Deepwater Dynamo: Keppel Corp

By: Yiannis Mostrous

Keppel Corp KPELY remains one of my top plays on the global energy and infrastructure boom. The company operates three main divisions: offshore and marine (O&M), property, and infrastructure. In 2011, the company’s O&M division generated 69.5 percent of the company’s operating profit, while the property division contributed 24.1 percent.

The O&M segment should be able to sustain its strong performance during 2012. And Keppel could win another USD3 billion to USD4 billion in new contracts this year, in addition to the contracts the company has secured from Brazil.

At the end of December, Sete Brasil awarded Keppel a USD809 million contract for a semisubmersible rig slated for delivery in the fourth quarter of 2015. The new rig will use Keppel’s proprietary design–known as DSS 38E–which is an improved version of Keppel’s fifth-generation deepwater rigs currently in use in Brazil, West Africa and the Gulf of Mexico.

Keppel’s DSS 38E design is rated to drill to depths of 33,000 feet in water as deep as 10,000 feet. The rig is 355 feet in total length and its main deck is 240 feet by 240 feet. The rig’s accommodations can house a crew of 160 people.

In addition to the USD600 million to USD800 million per contract the company brings in from building new rigs, Keppel also earns USD150 million to USD200 million per contract when upgrading existing rigs.

The cost of building a new rig largely depends on where it’s constructed. In Singapore, semisubmersible rigs take 30 months to build and their cost of production is around USD600 million, while the same or similar rig takes 48 months to build in Brazil and costs USD800 million to produce due to higher operating costs.

But because many of the rigs built in Brazil are delivered to the Brazilian government’s majority-owned Petrobras PBR, the higher cost of production is usually overlooked. As a result of both Keppel’s product line and its strong relationship with Petrobras, the company could garner an additional USD4 billion in contracts from Brazil.

Keppel’s O&M margins have steadily climbed, and its exceptional performance last quarter surprised analysts. Although the division may experience weaker margins this year due to a rise in costs, Keppel takes a disciplined approach to acquiring new business and will not overbid for contracts. In the past, the company has refused to participate in potential deals when the terms were viewed as unprofitable for the company. The division may have difficulty maintaining margins above 20 percent in the long term, but management’s efforts could produce a performance that beats expectations again this year.

The deepwater market remains relatively tight, and utilization of the global semisubmersible fleet is already at 88 percent. According to industry sources, there are only eight uncontracted deepwater rigs coming to market through the first quarter of next year.

The next two years should be good ones for Keppel, especially for its O&M and property divisions. Operationally, working capital and capital expenditures could increase this year as more rigs go under construction on 20/80 payment terms, but that will be offset by the strength in the real estate business.

The property division’s luxurious new development in an emerging marketlike Singapore is expected to be quite profitable. The project is already 70 percent pre-sold, and as many as 150 units will be retained as corporate residences.

Keppel’s stock trades at 11.5 times projected earnings, and I expect its share price to rise further once the market recognizes the company’s rock-solid fundamentals With a dividend yield of 4 percent, Keppel Corp is a stock to watch.