Outlook Remains Strong, Supported By High Oil Prices
The rig market, particularly the semi-submersibles segment, has continued to gain strength in 2022 with higher utilisation and day rates. The industry continues to search for an equilibrium as supply destruction has persisted across asset classes this year. Heading into 4Q22 and 1Q23, we believe that oil prices will be well supported above the US$100-110 range. Our sector rating remains OVERWEIGHT, and our top picks are Yangzijiang, Keppel and Sembcorp Marine.
• Since our Mar 22 report, the offshore market has continued to strengthen with utilisation rates back above pre-pandemic levels (see chart on RHS) while day rates for semi-submersibles in particular have been extremely strong. The supply-demand dynamics continue to shift positively in favour of rig owners as supply destruction has continued – on a yoy basis, the global offshore rig industry had lost 36 rigs (-7%) to 694 rigs as at 12 Aug 22. Importantly, this supply destruction was seen across all asset classes with semi-subs registering the largest decline in supply in percentage terms, decreasing 12% yoy to 106
rigs. In our view, this is positive as the extraction of excess supply should allow utilisation and day rates to continue to further firm up going forward.
• Industry activity to pick up in 2022 and 2023. Looking at future projects, the demand for production assets appears to have meaningful upside in the next few years, which could have positive ramifications for both Keppel Corp (KEP) and Sembcorp Marine (SMM). According to Rystad Energy, offshore investments in 2022 are set to increase 7% yoy from US$145b to US$155b. In addition we highlight that the US$150b of greenfield projects sanctioned in 2021 (2020: US$80b) will likely be repeated in 2022, thus underlining the positive outlook for the offshore marine sector in the near to medium term.
• Oil price outlook. Heading into winter in the northern hemisphere, we believe that Brent oil prices will be well supported above the US$100-110 range. In late-Aug 22, Saudi Arabia warned that there was a significant disconnect between financial and physical markets and that this “extreme” volatility could prompt the OPEC+ alliance to act to throttle back production. This, together with OPEC spare capacity close to historic lows (see chart on RHS), and large scale gas-to-oil switching taking place in Europe due to a lack of Russian gas, oil prices should remain high in the near to medium term.
• Maintain sector view at OVERWEIGHT. We continue to like Yangzijiang (YZJ) which remains inexpensive at 2022F P/B of 0.7x and will see margin expansion in the next few quarters. We also like KEP and SMM, which combined have seen nearly S$10b worth of orders ytd. In our view, this bodes well for the merger which is expected to be completed by 4Q22.
• Jack-up rigs seeing higher demand. Global jack-up demand has risen ytd with jack-up contractors having secured 100 charters or 165 rig-years of work for the first five months of 2022 – this formed 76% of the jack-up time booked in all of 2021, thus signalling greater demand in 2022. With 45 known jack-up requirements that are still open this year, coupled with higher commodity prices and increased willingness by oil & gas companies to spend on capex, it would appear that jack-up awards in 2022 should easily exceed 2021’s numbers. According to data from Bassoe, the Middle East region has been the main driver behind the increased demand, with Saudi Aramco and ADNOC leading the way, followed by India and Southeast Asia.
• Semi-submersibles see a significant increase in contracts awarded. Despite day rates for mid-water semi-subs (5,000-8,000ft) having risen 40% ytd, with advanced semis priced around US$400,000/day in Aug 22, the number of contracts for such rigs have significantly surpassed the contracts for jack-ups. As a result, the number of semi-sub contracts signed this year has outnumbered jack-ups by almost 2:1.
• Bullish FPSO outlook. The latest 2Q22 floating production systems report by Energy Maritime Associates (EMA) shows 190 offshore production projects in the pipeline, an increase of seven from 1Q22, thus implying a bullish outlook for new orders. Importantly, EMA notes that 21 floating production systems have been awarded ytd, which is the highest level since 2013, and that SMM’s yards are well placed for new orders.
• European bureaucracy holding back growth in offshore wind. In 2021, the EU saw €41b invested in 25GW of new wind farms; however this falls far short of the 39GW/year needed to grow from the current wind capacity of 190GW to the targeted 510GW by 2030. Part of the reason is due to the EU’s lengthy permitting procedures, which means that the region’s energy transition has become more time consuming and expensive, eg the installation of three wind turbines in Germany requires over 30,000 pages of paperwork.
• Offshore wind in the US – growth off a very low base. Wind power was the country’s fastest growing energy source in 2021, forming 32% of total US energy capacity growth. However, we note that this is off a very low base (see chart on RHS) as the country only has two operating offshore wind farms off the Rhode Island and North Carolina totalling 42MW. While President Biden’s Inflation Reduction Act provides US$370b for climate and energy programmes, signalling a material expansion in clean electricity generation, developing offshore wind in the Gulf of Mexico (GOM) may be problematic given that on an annual basis, it is prone to hurricanes between July to November. Thus, industry studies have shown that 10-15% of any offshore wind infrastructure built in the GOM may be prone to hurricane destruction. Rystad nevertheless estimates that capex for offshore wind in the Americas will grow from c.US$4b in 2022 to more than US$15b by 2030 (or 18% CAGR).
• Oil demand expected to grow, but forecasts face heightened uncertainty. In its latest Aug 22 update, the US Energy Information Administration (EIA) forecasts oil demand growth of 2.1mmbpd for both 2022 and 2023 (see chart on RHS). Note that in the past few months, the US EIA has gradually downgraded 2022 oil demand growth from its Mar 22 forecast of 3.1mmbpd growth. It has highlighted that its forecast is subject to “heightened levels of uncertainty” resulting from a variety of factors, including Russian oil sanctions as well as less robust global economic activity. Note that an additional Russian oil embargo goes into effect on 5 Dec 22, banning the provision of shipping, insurance and other services related to Russian oil. If the US successfully bans dollar clearing for Russian oil purchases, this would result in tighter oil and natural gas markets in the near term.
1H22 RESULTS RECAP
Yangzijiang Shipbuilding (YZJSGD SP/BUY/Target: S$1.16)
• Operationally a strong set of numbers. YZJ reported 1H22 revenue growth of 70% to Rmb9.7b which resulted in a 32% yoy increase in net profit from continuing operations to Rmb1.2b. As guided by management and as previewed in our previous note, the company delivered 35 vessels during 1H22 which, on a run-rate basis, is ahead of its previous 2022 delivery target of 60 vessels. In our view, YZJ is highly likely to achieve its new target of 70 vessels. At the bottom line however, the results missed expectations due to fair value loss on currency hedges.
• Maintain BUY with an SOTP-based target price of S$1.16. We have used an 8x and 5x multiple for its shipbuilding and trading & other business segments respectively, thus arriving at a S$1.14 and S$0.04/share valuation for these two segments (see table below). By using publicly-sourced replacement cost for its shipping assets, we value this segment at Rmb4.8b or S$0.26/share – this is double that of the company’s carrying cost of these assets, or 3x higher than its book value of S$0.09 as at end-21. At our target price, YZJ would trade at a 2022F PE of 6.9x which we do not view as stretched.
Keppel Corp. (KEP SP/BUY/Target: S$10.11)
• Solid contribution from all businesses. KEP reported 1H22 revenue from continuing operations of S$3.4b (+16.2% yoy), which resulted in a 26% yoy increase in net profit from continuing operations of S$434m. The company declared a better-than-expected dividend of S$0.15/share which represents a payout ratio of 62%, and higher than its historical payout ratio of 39-59% in the past 10 years.
• A resurgent offshore marine business. As at end-1H22, Keppel Offshore Marine (KOM) had S$4.4b net orderbook with a further S$8b worth of potential contract in advanced discussions. Importantly, the company managed to garner S$255m worth of bareboat charters for four of its legacy rig assets (which are not going into the SMM merger); management appeared confident that it would be able to sell its other rigs sooner rather than later given the more bullish offshore marine environment.
• We have a BUY rating on KEP with an SOTP-based target price of S$10.11. The company appears to be at an interesting crossroad in 2022 with the exit of its KOM segment and its move towards a more asset-light and recurring earnings business model. It also has a 15% ROE target vs 9.1% in 2021 and 1H22 annualised ROE of 8.4%. Of interest will be the pace of its asset monetisation which could bolster earnings again in 2022 and thus lead to another dividend surprise.
Sembcorp Marine (SMM SP/BUY/Target: S$0.156)
• Loss for 1H22 but financials should strengthen in 2H22. SMM reported a 1H22 loss of S$143m which was significantly better than the S$1.2b loss in 1H21. We assess the results as being largely in line with our expectations. We believe that the company’s financials will witness sequential strength in 2H22 given its higher order wins ytd. In addition, we highlight that the company is on track to deliver Transocean’s Deepwater Titan which would then enable it to collect S$350m in revenue in 2H22. No significant delays were reported for current and new projects.
• New order wins in 1H22 bode well. SMM disclosed that ytd order wins total S$1.9b, with around S$300m of this being repair and upgrading works. Given that order wins for the wind turbine installation vessel and Brazilian Navy total S$850m, it would imply that the recent order win for gas topsides from an oil major is worth around S$750m. During the analyst briefing, SMM’s management stated that it was unable to disclose any details on neither the project nor the client at present. The company’s current net orderbook is >S$2.5b.
• Maintain BUY with S$0.156 target price. With the SMM/Keppel merger terms largely in place and the uncertainty out of the way, the focus on SMM will be to garner new orders in 2022 and add to its orderbook. Our target book-value multiple for SMM of 1.2x reflects our confidence that it will garner such order thus leading to positive share price performance.
RISKS TO OUR THESIS
• Delays in project sanctioning due to supply chain inflationary pressures
• Lack of financing for industries that are seen to be related to the fossil fuel industry
• Despite the high oil price resulting in super-normal free cash flow, oil companies may remain wary of committing to offshore capex and instead focus on share buybacks or paying dividends