Sembcorp Marine

Sembcorp Marine: (S$2.23) First rig contract cancellation a foreboding of things to come?
Marco Polo Marine (MPM) has terminated a US$214.3m jackup rig contract with PPL Shipyard, Sembcorp Marine’s subsidiary, on claims that it found cracks on all three legs of the rig.

MPM had ordered the jack-up rig during the rig building boom in Feb ‘14, right before the crash in oil prices, as part of plans to expand into the rig chartering business. To-date, it has not operated a rig before and has yet to secure any charter for the intended rig, scheduled to be delivered in 4Q15.

As at end Sep '15, MPM has a net gearing of 0.94x, with cash of $15.5m and would require huge funding if it were to take delivery of the rig, which would further stress its balance sheet. It is demanding back its 10% deposit from SMM, which suggests that this was a deferred payment contract.

SMM is not taking the contract cancellation lying down, refuting MPM’s allegations, and accusing MPM of a repudiatory breach of the contract. SMM is terminating this contract on its end and claiming for amounts due.

SMM should have completed and booked a substantial portion of this contract given that it is due to be delivered in 4Q15. If the event it is unable to claim the amounts due or resell this unit, it may have to reverse the profits recognised, thereby impacting its FY15 results.

While this rig contract marks the first rig contract cancellation for SMM, the worry is that other heavily indebted clients may extend beyond just delivery deferrals and imitate MPM's actions, putting SMM’s orderbook quality at risk.

According to various sources, the following contracts are at the greatest risk of cancellation:
1) Two drillships for Transocean (US$1.1b)
2) Two jack-up rigs for Perisai (US$420m)
3) Three jack-up rigs for Oro Negro (US$1.2b)
4) A jack-up rig for Noble Corp (US$596m)

Together, they account for 40% of its $11.6b order book.

With issues being faced on multiple fronts, Maybank-KE does not see any respite for the rigbuilder any time soon, particularly with oil prices remaining depressed. The house thus reiterates its Sell rating with street low TP of $1.75.

SMM is trading at 12.4x forward P/E. The street is bearish on the counter with 3 Buy, 8 Hold, and 12 Sell ratings on the counter and a consensus TP of $2.33.