Sunday, 24 July 2016

Keppel Corp – A Good Captain Sailing Through Rough Waters

If you had read my previous post on How Will Keppel Corp Navigate the Oil Crash?, you would know that I am ready to sell Keppel Corp before the full force of the storm hits it. Yet, I have to admit that Keppel Corp's management is doing a pretty good job in steadying the ship given the circumstances which they have not much control over. The recently released financial results for 2Q2016 reaffirms my belief that Keppel Corp has a chance of surviving the harsh winter, and if it survives, it will come out much stronger.

It has been said that the Oil & Gas (O&G) industry is facing a long and harsh winter. But how long and harsh will it be? A glimpse of Keppel Corp's order book for the Offshore & Marine (O&M) segment provides an indication of how harsh the winter is going to be. In 1H2016, Keppel Corp booked a revenue of $1.54 billion, which is 56% down from a year ago. Over the same period, it has only managed to secure new orders of $0.36 billion (I excluded the recent order of $0.1 billion because it was announced after the close of 2Q2016). This means that for every $1 of revenue that Keppel Corp delivered, it only managed to secure $0.23 of new orders. From another perspective, the book order is decreasing rapidly at a rate of $1.18 billion every 6 months, or $2.36 billion per year. As at Jun 2016, the net order book stands at $4.28 billion after excluding Sete Brasil's orders. Assuming the same rate of depletion of order book, Keppel Corp's O&M segment will effectively run out of business in less than 2 years' time (note: the last delivery is in 2021, but there is not much business to sustain high utilisation of the yards). Currently, Keppel Corp's O&M segment is still turning out a profit (its 2Q2016's net profit is $61 million, a 65% drop from a year ago), but it will not be long before the segment incurs losses. I do not have any information on how badly the losses are going to be, but I believe the depreciation and manpower costs are not going to be small. 

For Keppel Corp's O&M business to recover, its customers, i.e. the oil drilling companies, have to recover first. Below is a figure of the utilisation and day rate for semi-submersibles from IHS, the ones Keppel Corp is building for Sete Brasil.

Fig. 1: Utilisation & Day Rates for Semi-Submersibles

The utilisation is down by nearly 50% from its peak 3 years ago while the day rate is down by almost 60%. The trend is the same with other types of oil rigs. Multiplying the utilisation by the day rate, you will see that the revenue of drilling companies has fallen by more than 70% from the peak! It is no wonder that drilling companies are not placing new orders for oil rigs. Even North Altantic Drilling, which ordered a semi-submersible from SembCorp Marine, has deferred taking delivery of it until a drilling contract is found. Looking at the steep decline in utilisation, it will be a fairly long time before utilisation bottoms out and recovers. Even when utilitisation and day rate recover, it will still take some time for the benefits to trickle down to the shipbuilders, as drilling companies need several years of profit to repair their balance sheets. I think it will be faster for Britain to recover from Brexit than it is for O&G companies to recover from this severe slump.

Yet, despite the extremely challenging conditions facing Keppel Corp, its management has done a pretty good job in steering the ship. On the corporate side, Keppel Corp is leveraging on the expertise within its various business segments to maximise revenue. One of the key planks of this strategy is to strengthen its asset management segment by consolidating individual REIT, business trust and fund management units into a newly set up unit known as Keppel Capital. The figure below provides an example of how the various business segments will work together to maximise revenue for Keppel Corp.

Fig. 2: Different Business Segments Working Together to Maximise Revenue

From the set-up of a new fund, to developing new data centres to managing data centres, Keppel Corp's business units are involved in every step of it. And when the data centre is sold to Keppel DC Reit, the capital is recovered and the entire process can be repeated. In the meanwhile, Keppel DC Reit continues to derive asset management fees from managing the data centres. The strategy is not confined to data centres only. It works with any operating assets that are capable of generating regular stream of income, including O&M assets (when utilisation and day rate recover). Below is an extract from Keppel Corp's CEO speech when he released the 2Q2016 financial results:
"Established institutional investors have told us that they want to get closer to the coal face to own 'real assets', including those in the offshore and marine, real estate and infrastructure industries."
This new corporate strategy has the potential to rapidly expand its assets under management and generate good revenue for Keppel Corp in the years to come.

Even in the O&M segment, Keppel Corp has taken the right steps. It acquired the LeTourneau rig business to provide aftermarket sales and services. Even though drilling companies are not ordering new rigs, they still have to maintain their existing rigs, so that business provides a steady revenue stream to supplement the rapidly slowing revenue stream from ship and rig building.

It has also partnered Shell Eastern Petroleum to provide Liquefied Natural Gas (LNG) bunkering business. This might yet open more doors in the LNG area, such as building/ retrofitting LNG vessels. Given the concern over climatic changes and resulting search for cleaner fuels, LNG might gain greater prominence in future.

Although the above 2 actions might not yield immediate results as oil majors are still cutting costs wherever possible, it demonstrates that Keppel Corp knows what it needs to do. In the 2Q2016 speech, Keppel Corp's CEO said that if necessary, they might mothball yards with low work volumes. If implemented, this will reduce the depreciation cost of its yards. 

If there is any action that can be reconsidered, it is Keppel Corp's privatisation of Keppel Land in Jan 2015 for $3.1 billion in cash. Keppel Corp's net debt is $7.3 billion, with a net gearing ratio of 0.62 as at Jun 2016. Imagine how nice it would be to have an additional $3.1 billion in cash. Having said that, the privatisation decision is more bad timing rather than bad decision. Sete Brasil had just stopped progress payment on its rigs 2 months earlier in Nov 2014, and it was not clear at that time if it would be temporary or permanent. Given the sharp fall in oil price, it was reasonable to diversify earnings away from O&G by privatising Keppel Land. The decision cannot be faulted given the circumstances at that time.

In conclusion, Keppel Corp is sailing into the full force of the storm. However, the captain (i.e. its management) has demonstrated that he is a very capable captain. Even if I do not manage to sell Keppel Corp at above my purchase price and have to ride through the storm with it for 5 years, with such a capable captain at the helm, I can relax, knowing that it is in good hands.


  1. our focus in Kep should now be outside O&M how they grow property and DC reit business. They may also sell stakes in M1.

    In O&M they should be able to get another big FLNG order from Golar and also other projects in FPSO and Special vessels! The problem now is LOWER MARGIN and with the current group of people, how will they able to execute the more difficult customized projects with lesser expertise and experienced people!!!

    Orders may not equal to profits!

    The CEO focus is really to grow other segments and sell assets off from O&M! He has no other choice!

    1. Agree with you that the new contracts will have lower margins. But I guess having some orders is at least better than having no orders. The challenge is getting enough business to cover the overheads of the yards and salaries of staff.

  2. Hmm.. BI,

    If captain is the core consideration here, and also waiting for winter to end, have u look at Yangzijiang?

    Although not in O&G sector, it's shipbuilding business is in harsh winter too.

    1. Hi SI,

      I sold YZJ a year ago. While they are getting new orders, these orders come with lower margins. Although it is also facing headwinds, at least it is not in the O&G sector, so its challenges are smaller.

    2. Hi BI,

      It seems then u are not just looking at captain and survivability but also trough valuation for purchases.

      In terms of stewardship I felt Ren is one up, in the treachery waters of China shipyards, with internal unfair advantage of SOE builders, ext Korean Giants. They manage to bypass the O&G fallout by restricting their order only to 1.

      What they want to do, they did. First, bigger Teu, then LNG.

      Their next move is Ren's Pet. Investment holding, the official "coming out of the shadows" of HTM.

      (Not vested) hoping to bottom fish too, with low margins orders reality sinking in

    3. Hi SI,

      If the way ahead is smooth, there is less need to look at the captain's capability. But if the way ahead is rough, then a good captain can be very helpful in steering the ship through the storm safely.

      Yes, Ren has been leading YZJ to climb up the technology ladder. But I think he is going to hand over the reins to his successor soon.

  3. Because o&m constitute approx. 45% of total business so Keppel will experience be a long harsh winter in the next 2 years. Even though property and infrastructure are not as big as o&m but it has a long and established name and not forgetting geographical presence to grow further. Both property and infrastructure will need to grow faster to outpace the decline in o&m. For now, it needs recurring income however small, for example M1; so l am sceptical for it to divest any non-core. Let's see ...

    1. I also think that Keppel Corp is trying to grow its recurring income and will not divest M1. But for those non-core businesses that do not bring in recurring income, I believe it will divest them to pay down debts.

  4. what is the fair value by your estimation now? has the current price already discounted the harsh winter into it?

    1. I don't have a fair value estimate for it. I am ready to sell if it goes above my purchase price.