Punting on O&M recovery is foolhardy before solid research

MOST offshore and marine (O&M)-related counters took a beating along with a broad-market slide the first half of last week before some counters clawed back losses over the weekend.

Amid the stock market jitters, brokers contacted by The Business Times have maintained their buy calls for the sector, particularly for the two large caps, Keppel Corp and Sembcorp Marine. Most consider the recent slide was part of a broad-market correction. Noting how broker reports have turned bullish particularly on the outlook for Keppel Corp and SembMarine, one remisier views the surge leading up from late last year as a sign of "sentiments moving six to nine months ahead of an expected improvement in fundamentals".

So despite Keppel Corp's first-ever quarterly loss at the start of this earnings season, CIMB is "hopeful of happy days ahead"; Credit Suisse calls on investors to "get on the boat"; and DBS Vickers says "the rally has legs... with new orders driving re-rating". Small- to mid-cap O&M counters that have cleaned up their balance sheets have also scored significant advances. In an online forum, one retail investor raved about Dyna-mac's recent "rocket rally".

It certainly helped that oil prices had already surged past US$70 in early 2018 before stabilising in the US$60s. That said, new orders have indeed risen significantly at SembMarine - its order book stood at S$4.85 billion at the end of the third quarter, including large turnkey projects from the exploration and production (E&P) value chain. Equity analysts have thus far argued that more E&P projects will enter the tender pipeline and that will continue to bolster earnings for SembMarine and Keppel O&M (KOM).

Light at end of tunnel

Early signs of a sectoral recovery have emerged in the small- to mid-cap space - Marco Polo Marine's S$60 million rescue financing points to light at the end of the tunnel for highly-leveraged players. Expectations have also been running high on the lifting of Ezion Holdings' trading suspension now that the liftboat-focused group has secured support from both its noteholders and bank lenders.

The question still begging an answer, however, is whether the market is running too far ahead of the curve considering fortune can turn its back very quickly on O&M players. The sector has just emerged from the aftershocks of KOM's US$422 million fines for corrupt payments made in Brazil and two high-profile insolvencies of erstwhile stock market darlings - Ezra Holdings and Swiber Holdings.

There also remains one too many moving parts that can trip up the sector in its road to recovery. To begin with, the US shale industry continues to pose a threat to the sanctioning of offshore oil and gas (O&G) projects that have answered for the bulk of SembMarine and KOM's order books. UOB Kay Hian noted that at US$60 for oil, ExxonMobil has already tabled a plan "to double down on its bet on shale", a worrying sign that oil majors may prioritise "short-term plays like shale" over higher capex offshore O&G projects.

IHS Markit's Asia-Pacific lead for yards and fabrication, Ang Dingli, also cautioned against equating increases in order books with improved earnings when sizing up lump-sum turnkey contracts for these O&G projects. He noted that even at the height of the last industry upswing, South Korea's top yard groups have seen millions of dollars wiped out from their bottomlines as a result of slippages on the execution of these projects. "The ability of the contracted yard group to keep its cost in check as well as managing the engineering and construction properly are critical in ensuring profitability," he explains. For KOM and SembMarine, this implies that out-bidding their larger South Korean rivals to land such contracts only signifies a battle half-won.

Severe challenges

Small- to mid-cap counters active in vessel and rig chartering sub-sectors are also subject to no less severe challenges. Those forced to lay up large numbers of vessels and rigs now face the uphill task of convincing their clients that they are still in business.

They also have to run up large tabs to reactivate idle vessels and rigs once these are contracted for work. Reactivation cost for each vessel can range up to hundreds of thousands in US dollars, industry veterans say. With all these considered, it does appear Singapore's beleaguered O&M sector is not out of the woods as yet. For those who aren't seeking a quick buck by punting on the promise of a resurgence in investor interest, it is certainly worthwhile to take a moment to delve more deeply into the fundamentals before taking the plunge with the rest of the herd.