O&M

O&M: Sete Brasil's potential bankruptcy only the tip of the iceberg
According to Bloomberg, shareholders of Sete Brasil are mulling a bankruptcy filing at an investor meeting this month after the financially troubled rig venture was crippled by a corruption scandal and collapsing oil prices.

Should this play out, Maybank-KE fears that Keppel Corp and Sembcorb Marine (SMM) could see their fortunes take a turn for the worse.

At stake are Keppel’s US$4.9b and SMM’s US$5.6b rigbuilding contracts with Sete Brasil, which are in danger of cancellation, should the bankruptcy proceedings materialise. Already, both yards have not received progress payments from the Brazilian rig builder.

Keppel and SMM are estimated to have recognised about $1.5b to $2b of revenue from its Brazilian contracts, while unrecognised portions of these contracts make up about 40-50% of their combined order book.

In a worst case scenario of Sete Brasil going into bankruptcy, the house sees:
1) 17%/50% cut to FY16-17 EPS for Keppel/SMM
2) SMM’s net gearing increasing to 0.9x (3Q15: 0.6x) due to a reduction in cashflows
3) Impairments to inventories on both sides
4) Write-offs of revenue recognised previously

While the above are likely immediate repercussions of a potential Sete Brasil bankruptcy, the house warns that the wider implications on the sector are something investors should be weary of. These include:
1) Further impairments by yards and asset owners leading to debt covenant breaches
2) Intense price competition as companies get desperate to lease out assets and avoid impairment
3) Multi-year locked-in contracts at low prices, slashing margins and crimping the ability to benefit when the industry recovers.
4) Absence of safe havens in the industry
5) Stock valuations possibly hitting below GFC lows if risks escalate

Maybank-KE maintains its negative outlook on the sector.

Currently, Keppel is trading at 1x P/B while SMM is trading at 1.1x P/B hovering around their nadir experienced during the GFC.