Prices of recent jack-up orders (Pacific Class 400 design) secured by Sembcorp Marine (SMM) are on average 12% lower than orders clinched in the peak years of 2007-08, which is better than our expectations. Going forward, should new orders continue to flow, the number of available rig slots at prominent shipyards will decrease, and yards such as SMM may enjoy greater pricing power as the tide turns in their favour. We also gleaned insights from recent analyst briefings of three US drillers and found increasing optimism about the general outlook for the rig market in various parts of the world, though activity in the Gulf of Mexico is expected to remain low. For SMM, we keep our FY10 earnings estimates intact but increase our FY11F net profit forecast after incorporating higher margin assumptions. Meanwhile, we have also updated the market value of SMM’s stake in Cosco. As such, our SOTP-based fair value estimate rises from S$5.70 to S$6.17. Maintain BUY.

Margins likely to remain healthy. Looking at recent prices of jack-up orders secured by Sembcorp Marine (SMM) since Oct 2010, we estimate that the average price of US$185m/rig for its popular Pacific Class 400 design (based on Oct 2010- Jan 2011 data) is about 12% lower than the average price of US$210m/rig for its earlier Pacific Class 375 design (based on Jun 2007- Sep 2008 data). Previously we had conservatively incorporated a 20% haircut compared to peak orders in 2007-2008 in our pricing assumptions. Should new orders continue to flow, the number of available rig slots at prominent shipyards will decrease, and yards such as SMM may enjoy greater pricing power as the tide turns in their favour. Meanwhile, the group has also seen a substantial increase in operating margins from 9.9% in FY08 to 18.5% in 9MFY10, partly due to higher productivity. With the higher-than-expected newbuild prices, we now assume operating margins of 14-16% for FY11-12, at the same time noting that margins from Petrobras may be lower should SMM clinch orders in the 28-rig tender.

Comments from US drillers. We also gleaned insights from recent analyst briefings of three US drillers – Atwood Oceanics, Noble Corporation and Diamond Offshore the rest will report their earnings in mid to late Feb. Atwood mentioned that regarding the price of options for its newbuilds, there are “fixed price elements”… ‘with some indexation”, possibly meaning there may be cost escalation clauses if prices such as steel rise considerably in the future. The three companies also expressed optimism about the general outlook for the rig market in various parts of the world (e.g. Brazil, North Sea, West Africa), though activity in the Gulf of Mexico is expected to remain low despite the absence of an official moratorium. Other salient points include tighter shipyard capacity (especially for deliveries in 2013 and 2014) as well as operator preference for newer units (even though the capabilities of older units may match the drilling program).

Maintain BUY. We are encouraged by recent orders placed by established rig owners, and expect more to come, possibly at higher prices and better payment terms for the shipyards. For SMM, we keep our FY10 earnings estimates intact but increase our FY11F net profit forecast by 9.3% after incorporating higher margin assumptions. Meanwhile, we have also updated the market value of SMM’s stake in Cosco. As such, our SOTP-based fair value estimate rises from S$5.70 to S$6.17. Maintain BUY.