3 reasons why Sembcorp Marine trumps Keppel as a stock pick

Maintain sector Overweight, SMM as preferred rigbuilding play. We continue to like the rigbuilders as we see mispricing in the stocks. We have Buy ratings for the duo, but our preference is for SMM (Buy, TP SGD5.40) over Keppel (Buy, TP SGD12.50) for its (1) higher earnings growth profile, (2) better revenue coverage and (3) relative underperformance. We also think that SMM should perform better on the upcycle given its pure play exposure. Maintain Overweight on the Singapore O& M sector.

Rig ordering cycle is still on an uptrend. The surprise upside in jackup orders in the first half of the year would only serve to boost the impending cycle. Next in play would be the return of more semisub orders following heightened deepwater activities. Major drillers echoed a consistent positive outlook in their 1Q13 results commentaries. While oil price may see some near-term volatility, we believe that it would be sustained above the crucial USD80/bbl level which is economically viable for most offshore oil and gas projects.

We expect average rig prices to rise. Despite rising threats from Chinese and Korean yards, we hold the view that Singapore yards have unique niches to defend against these competitions while they move up the value chain. We expect Keppel and SMM to secure a combined SGD11b in new offshore orders in FY13F (SGD8b in FY12 excluding Petrobras related orders). More importantly, we argue that despite the impending competition, average rig prices would hold up and even rise in the next 3 years.

Expect margins to trend up. Operating margin recovery for both Keppel and SMM in 1Q13 supports our view that consensus are overly pessimistic in margin expectations. We point out that margin declines in preceding quarters was due to a mix of lower price contracts from the start of a new rig building cycle and have nothing to do with current competition. Better product mix, operating efficiency and incremental price increases could soften risks from execution of Brazil orders. The release of risk contingencies taken upfront at later stages could also add to margin upside. We expect margins to trend up (albeit at a moderate rate), not decline as expected by consensus. We believe that data points in subsequent quarters would validate our view, triggering upward revisions in margin forecasts.

Concerns on margins over-amplified. Share price performance for Singapore rigbuilders has been capped due to persistent worries over margin contraction. While we recognise the existence of such risk, we believe that the concern was overdone. We expect continual order ins, increasing rig prices and margin outperformance in 2013 to lead to moderation of such fears. We urge accumulation during current stock weaknesses, ahead of the play out of our positive expectations.  

Sembcorp Marine pops the champagne on $13.6b orderbook

Results were down sharply vs. 4Q12 though, with revenue coming in 23% lower while PATMI at SGD119mn was down 28.7% q-q. The sharpest decline in revenue was registered in the rig building segment (-31% q-q) followed by conversion and offshore (-12%).

EBIT margins, though, recovered strongly to 13.7% during the quarter (10.8% in 4Q12) as general and administrative expenses declined 37% q-q.

Management has maintained its positive outlook on the sector, citing  strong enquiry levels across business divisions and healthy  fundamentals for the offshore & marine sector driven by the projected  rise in offshore exploration and production spend.

Given strong  competition for new orders, the group will focus on improving productivity  and operational efficiency and ensuring timely and within-budget delivery  of orders to clients.

According to management, demand for ship repair  and upgrade work too remains high. The group has a strong orderbook  of SGD13.6bn with deliveries extending to 2019 while new orders  secured during the quarter amounted to SGD1.7bn.