Investment Thesis

#1 &ndash Business underperformance

#2 &ndash Low order book, High operating leverage

#3 &ndash Weakening balance sheet

#4 &ndash Others

(a)  Fundamental shift in supply and demand

As a consequence of USA increasing oil production at the expense of OPEC and a fundamental shift into LNG and renewables, there is a change in the mix of energy production and also of onshore/offshore oil production. USA has became an oil powerhouse and are now a net exporter of oil.

We have still not seen any significant uptick in capital expenditure by the European E& P players which have been major customers of SMM.

The Chinese and Korean yards have also successfully competed for contracts on many occasions

(b) Overhang from corruption probe and Sete brasil contracts

The corruption probe by the Brazilian authorities continues place uncertainties relating not only to risk exposure, but also the ability to secure further contract wins in that region.

We note that there is already a full provision for costs incurred for the 7 Sete Brasil drillships. SMM made a S$329m provision in 2015 for the costs incurred for which there were no payments received.

On 7 Oct 2019, SMM released an announcement noting the settlement of all 7 drillship contracts. For 5 of the 7 drillships, the Group will keep all works performed. In respect of 2 of the 7 drillships which have the most advanced construction progress, the titles to such works will be apportioned between the Group and Sete Brasil in proportion to payments made by Sete Brasil. Sete Brasil has identified a purchaser for the companies of Sete Brasil which own the 2 drillships. The purchaser is expected to negotiate with the Group to enter into new contracts to complete the drillships. This will be positive for the orderbook and cashflow if successful.

SMM will continue to carry the 5 drillships on its books and is unlikely to continue construction until they find a purchaser.

Notwithstanding the current supressed environment, we note that the main upside potential for this settlement is that SMM is now free to enter into contracts for the completion of all 7 drillships, should they be able to secure buyers.

(c) Support from substantial shareholder

SCI has recently provided a $2 billion loan facility to SMM which SCI has funded via a bond issuance to investors such as Temasek. Without this facility, the duration and cost at which SMM secured borrowings may not be as favourable. We

(d) IMO 2020 clean energy & asset renewal program of customers

The IMO 2020 clean energy requirements will lead to an increased order book for the SMRU segment in the form of retrofits and installation of scrubbers. Some companies may also choose to retire their current vessels earlier as it may be costly for some existing vessels to comply with IMO 2020.

As part of a capital expenditure cycle, there is also no doubt that many drillships and offshore platforms are due for scrap and/or refurbishments in the coming few years which should provide some support to the order book. However, we do not think we will see a > $10b peak order book (last seen in 2012) in the near future.

(e) Low likelihood of merger or delisting

There has been speculation about a merger with Keppel O& M, we think that it is unlikely to happen for the following reasons:

• Unlikely to lead to a rerating of valuations as both segments are underperforming. Where there is a macro-level impact, the valuations may actually rerate down.
• SMM has just consolidated its yard in Benoi and is accelerating the Admiralty yard closure, as such it does not make sense to consolidate yards again in this capital cycle. Some analysts view the merger as something that will happen eventually, our view is that if both SMM & KOM continue to shrink, there may come a point where there is a need to merge to obtain economies of scale.

Conclusion