/BV lows, we upgrade the counter to NEUTRAL. Further cancellations are the key earnings risks now – if two of the Brazilian drillships are cancelled, our TP could fall c.34%. (Read Report)

Source : RHB Research

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