Singapore Oil & Gas Services

DMG & Partners Research, Sept 16

WE upgrade to "overweight" Singapore's rig builders, which have underperformed the Straits Times Index (STI) due to concerns over rising competition and consensus earnings downgrades.

We turn positive as the potential recovery in shipbuilding orders and tightening credit may ease competition for offshore orders, the risk of EPS downgrades declines and valuations look appealing as we roll forward to FY2014 earnings. We prefer Sembcorp Marine (SMM) over Keppel Corporation (KEP) and Sembcorp Industries (SCI).

Data from Clarksons indicate that newbuild prices and new orders are improving. We are of the view that the revival of shipbuilding orders will divert the attention of South Korean and Chinese mega yards towards seeking ship orders rather than offshore orders, thus bringing some relief to the intense competition in the offshore market.

Dalian Shipyard has secured orders for nine jackups year-to-date, of which eight are from Seadrill and one from PT Apexindo. These are due to be delivered between Q2 2015 and Q3 2016. We believe Dalian has largely filled its near-term slots. As other Chinese yards jostle to win the confidence of blue chip customers and credit conditions imposed on weaker yards tighten, we believe the pricing power of Singapore shipyards may improve.

We previously argued that street EPS expectations for FY2013 and FY2014 had been too bullish and may lead to downward revisions. Since November 2012, consensus has cut EPS estimates for KEP, SMM and SCI by 5 per cent, 23 per cent and 13 per cent respectively. As we believe the earnings downgrades for rig builders are close to the bottom, their downside risks are now lower.

Rig builders saw earnings decline in H1 2013 as operating margins normalised. We expect their earnings momentum to swing back to positive growth in FY2014.

We believe SMM is a more leveraged play to the positive outlook. The key risks to our view are expansion in rig building capacity by Chinese state-owned yards, a steep drop in crude oil prices and execution risks in Brazil.

Sector - OVERWEIGHT