A well-structured deal could give SembMarine the economies of scale it needs to compete, say analysts

 

SEMBCORP Marine (SembMarine) has a " margin problem" that could be solved with an acquisition of Keppel Corp' s offshore rig business, some market watchers said. If a deal is structured right, SembMarine could gain the economies of scale it needs to compete.

 

SembMarine had been a growing weight on the earnings of Sembcorp Industries before it was fully separated from the latter last year. The gross margins of the offshore and marine company had been as high as 11 per cent in 2017, but were a negative 3.2 per cent in 2019.

 

The industry in which SembMarine operates is increasingly regarded as unattractive - partly because lower oil prices have made oil exploration and production less lucrative, and partly because demand for fossil fuels is expected to continue declining in favour of renewable energy.

 

British oil major BP, for instance, plans to cut its oil and gas production by 40 per cent by 2030 as it transforms into an integrated energy company. S& P, meanwhile, has lowered its credit ratings on US players ExxonMobil, Chevron and ConocoPhillips, citing climate change risks.

 

SembMarine' s management appears to understand the need to change with the times. The company now hopes to derive 30 per cent of its total income from sustainable products by 2030.

 

But an acquisition of Keppel' s now unwanted offshore rig building operations is still viewed favourably by some.

 

In fact, Justin Tang, head of Asian research at United First Partners in Singapore, said that the poor market outlook, as evidenced in Keppel Offshore & Marine (O& M) and SembMarine' s recent results, " means that consolidation is more a question of when rather than if" .

 

Senior counsel Francis Xavier, regional head of dispute resolution at Rajah & Tann Singapore, said: " The distressed assets of a target company - even in an embattled sector - could be a viable opportunity for an acquirer who is already in that space, especially if the price point is attractive.

 

" A grab of a greater share of the market and overall economies of scale could be useful end results."

 

Furthermore, David Kuo, co-founder of investment education website The Smart Investor, suggested that SembMarine' s difficulties had less to do with revenue and more to do with margins. A merger could therefore help, he added.

 

Acquiring some of Keppel' s O& M assets would also give SembMarine the necessary heft to compete with foreign shipyards, said Phillip Securities Research' s senior research analyst Terence Chua.

 

He noted that some of SembMarine' s competitors, such as Hyundai Heavy Industries and China State Shipbuilding Corp (CSSC), are substantially larger. In 2019, CSSC merged with China Shipbuilding Industry Co to create the world' s largest shipyard.

 

But Mr Chua added that the value of such a deal would depend on its structure, citing factors " such as the debt and equity mix used to finance the deal" .

 

Whether or not SembMarine can afford to make such an acquisition is a separate matter. The company' s operations have not been generating cash. In FY2019, net cash used in operating activities was S$296.17 million. Following its rights issue last year, net gearing for SembMarine stood at 0.52 times as at June 30, 2020, compared with 2.10 times before the rights issue.

 

And although SembMarine stands to gain from an acquisition of Keppel O& M' s offshore rig assets, it could invest its funds elsewhere, given that Keppel O& M' s withdrawal from the rig space will already reduce the local competition that SembMarine faces.

 

DBS Group Research analyst Ho Pei Hwa suggested that any acquisition could instead " help to beef up their research and development, and engineering capabilities" in renewable projects.

 

Phillip' s Mr Chua, too, said a merger with other clean energy companies is also a solution to lift SembMarine' s depressed margins. He added that the two investment options - fossil fuels versus renewables - are not mutually exclusive.