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Gust Post by sgwealthbuilder.com
The recent corruption fine on Keppel Corporation amounting to $566.91 million by US, Brazil and Singapore authorities certainly rocked the market. The record fine came at a time when the oil market is perceived to be recovering from a devastating three-year slump. But more importantly, as a government-linked company, the episode left a taint on the reputation of Singapore, widely known to be one of the most corruption free cities in the world.
But beyond the corruption scandal, a far more sinister probably awaits Keppel Corp. In my opinion, it could be the dominance of US shale oil production that may change the game for the Singapore blue chip. Whilst the corruption fine may be staggering, Keppel Corp’s balance sheet is strong enough to withstand the impact without incurring significant damages to its growth prospects.
Diversified businesses
As an industrial conglomerate, Keppel Corporation has four major business divisions – Offshore and Marine, Property, Infrastructure and Investments. Keppel O&M (KOM) specializes in offshore rig design, construction and repair, ship repair and conversion, and specialised shipbuilding. It integrates and harnesses the experience and expertise of 20 yards and offices worldwide to be near customers and markets.
Keppel Land is the property arm of the Keppel Group, with diversified property projects in Singapore, China, and high-growth South East Asia countries like Indonesia and Vietnam. This business unit used to be listed in the SGX but was privatized in 2015.
Keppel Infrastructure develops and operates power plants, sewage and water plants. The unit also has businesses in logistic and data centres through Keppel T&T.
Keppel Investments Division consists of asset management arm Keppel Capital, which includes the asset managers Keppel REIT Management, Alpha Investment Partners, Keppel Infrastructure Fund Management and Keppel DC REIT Management, as well as the Group’s investments in k1 Ventures, M1 Limited and KrisEnergy.
Keppel Corporation
Guinness World Records
Despite the sprawling business empire, Keppel Corporation’s core business is still primarily in the oil and gas industry. In 2014, Guinness World Records conferred Keppel Fels, unit of KOM, the “world largest offshore rig maker”. Prior to that, it had set an industry record through the delivery of 21 new oil rigs to customers such as Shell and Exxon Mobile.
Being the number 1 player in the oil rig industry, Keppel has certainly leveraged its investment moat and rode the oil boom from 2001 to 2014. Arguably, the group’s best performance was in 2012, when it achieved a record revenue of almost $14 billion on the back of the surging oil price. Those good old days must be surreal to shareholders as demand for oil rigs peaked against the backdrop of record oil price. Back then, oil price was trading at average annual price of USD110 per barrel as there was fear that the supply would not be able to meet the ever-growing demand for oil.
It was the fear of depleting oil reservoirs that led to oil companies to venture into deepwater drilling. In 2006, Keppel Fels secured the first drilling rig contract for Brazil worth US$270 million and then in 2011, it secured US809 million deal from Sete Brasil. It was estimated that Brazil has an estimated 50 billion barrels of deep-sea oil and gas reserves. Brazil is the world’s 11th largest oil producer and is expected to be in the top five by 2020.
But things started to change in 2012 when US shale oil emerged to shatter the surging run of the oil price. Using the latest technology in drilling, US producers were able to extract shale oil from sedimentary rocks and substitute conventional crude oil with it. The technology disruption ignited a remarkable era of magnificent growth for the US as shale oil production is expected to increase from 1 million barrels a day in 2012 to 2 million barrels a day in 2020. Suddenly, US is challenging the Middle East and Russia for the oil market share.
Oil boom and bust
While it is too far-fetched to claim that US would overtake Saudi Arabia and Russia as the largest oil producer, the oil revolution created a new balance to the market. Suddenly, the world does not need to look to the Middle East cartel or Russia to meet its insatiable energy needs. Many major oil companies like Shell, Chevron and Exxon Mobil are rushing to extract shale oil onshore in West Texas. Due to the 2010 BP disastrous oil spill, the oil giant is also cutting down deepwater drilling activities.
Like every industry, the O&G sector is susceptible to cycles of boom and bust. The challenge currently faced by Keppel Corporation is not entirely due to the supply and demand of oil because the root cause is actually the technology disruptions in the extraction of oil.
As a commodity, it is not possible to differentiate between oil and its substitutes. What this means is that consumers do not care whether the oil is derived from conventional crude sources or shale oil. If shale oil can substitute conventional crude oil, there are lesser needs for offshore deepwater drilling. And this would impact Keppel Corp’s business because its bread and butter technology is focused in deepwater oil drilling.
Long winter ahead
To put things into perspective, there is nothing much that Keppel Corp can do to mitigate the headwinds brought forth by the changing dynamics in the oil landscape. As a company in the mid segment of the oil value chain, Keppel Corp is at the mercy of oil producing companies. If there is lesser demands from the oil producing companies, Keppel Corp would not be able to secure lucrative contracts worth hundreds of millions to design and build deep sea oil rigs.
In anticipation of the long winter, Keppel Corp has right-sized its staff count in 2016, retrenching 8000 staff. The massive reduction in staff force helped to reduce staff costs. For the nine months ending 30 September, staff costs amounted to $774 million, a 10.4% reduction year-on-year.
Group revenue of $4,419 million for the nine months to-date was $408 million or 8% below that of the corresponding period in 2016. Revenue from the Offshore & Marine Division declined by $742 million to $1,312 million due to lower volume of work. The latest data suggested that Keppel Corp is nowhere near “light at the tunnel” for its Offshore and Marine Division.
Nonetheless, revenue from the Infrastructure Division grew by $386 million to $1,614 million as a result of increased sales in the power and gas businesses and progressive revenue recognition from the Keppel Marina East Desalination Plant project. The Infrastructure arm offers a glimmer of hope for Keppel Corp because infrastructure assets are typically considered more defensive in nature. Infrastructure facilities provide essential services like electricity and sewage processes, thus such asset classes are less susceptible to boom and bust cycles.
Keppel TatLee Bank
The major shareholder, Temasek Holdings, may consider merging the oil rig capabilities of Keppel Corp and Sembcorp. The merger will make sense because of the cost saving that is expected to derive from business consolidation. Given that demand for new oil rigs will remain weak going forward, the market will not be big enough to cater to the world’s two largest oil rig builders.
The scenario of the merger of Keppel Corp and Sembcorp oil rig capabilities is not entirely implausible. Many older Singaporeans may recall that Keppel TatLee was sold to OCBC Bank in 2001 in the aftermath of the banking consolidation.
The chances of Temasek Holding delisting Keppel Corp is extremely remote because the sovereign wealth fund currently only holds 20.47% of Keppel Corp as of January 2018. With such low stake, chance of a successful privatization is very low unless the offer is out-of-world attractive. It is also unlikely that Keppel Corp will issue rights to raise capital because that will further dilute the major shareholders’ stake.
Second scenario could be the re-alignment of its key business segments. With its core engineering capabilities, it is possible to transfer its workforce skill-set in the oil and gas sector to its property and infrastructure businesses. The current weak market provides a good opportunity to venture into emerging fields like data centres, power-plants and waste-to-energy plants. Even if the oil prices do recover, it is unlikely that Keppel Corp will witness the kind of explosive growth in previous years. So it is time opportune for Keppel Corp to grow new business opportunities in other areas.
My strategy
Keppel Corp’s story is intriguing. For the past ten years, it has ridden on the wave of the oil boom very well but the next ten years look kind of dark and gloomy. Many investors are waiting on the sideline and expect Keppel Corp share price to drop further before buying on the cheap. In view of the uncertainties, I will not invest in Keppel Corp until there is visibility of business turnaround.
Although this blue chip is still making healthy profits, the balance sheet looks shaky with net gearing ratio at 0.50 and debt of $6.25 billion. While I understand that the oil and gas industry is a capital-intensive sector, the management may want to reduce the risk of potential interest rate hikes in 2018.
