Keppel, SembMarine crucial to survival of Singapore's O&M ecosystem

Shares in Keppel Corporation and Sembcorp Marine (SembMarine) have mostly been trading in the red since news on Sete Brasil's approved bankruptcy filing broke before trading hours on April 21. The falls came as the latest Sete Brasil development sparked concerns about the weak fundamentals of the offshore and marine (O&M) sector, the downturn of which is proving to be more protracted than feared.

Also back in the fore are questions about the appeal of these two companies to investors - both retail and institutional - and the thinking of Singapore investment company Temasek Holdings, their common key shareholder.

The market concerns over Keppel Corp and SembMarine are understandable given that Sete Brasil, a rig-owning vehicle affiliated to Brazil's national oil company Petrobras, is the largest singular rig-building client of both these two large-cap O&M players, accounting for about US$5 billion (S$6.8 billion) of each of their outstanding order books.

Before the Sete Brasil's bankruptcy filing dust has settled, Houston-based Hercules Offshore separately warned that it could be slipping into Chapter 11 bankruptcy protection for the second time after failing to fulfil repayment terms of a US$450 million loan.

The rigs under construction at Keppel Corp and SembMarine for Sete Brasil and Hercules Offshore are supported by long-term offshore drilling contracts with end-clients Petrobras and Maersk Oil.

Questions have been raised whether Petrobras - having fallen under severe financial pressure - would default on some, if not all, its contracts with the Sete Brasil rigs.

Backed by the Danish conglomerate AP-Moeller Maersk group, Maersk Oil, in contrast to Petrobras, is more than ready to take delivery of the high-specification jack-up Hercules has commissioned to SembMarine. The Hercules jack-up in question is understood to have been contracted to work in Maersk Oil-operated Culzean project off the UK. But how Hercules' latest disclosure may impact on the delivery of the jack-up rig from SembMarine and the fulfilment of the Maersk Oil contract remains unclear at the time of writing.

If Hercules were to default on taking delivery of the SembMarine jack-up - even with a ready contract on hand - it would trigger more questions on the health of the rig-building backlogs on the books of Keppel Corp and SembMarine.

Beyond oil price

The share prices of these two O&M players - as with most other listed counters in the same sector - have been observed to be moving in tandem with oil prices. The question now is whether the weak O&M fundamentals will finally overshadow any positives stemming from oil price movements? In a recent email to BT, Maybank Kim Eng argued that the time is ripe, given the excessive supply and the now badly damaged balance sheets of offshore drilling contractors - Hercules included - for O&M share prices to decouple from shorter-term oil-price rebounds.

Industry veterans BT spoke to share Maybank Kim Eng's view, noting this downturn has surpassed precedents in the sector.

If that is the case, Keppel Corp and SembMarine may no longer appeal to retail investors seeking quick returns in the short run. What could be harder to gauge, however, would be the reactions of institutional investors who are said to have returned to the O&M fray to hunt for bargains.

More specifically, the market would be interested to see how Temasek Holdings, as a direct or indirect key shareholder in Keppel Corp and SembMarine, would respond to the industry situation.

Bankers speaking to BT have credited Temasek for supporting Neptune Orient Lines through the hard times leading up to the now ongoing merger with CMA CGM. Temasek had also held out on STATS ChipPAC before the semi-conductor sector player came under the fold of a China-based entity.

Would Temasek soldier on, or pull back from its investments in Keppel Corp and SembMarine?

Industry veterans are inclined to go with the former than the latter. Maritime, inclusive of the O&M sector, contributes 7 per cent of Singapore's gross domestic product. Keppel Corp and SembMarine's rig-building successes have supported the development of a flourishing O&M logistics supply chain in Singapore. The two yard groups are training grounds for engineers, IHS principal analyst Ang Ding Li said. Mr Ang said they also provide, through subcontracting, the basis for small-medium enterprises in the O&M value chain to gain economies of scale that would otherwise be challenging, especially for low-tech SMEs relying soley on exports. Singapore stands to cede its O&M edge to its Asian neighbours if the O&M logistics supply chain here were to lose the anchoring support from the two yard groups.

So to what extent would Temasek extend a helping hand to Keppel Corp and SembMarine?

Keppel Corp, based on the strength of its balance sheet and a more diversified business portfolio that overlays into infrastructure and real estate, is widely considered to be in a better position to weather the storm. Analysts are more bearish towards the prospects of SembMarine, whose sole business focus is O&M.

Against this backdrop, one industry veteran suggests that Temasek may next look beyond injecting cash, either through the equity or bond markets, in attempting to stem the enlarging impact of a rig-building fallout.

As a key shareholder, Temasek can throw its weight behind two options - privatisation of SembMarine, or reviving the proposed merger between Keppel Corp and SembMarine.

Merger question

A merger of the two large-cap O&M players would remain subject to negotiation over not only equity valuations but also management control over the operations.

Despite the near-term turmoil, Keppel Corp and SembMarine have proven O&M track records that can be transferred to related sub-sectors, if given the time to build new businesses.

Keppel O&M is branching out to LNG bunkering and has been pitching for the construction of LNG-fuelled vessels. SembMarine has wrested control over GraviFloat, an entity with proprietary rights to a technology extendable to near-shore power plant developments.

Given their track records, it is unlikely that Temasek will throw in the towel over these businesses without exploring all options.

This article was first published on May 4, 2016.
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