Offshore & Marine

Kim Eng on 21 May 2014

• Cut sector weighting to NEUTRAL on rating downgrades for large-cap rig builders.
• Near-term headwinds put backlog order momentum for rig builders at risk. Switch to P/BV and EV/Backlog valuation framework for a more intuitive accounting of cyclicality and backlog, the key stock price drivers.
• Opportunities beckon in OSV segment. Recovery for Chinese shipbuilders this year to be mild and fragile.

What’s New
Oil companies are cutting their 2014 spending and deepwater floaters are seeing dayrates softening. These developments could put rig order momentum at risk in the next 6-12 months, with a knock-on effect on offshore shipyards whose stock prices are primarily driven by their order backlog. We therefore switch to a P/BV and EV/Backlog valuation model for shipyard-related stocks to allow us to account for cyclicality and backlog, the key stock price drivers, in a more intuitive manner.

What’s Our View
We expect rig order momentum to diminish temporarily as rig owners react to oil companies’ budget cuts and softening deepwater dayrates. This means backlog-driven shipyard stocks would experience muted share price performance until the order cycle resumes.

We prefer to focus on opportunities in the OSV sector as we believe the influx of new rigs this year and next would fuel a return in demand for offshore support vessels. We turn neutral on Chinese shipbuilders as share prices retreat. Downside may be limited, but a recovery this year would likely be mild and could easily slide back into a slump if shippers fail to rein in their exuberance and start to add new capacity again.

We downgrade Keppel Corp to HOLD in view of the aforementioned risks. This comes after our recent downgrade of Sembcorp Marine (SMM) to HOLD following its disappointing 1Q14 ship repair ramp-up. With most asset builders likely to see muted stock performance, we prefer to focus on stocks with opportunities in the more positive OSV market and asset operators less affected by oil companies’ capex spending. We maintain our BUY calls on Nam Cheong, Vard, Ezion and Mermaid Maritime. We downgrade our sector call to NEUTRAL (from OVERWEIGHT) as the large-cap rig builders under our coverage, Keppel and SMM, have been cut to HOLD.