SINGAPORE (Dec 17): UOB Kay Hian is maintaining a “market weight” rating on Singapore’s shipyards, with Sembcorp Industries (SCI) as its preferred pick.

The research house has a “buy” call on SCI with a target of $3.41, as the group has a stable utilities business, and exposure to Sembcorp Marine’s (SMM) improving financials.

It adds that SMM is the most direct proxy to the recovery play as it has the potential of breaking even at the operating level in 2019 and the stock is trading near -1SD to its long-term mean price-to-book ratio.

On the other hand, Borr Drilling, the biggest acquirer of stranded jack-ups from Singapore shipyards, owes local shipyards close to US$1.2 billion ($1.65 billion). This includes repayment of delivery financing, back-end financing fees and deferred payments, following a year since Borr started acquiring rigs from Singapore for close to US$2.9 billion.

Borr’s ability to repay the outstanding debts is based on a thesis that shallow water drilling activity will return very strongly, prompting rates to rise rapidly. Although activity might be picking up, data from IHS-Petrodata suggests that it might not be at the rate that Borr envisioned.

Assuming a dayrate of US$90,000/day, Borr is generating about US$9 million of free cash flow per working rig per year, implying that it will take about 10 years to recoup the principal outstanding of US$84 million, double the five-year term that shipyards like SMM have extended for delivery financing.

In a Thursday report, analyst Foo Zhiwei says: “Based on our estimates, the rigs have to be put out to work at rates of US$120,000/day at the minimum to generate sufficient cash flow to repay its financing on time.”

Another concern is that only three out of 10 rigs that Borr has taken delivery from the Singapore shipyards have been mobilised for work. The rest remain warm-stacked. And the group will see another nine rigs being delivered by end-2020.

“While there is still time to play catch-up, the situation may become an issue over the longer term if activity does not pick up fast,” says Foo.

In the worst case scenario where dayrates and activity do not pick up as fast as expected, the analyst reckons that Borr will have to seek liquidity to finance delivery payments as they come due, starting 2022, via additional debt financing or further issuance of shares.

However, the stock has significantly declined over the year and any further share issuance will likely be dilutive. And given the quantum due is over US$1 billion, it may be difficult to raise those monies, raising the spectre of balance sheet issues and stranded rig assets all over again for the yards.

Overall, Borr’s acquisition was just the beginning, as Singapore shipyards have managed to successfully offload their stranded rig assets and recoup some of their capital. But until Borr pays off the rigs in full, the analyst believes that receivable risks remain.

Although the worst for the sector is over, it is still far from a complete recovery as shipyards remain at or below breakeven at the operating level. And after including the net interest expenses, they remain loss-making and are likely to be until their debt falls off significantly.

“With balance-sheet risks remaining on the cards, the yards are not completely out of the woods yet. Profitability remains distant, and the yards are still trading plays at best,” says Foo.

As at 12.25pm, shares in SCI are trading at $2.64, while shares in SMM are trading at $1.61.