A Tsunami May Be Heading For Keppel Corporation Limited And SembCorp Marine Ltd

Oil-rig builder Sembcorp Marine Ltd (SGX: S51) and Keppel Corporation Limited’s (SGX: BN4) offshore & marine segment have one thing in common: They both see Brazil-based Sete Brasil, one of the largest rig owners in the world, as a major customer.

At the moment, Sete Brasil has orders for seven drillships with Sembcorp Marine and six semi-submersibles with Keppel Corp that make up around 40% of each of their outstanding orderbooks of S$11.6 billion and S$10 billion (as of the third-quarter of 2015), respectively.

Problem is, Sete Brasil, might file for bankruptcy protection soon.

What does this mean for the two rig builders?

If the bankruptcy filing for Sete Brasil does happen, both Sembcorp Marine and Keppel Corp would most likely have to impair their outstanding orderbooks and revenues that have already been recognised from the Brazilian company’s projects.

According to analysts, Sembcorp Marine and Keppel Corp have already recognized revenue from Sete Brasil projects of S$2.5 billion and S$2.0 billion, respectively, with a portion of the recognised-revenue yet to be collected and are thus still considered as account receivables.

Keppel Corp in particular might have a deep impairment charge on its hand. Its chief executive, Loh Chin Hua, mentioned in the earnings presentation for the second-quarter of 2015 that Keppel Corp has “not received payments since November [2014] for these projects,” citing payment issues with Sete Brasil.

If both Sembcorp Marine and Keppel Corp have to impair their order books as well as their already-recognised revenue, both companies may end up making losses in 2016. Moreover, it would add to the financial stresses both companies are facing given that they are already sitting on significant amount of debt.

Keppel Corp and SembCorp Marine's net-debt to equity ratios since third-quarter of 2010
Source: S&P Capital IQ (click chart for larger image)

As the chart above from my colleauge Chong Ser Jing shows, the net-debt (total debt minus cash) to equity ratios of both Sembcorp Marine and Keppel Corp are currently above 50% and are at their highest over the past five years.

Foolish Summary

In the worst case scenario, the survival of Sembcorp Marine and Keppel Corp might be in question. Would the two companies be able to access debt markets for additional funds to weather through the storm? Or would they have to tap the equity markets and ask new investors or existing shareholders for help? These are serious questions that the companies’ current and prospective investors, as well as management, need to consider in the coming months.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns shares in Keppel Corporation.