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Sembmarine – leveraged play among oil companies (29 Apr 19)

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Dear all,

This week, Sembcorp marine (“SMM”) caught my attention amid positive industry reports and its strengthening chart. I have started to accumulate SMM with my usual take profit target of a few bids, if any.

Let’s look at the basis, and importantly, the investment risks.

 

Basis

a) Analysts are turning positive

Based on Figure 1 below, average analyst target price for SMM is around $1.93, representing a potential capital appreciation of around 12% from the current price $1.72. It is noteworthy that JP Morgan has turned positive on SMM last month with a target price of $2.10, after six years of underweighting SMM.

Figure 1: Ave analyst target $1.93

SMM analyst

Source: Bloomberg 26 Apr 19

b) Chart is supportive

Based on Chart 1 below, SMM breached its trading range $1.60 – 1.72 on 23 Apr 2019 and touched an intra-day high of $1.81 on 24 Apr 2019. With the recent up-move, it has closed above its 200D EMA (currently around $1.73) for three consecutive trading days, a feat which did not occur since Oct 2018. It is now pulling back to its support region $1.67-1.73. ADX has been rising and last trades at 32.0 on 29 Apr 2019, amid positively placed DIs (indicative of a trend). This, coupled with almost all the moving averages (which I use) are rising (except for 200D SMA), this seems to indicate an uptrend. OBV has also broken on the upside which looks positive, especially when it is in tandem with the upside break of $1.60-1.72. OBV is now testing its own support area.

Near term supports: $1.73 / 1.71 / 1.67

Near term resistances: $1.81-1.82 / 1.89 – 1.91 / 1.95 – 1.96

Chart 1: SMM testing its support on pullback, amid light volumes

SMM 1.73 29 Apr 19

Source: InvestingNote 29 Apr 19

c) Industry seems to be turning around

Oil and gas industry seems to be turning around which can be seen from various aspects. Firstly, based on a Business times article dated 17 Apr 2019 (click HERE), SMM’s chairman Mohd Hassan Marican was quoted at its recent annual general meeting (“AGM”) that SMM may be approaching the bottom of “a very long downcycle”. Recovery could be as soon as later this year or in 2020. Secondly, according to a DBS Research article dated 12 Apr 2019, DBS believes spending on exploration related activities is likely to increase 24% y/y in 2019. Thirdly, management from various large oil related companies are sounding more positive. For example, Haliburton sees national oil companies (“NOC”) continue to focus on mature oil fields and such activity is likely to increase via greater investments by NOC. Given the above developments, SMM may win more orders in the next couple of years.

d) Oil price seems to be supported

Based on a DBS Research article dated 25 Apr 2019, it has just increased its oil price forecast by US$5/bbl. to US$70-75/bbl. for 2019 / 2020. It cites tighter supply demand dynamics and believes any OPEC’s decision to increase production is likely to be moderate. A strong oil price is likely to bode well for companies like SMM’s in terms of business and its share price movement with the latter showing a strong correlation to oil price movement.

e) Merger of shipyards

Whenever SMM drops to a low enough price, this rumour on its takeover or privatisation will rekindle. According to DBS Research, they believe that a merger of our Singapore ship yards may make sense on a business aspect. This is because there may be synergies and eliminate competition in the medium term.

f) Securitisation of S$1.1b receivables for SMM’s borr rigs

If SMM is successful in securitisation of S$1.1b receivables for its borr rigs, this will alleviate its stretched balance sheet to a significant extent.

g) Significant cost savings of S$48m per annum from FY20F

Based on an article on Seatrade Maritime (click HERE), SMM plans to move all operations from its Tanjong Kling yard its integrated Tuas Boulevard Yard by end-2019, four years ahead of schedule. This move is expected to generate annual cost savings of around S$48m.

h) Valuations are relatively low

With reference to Figure 2 below, SMM trades at 1.6x P/BV vs its 10-year average range 2.9x. PE basis is not used as SMM reported a net loss for FY18.

Figure 2: Valuations are relatively low on a P/BV basis

10Y PEBD

Source: Bloomberg 26 Apr 19

With any investment, there is bound to be some risks. The list of risks below is not exhaustive.

Investment risks

a) Cost over-run from new projects

SMM has gradually shifted from fabrication and pure construction work to gradually becoming a marine engineering solutions provider, with a bias towards gas solutions. Projects which are new in nature (i.e. different from SMM’s bread and butter business) may (more likely) incur cost over-runs which may affect its margins.

b) Drop in oil price

A drop in oil price over a sustained period may affect rig count and new building activities which may affect SMM.

c) Implications from its stretched balance sheet

Its stretched balance sheet with net gearing of around 1.4x limits its ability to secure new sizeable contract wins as it juggles between working capital constraints, capex requirements and securing contract wins. Furthermore, to alleviate its stretched balance sheet, there may be possibility of share issuance.

d) Order book replenishment and potential order cancellations

According to SMM’s recent AGM, the challenge is to replenish its order books as they actively “digest” the order books won till date. In addition, there is always a risk that orders awarded, may be cancelled by their customers.

e) Potential short-term selling pressure from contra players

Today is T+4 of the sharp up-move on 23 Apr 2019. i.e. Contra players may be forced to exit as their contra period nears.

f) Results – a potential event risk

It is going to report results on 3 May before market opens. As with any results, the results and guidance should beat analyst expectation for it to continue moving higher. If their results, or / and guidance disappoint the market, share price is likely to weaken. Based on CGS-CIMB report, SMM is likely to recognise accelerated depreciation worth S$60m over the past five quarters from 4QFY18. Although this is non cash in nature, it is likely to affect reported profit to some extent.

g) Risks from corruption allegations in Brazil

There seems to be no new information from the corruption allegations in Brazil since 2018 based on my searches online. Nevertheless, if SMM is found guilty, this can lead to reputation and financial loss.

 

Conclusion

In view of the above, SMM looks interesting amid the buoyant oil price and as the industry recovers from its multi-year down cycle. However, it is noteworthy that there are several risks, such as equity issuance, order cancellations, results etc. It is noteworthy that as I am a full time remisier, I can change my trading plan fast to capitalize on the markets’ movements (I am not the buy and hold kind). Readers should exercise their due diligence and evaluate carefully.

Readers who are not familiar with SMM can take a look at the analyst reports HERE.

Readers who wish to be notified of my write-ups and / or informative emails, can consider signing up at http://ernest15percent.com. However, this reader’s mailing list has a one or two-day lag time as I will (naturally) send information (more information, more emails with more details) to my clients first. For readers who wish to enquire on being my client, they can consider leaving their contacts here http://ernest15percent.com/index.php/about-me/

 

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