SMM

SMM: DMG insti note that wat is hurting Sembcorp though is the decline in margins that we have now seen since the sector peaked 3 qtrs ago, which was again reconfirmed in the recent result last wk. Gross margins have now declined from the peak of 21.8% in 4Q11, to 15.7% for the full year 2012, to only 12.6% in last quarter of 2012. Even more telling is the guidance, which is for the margins to continue to fall, and they are now expecting only 10-11% for the coming qtrs. This of course filters down to the net profit margin as well. Trading on 17.1x FY2013 PE and with the disappointing dividend payout, house believe the stock is very fully valued, and worse still, given that the consensus street estimates remain too high (14-17% margins are still being forecast despite the mgt downgrade), think the entire sector should now be coming under pressure. Whilst we still believe in the strength of the Jack up rig market, what we are seeing is a normalization of margins (much faster than even we expected) from the previous three years which had been boosted by record rig pricing. Rig pricing is now slowing down and we believe this is attributing to the rising competition for offshore orders (especially from the Chinese, Middle East and Korean Yards which now appear to be pricing for volume rather than profits). So whilst the order book remains healthy, margin prices are now the key. Technically, Sembcorp is stuck in a declining wedge, and looks set to test the bottom of the range at the 4.10 level. A break of this support would clear the way for a retest of the $3.60 level which is more in keeping with historical valuations for the stock. Use the declining wedge top as a stop loss if it is broken.