Friday, May 24, 2013

World's Biggest Rig Developer Posts a Massive Drop in Income

From the Motley Fool, dated 9th May, 2013
Keppel Corp (NASDAQOTH: KPELY.PK)the world’s largest builder of offshore oil rigs has reported a significant slide in earnings, but this shouldn’t come as a surprise as management has been giving warning signals to shareholders. The company also operates in property and infrastructure segments, but its bread and butter mainly relies on developing offshore rigs for oil majors such as Royal Dutch Shell (NYSE: RDS-A). Keppel is one of the biggest firms in Singapore, and is responsible for half of the world’s jack-up rigs delivered since 2000.It has also moved into the relatively newer Floating LNG, or FLNG, vessel segment and is currently
developing one of the world’s first such ships. 
Meanwhile, Shell is leading the industry in deploying FLNG vessel in the Australian waters off the Kimberley coast. Just this past week, the keel for its first enormous FLNG vessel was laid down in a shipyard in South Korea as the 600,000 ton ship gears up for assembly. FLNG is the only feasible way to utilize relatively smaller offshore oil and gas assets. The move of big oil firms like Shell towards this technology is going to herald a new era for this sector, and Keppel would be well positioned to capitalize on this, and Shell is making the first move. 
Although Keppel's current results disappointed investors, the demand for energy remains high as oil firms are increasing their budgets to replace or install new offshore rigs.  Last year, the company signed a landmark LNG vessel agreement with Golar LNG, in which Keppel started developing three FLNG vessels for the Norwegian firm.Shell's vessel has a capacity of 5.3 million tons per annum, while Golar's vessel's capacity is 2.3 million tons. 
Project pipeline
Keppel generates 62% of its income from Offshore and Marine, or O&M, 28% from Infrastructure in which Keppel focuses on energy, power and telecommunication projects, and 11% from its Property division, while the rest comes from its investments in other smaller areas. So far this year, Keppel Corp has secured seven new orders for KFELS B Class jack-up rigs. KFELS B Class is one of the most popular rigs, and Keppel has delivered 42 of these rigs since 2000 while it has 21 more units in its pipeline. Keppel’s O&M year-to-date order book stands at $1.8 billion, while it has secured total net orders of around $11 billion.
More recently, about a month ago, Keppel received another order for a KFELS B Class rig from the London based Ensco Plc for $225 million. This was followed by the first order from for a jack-up rig from the Singapore listed Falcon Energy worth $226 million.
However, Keppel is not the only one pumping its order pipeline. Its Singapore based rival and the world’s second biggest rig developer Sembcorp Marine has also secured new orders worth $417 million for developing two jack-up rigs for Mexico’s Integradora de Servicios Petroleros Oro Negro. Sembcorp’s year-to-date order book is about $154 million behind Keppel's. Semcorp’s quarterly results are due on  May 3, in which analysts are expecting a 29% increase in profits to $146 million.
On the other hand, Keppel’s most recent results released a few weeks ago show a 56% drop in net profits to $267.75 million, while its top line revenues fell by 35.3% to $2.24 billion. But last year’s results also included gains made from sale of the Reflections at Keppel Bay housing units, a part of its property division.
The company’s revenues from O&M fell 15%to $1.38 billion on the back of lower volume which included completion and delivery of five jack-up rigs. The infrastructure segment, the second biggest source of Keppel Corp’s revenues, posted an 11% increase in revenues to $613.5 million due to a boost it received from its cogeneration power plant. In infrastructure, the relatively better performance of Keppel Energy is making up for the losses from Keppel Integrated Engineering. The revenues of the Property segment fell by 80% to $242 million mainly due to the sale of the Reflections property.
The Offshore and Property divisions dropped by 12% and 80% to $168.6 million and $64.83 million respectively while Infrastructure doubled its profits to $44.6 million. In this quarter, Infrastructure made the second biggest contribution to the top-line but is behind Property in terms of profits.
Both Keppel Corp and Sembcorp have significant representation in iShares MSCI Singapore Index Fund ETF (NYSEMKT: EWS). Keppel Corp is the fifth largest holding in this $1.64 billion ETF, with a weightage of 6.04%. Sembcorp is also represented in the Guggenheim Shipping ETF where it is the fourth largest holding with a weightage of 5.86%. In the last six months, SEA has outperformed EWS but EWS gives a much better dividend yield of almost 4%, versus less than 3% for SEA:

Although Keppel's current results, particularly the drop in O&M earnings, is disappointing, I believe that the fundamentals of this industry are strong and the macroeconomic environment is going to improve in the coming years; therefore there are reasons to be optimistic about Keppel's O&M segment. The company holds half of the global market share in offshore oil rigs, and its KFELS B Class rig has become  an industry standard. The global economy is showing gradual recovery, and oil prices are expected to show more stability in 2013. The future rise in oil prices will translate into more opportunities for Keppel. Meanwhile, energy demands are as high as ever and firms will continue to invest in development of offshore rigs.
Secondly, oil companies in general have under-invested in exploration following the global financial crisis. The reserve replacement ratios (RRR) of some of the leading oil firms are far from encouraging; last year, Shell's RRR was just 85% -- when 100% is considered acceptable, while RBC Capital Markets believes that 118% is required for a 2% increase in output. There is a growing need for oil firms to tap into their reserves and I believe Keppel will witness increasing demand in the coming years, for offshore rigs, drill ships and FLNG vessels.
Thirdly, most of these rigs and drill ships are constructed in yards around Singapore and South Korea. Once the ongoing construction work at  Korea is complete, I think Keppel will record more orders for its drill ships, particularly the DS-1200. Investors should also note that the shipping industry has been struggling and yards have plenty of spare capacity. Add the rising demand for rigs to this equation and Keppel emerges as a winner.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article