Asia-Pacific Equity Research Industrials – offshore & marine July 2012

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Industrials – offshore & marine Neel Sinha* Head of Research, Southeast Asia The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch +65 6658 0658 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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Seismic

• • • • • • • • •

CGG Veritas PGS WesternGeco TGS Nopec Fugro Ion EMGS Dolphin BGP

• • • • • • • • •

Subsea & Offshore Equipment

Subsea & Offshore Construction

FMC Cameron DrillQuip Aker Solutions GEVetco Technip NOV Nexans Prysmian

• • • • • • • • •

Technip Saipem McDermott Bumi Armada Floatec Subsea 7 Clough Ezra Sapura Kencana

• Keppel • Sembcorp Marine • Samsung Heavy • Hyundai Heavy • Daewoo Shipbuilding • STX Offshore • COSCO (S) • Yangzijiang • OSX

FPSO/ production platforms

Offshore drilling

Shipyard

• • • • • • • • • •

Transocean Noble Diamond Seadrill ENSCO Odfjell Maersk Fred Olsen Rowan China Oilfield Services • Aban Offshore

• • • • • • • • •

SBM Offshore BW Offshore Modec Bumi Armada Saipem MISC Teekay Prosafe Maersk

Supply vessels & services • • • • • • • • •

Tidewater Bourbon Farstad Bumi Armada Swire Ezra Edison Chouest Maersk Solstad

Asia-Pacific Equity Research Industrials – offshore & marine July 2012

Offshore equipment and services value chain

Asia ex Japan companies highlighted in red

Source: HSBC

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Asia-Pacific Equity Research Industrials – offshore & marine July 2012

Asia ex Japan offshore oil & gas equipment & services sector USD returns vs MSCI Asia ex Japan (Indexed) 1,600 1,500 1,400 1,300 1,200 1,100

2006-07 - oil price rises leading to a new rig ordering cycle

1,000 900 800 700 600

2011 European Crisis

500

2008-09 Financial crisis 400 300 200 100

Aggregate retuns

Jun-12

Mar-12

Dec-11

Sep-11

Jun-11

Mar-11

Dec-10

Sep-10

Jun-10

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

Dec-08

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

Mar-05

Dec-04

Sep-04

Jun-04

Mar-04

Dec-03

Sep-03

Jun-03

Mar-03

Dec-02

Sep-02

Jun-02

0

MSCI Asia ex Japan

Source: MSCI, Thomson Reuters Datastream, HSBC

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Asian offshore marine equipment & services – five-year average EBIT margins and total asset turnover 50%

45% Aban Offshore 40%

EBIT margin (5 year average)

35%

Bumi Armada Ezra Holdings China Oilfield Services

30%

25%

20%

Yangzijiang Shipbuilding

15%

Keppel Sembcorp Marine

Hyundai Heavy Sapura Kencana

10% COSCO (S)

Samsung Heavy

Daewoo Shipbuilding

5% STX Offshore 0% 0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Total Asset Turnover (5 year average)

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Note: Sapura Kencana numbers are based on SapuraCrest & Kencana Petroleum reported numbers before their merger in May 2012 Source: Company, Thomson Reuters Datastream, HSBC

Asia-Pacific Equity Research Industrials – offshore & marine July 2012

Sector description The various segments of offshore and marine services industry are as follows:  Seismic. These companies provide services and equipment for geophysical studies of oil fields to ascertain the quantity and quality of gas reserves. Based on seismic studies oil companies bid for oil fields and develop drilling and production strategies.  Subsea & offshore equipment. This involves developing subsea equipment like trees which are used to develop a pipeline network to supply the oil or gas produced from the wells to production platforms.

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Neel Sinha* Head of Research, Southeast Asia The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch +65 6658 0658 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

 Subsea & offshore construction. These companies buy equipment from subsea equipment suppliers and are responsible for developing the pipeline network on the seabed to transfer the produce to floating production, storage and offloading systems (FPSOs).  Shipyards. Offshore platforms operate and house the heavy-duty drilling equipment and production facilities. Equipment made by shipyards includes drill-ships, jack-ups, semi submersibles, FPSOs, supply & support vessels, manpower accommodation platforms.  Offshore drilling. These companies operate the drilling rigs in offshore oilfields owned by oil companies which charter offshore drillers based on a per day rate. The day rate depends on the prevailing supply demand dynamics for that particular rig (higher specification rigs get higher day rates), duration of the contracts and type of field.  FPSO operators. These operators come into the picture after the well is ready to produce oil. If the field is near the shore pipelines are developed to transfer the oil to an onshore processing facility. If the field is in a remote area and/or is too small to warrant developing a pipeline, a floating oil production/processing facility is used. Similar to offshore drillers, most FPSOs have a long-term day rate contract with oil companies.  Supply vessels. Supply vessels are used to supply drilling chemicals, manpower and to move or anchor heavy drilling equipment like jack-ups and semi-subs. Like drilling and FPSOs, there are specialised companies that provide supply vessel support on a day rate basis. The offshore oilfield equipment and services comprises of a number of large and small companies. For several decades this sector was dominated by the US and European companies. Since the 2000s the rig building industry is almost fully dominated by Asian rig-builders. The offshore services business is still dominated by western companies but new Asian challengers have emerged over the last four to five years. Asian Oil & gas equipment and services companies have provided a USD adjusted return of c7x over the last 10 years compared with a return of 2.1x by the MSC Asia ex Japan USD index.

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Asia-Pacific Equity Research Industrials – offshore & marine July 2012

Key themes Oil & gas capex cycle The main theme in the sector is the capex cycle in the oil & gas sector which is mostly linked to oil prices. When prices are higher companies have more cash to spare for development activities.

Raw material prices Margins in the oil & gas equipment division are also driven by steel which is the main raw material for rig building. Rigs use a lot of special grade high tensile and high carbon steel which has limited and specialised uses, so they don’t really compete with the shipbuilding or general construction industry for the more generic steel types. They can therefore lock in prices for two to three years from suppliers, as there is a smaller number of takers for this type of steel.

Manpower cost Oil and gas equipment services to a high degree and rig builders to a certain degree have high manpower costs. The involvement of high technology in development and operation of rigs means skilled manpower is critical.

Margins and accounting policy Rig-builders use a percentage of completion method of accounting. They usually book lower profits during initial stages of the project to allow for cost overruns. Once projects are closer to completion and the company has a better estimate of the total margin, provisions booked previously are released and margins tend to improve.

Sector drivers Oil prices Oil prices are the single biggest factor determining the demand for offshore rigs. For instance, new rig orders fell sharply in 2009 along with the oil prices. In the case of offshore services companies, a strong oil price usually means high equipment prices and the best charter rates a higher oil price.

Equipment fleet age Equipment age is also one of the key factors determining the demand for equipment. When the average age of a rig fleet increases older rigs need to be replaced with new equipment. This is particularly true since the Maconda accident in the Gulf of Mexico. Another factor driving the demand for newer equipment is the increase in drilling in difficult locations like the Arctic, in deep seas or in rough waters. Oil and gas services companies with older fleets find it difficult to get new contracts.

Valuation Discounted cash flow is the best way to value rig-building companies as discounted cash flow enables the business to be valued across cycles. Conventional earnings multiples may not provide an accurate picture of the prevailing market conditions. This is because rig-building is a long cycle business and the order to delivery cycle can be two to three years. The orderbook may peak in bullish times but the profitability peaks two to three years after the order peak. This is what happened in 2008-09, which were bad years for new orders but were excellent for Singapore rig-builders from a profitability standpoint. As a result of this

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Asia-Pacific Equity Research Industrials – offshore & marine July 2012

dynamic newsflow on new orders or contracts is typically a more important are share price driver than the reporting of profits. Another variable which works well is the market value by order backlog. In case of oil & gas services companies, a discounted cash flow approach also helps to value the company or its assets across the full contract period and assists in estimating the options for extending contracts once charters expire. Another useful valuation matrix is EV by order backlog (expected receipts from current charters).

GTL

LNG

Oil Shale

Heavy

Enhanced

U ltra Deep

Arctic

Deep Water

Other

OPE C Middle

140 120 100 80 60 40 20 0 Already

Hu rdle Range($/b arrel)

Estimated E&P hurdle rates by region and energy type

Source: HSBC estimates

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