Excerpts from analyst's report

Nomura Securities analyst: Wee Lee Chong

Upgrade Keppel Corp to Neutral

Clarifying market’s three key misinterpretations of possible outcomes if Sete Brasil defaults 

Action: Upgrade KEP to Neutral rating, and cut TP to SGD5.05
We upgrade Keppel Corp (KEP) from a non-consensus Reduce rating (since 8 October 2014) to Neutral, and retain our Buy on Sembcorp Marine (SMM). We cut our SOTP-based TP for KEP by 11% to SGD5.05 and by 14% for SMM to SGD1.78.

Our TP for KEP is based on 1.4x P/B, versus 2x previously, on its key Offshore & Marine (O&M) business, which is equal to SMM’s GFC-trough P/B and we believe is justified by KEP O&M’s higher ROE versus peers. We use a lower 1.2x P/B for our TP for SMM due to the volatile market, versus 1.4x previously, which is 20% below its P/B-ROE model-derived P/B of 1.5x.

Photo: Company

We believe there are two significant events for KEP this week
We believe KEP’s share price has largely factored in our non-consensus view that we have held since early-2015 that: 1) O&M division’s profits will suffer as other O&M-related projects are insufficient to make up for the dearth of new orders for its key newbuild jackup rig products, 2) the expected 20% y-y cut in FY15F DPS to SGD0.40, and 3) the implied discount to its property business’ NAV with long gestation periods for overseas projects should be 50% despite the Keppel Land privatisation.

The 4% potential price upside to our new TP is not sufficient to warrant a Buy rating on KEP, combined with uncertainty on: 1) the extent of potential provisions on up to 12 jackup rig orders, and the size of possible DPS cuts in the FY15 results announcement on 21 January, and 2) the market’s likely negative reaction should Sete Brasil file for bankruptcy after its shareholders’ meeting on 21 January. On SMM, we believe order backlog and new orders outlook will give good FY16F profit coverage, and the market has priced in potential provisions since last month’s profit warning for 4Q15F.

Market has misinterpreted the implications of Sete Brasil defaulting
We believe the market has misinterpreted the extent of provisions needed to be made by KEP and SMM, if Sete Brasil eventually defaults, as:

1) A client filing for bankruptcy does not necessarily imply that orders will be removed from order backlogs, as this also depends on whether the bankers want to ring fence dedicated funding to save certain projects, as per our report on 7 October 2015. We expect two or three projects each for KEP and SMM to be at risk of cancellation if Sete Brasil defaults.

2) An order cancellation does not imply provisions need to be made. We expect one order for SMM to be at risk of requiring provisions and zero for KEP.

3) The possible and seemingly large revenue writebacks are likely to have little impact on net earnings, as they will likely be compensated by a surge in other income that is equivalent in value to the reduction in gross profits.

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