Broker's take: UOB Kay Hian maintains 'buy' on Keppel Corp on Awilco rig deal

UOB Kay Hian on Wednesday maintained its 'buy' call on Keppel Corporation, with a target price of S$9.30, unchanged from its previous estimate.

As at 11.55am on Wednesday, shares in Keppel Corp were trading 0.7 per cent, or six Singapore cents lower, at S$8.04 apiece.

UOB's rating comes on the back of Keppel Corp's announcement that it has signed a letter of intent with Awilco Drilling, for the construction of a harsh environment semi-submersible drilling rig, with the option to build up a further three units.

According to Keppel Corp, details of the agreement have not yet been finalised and are still subject to ongoing negotiations.

However, UOB noted that Awilco's presentation on the transaction mentioned that the UK-based drilling contractor is raising equity of US$65 million to fund the construction. According to Awilco, the construction price is approximately US$425 million, which represents the low end of semi-sub prices.

While UOB Kay Hian deems Keppel Corp's latest contract win as a positive, the broker expects margins to be low.

"Assuming Keppel Corp decides to pursue this project, the contract win will lift Keppel Corp's orderbook to S$4.4 billion (up 15 per cent) from S$3.9 billion as of end-17. However, the low construction price suggests that margins will be low," UOB said.

In addition, UOB analysts Foo Zhiwei and Andrew Chow highlight that Keppel Corp's payment structure for this deal leaves them "unsettled", as it might stretch the group's balance sheet further with the shipyard already facing tight liquidity.

Following Awilco's presentation, 10 per cent of the payment will be given upfront, with the second 10 per cent installment paid two years later, and the remaining 80 per cent on delivery.

"The payment structure will see Keppel Corp commit S$450 million of working capital to fund the project to completion, and is a negative (to us at least) given its impact to the balance sheet. Our estimates point to a 3-5 percentage point increase in net gearing as a result of that."

Taken together, the broker is of the view that the transaction seems to favour Awilco more. Delivery for the semi-sub is due March 2021, with an option to delay the delivery by up to a year. While their research suggests that a supply shortage of harsh environment semisubs exists, the analysts warned that cancellation risks remain.

"Should Awilco get its read of the market wrong (2021/2022 is a long delivery date), a cancellation of the order will represent a step backwards for Keppel Corp and its efforts to de-leverage post the downturn."

Nonetheless, UOB Kay Hian is maintaining its 'buy' call on the counter, premised on the value of the group's property projects in Asia, and expectations that China will drive Keppel Corp's earnings in 2018.