Labroy Marine @ 1.87 ( Marine / Singapore ) 2 comments
Final Poll Results: 4:2
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1. Doubts over sustainability of orderbook growth
2. Margin crimp possible due to factor price inflation
3. Unfavourable valuation comparison with peers in key segments
It is time for this stock to correct.
One of the market stars over the past two years, it has been a beneficiary of the recovery of the marine industry as a result of underinvestments leading to soaring charter rates; later on it has benefited from high demand for offshore vessels and then offshore rigs, both being required infrastructure for offshore oil exploration/production.
At the moment Labroy Marine is priced like a growth stock poised to deliver 25-30% medium to long-term growth, at 28X trailing PE and ~22X forward PE (assuming 30% earnings growth for FY06).
Many see this company nowadays as a shipbuilding play but the fact is that a majority of its operating profits (EBIT) are from its shipping division -- about two-thirds in FY04 and about 60% in FY05. Part of that has been due to vessel disposal gains contributing ~$10-15M every year, credited to this segment. Nevertheless, for a segment that contributes a majority of profit on a minority of revenue (~25 to 35%), it has to be seen to be as important as the other key segment (shipbuilding & repair). If one looks at this segment's asset composition, it is an impressive fleet of mainly tugs and barges, for transportation of energy-related commodities, mainly coal in the ASEAN region. In other words it is in the area of marine logistics, an interesting area if you ask me and probably offering sustainable revenue/profits over the next few years in terms of freight rates. A direct comparable is Sembawang Kimtrans, whose forward FY06 PE (ex-extraordinary items ) is likely to be 13-14X assuming 30% annual growth. Both are of about the same scale (~$100M revenue base) so it is not unreasonable to value Labroy's shipping segment at a similar forward PE.
That Labroy is valued higher than that suggests the inherent optimism regarding its other key segment: the shipbuilding and ship repair segment. Perhaps it may be clearer to split this into separate sub-segments that operate under different dynamics: the ship repair sub-segment, the incumbent shipbuilding sub-segment, the new offshore rig sub-segment.
From figures in the 1H06 financials, ship-repair activities contribute to ~20% of the total shipbuilding & shiprepair segment. This suggests that most capacity is being configured for shipbuilding at the yards.
The incumbent shipbuilding segment has been growing rapidly, and its order book is probably about $900M to be fulfilled over the next 3 years. It is worth noting that a large proportion of new orders, especially in recent times, has been for offshore AHTS vessels (a trend described in my earlier writeup "Demand trends within the shipbuilding industry"). You can't argue with a strong order book.... but look at the historical margins. Previous years' shipbuilding operating margins (without rigs) have been in the region of 7-8%, not exactly attractive. On the demand side, one wonders when the orders will dry up, given all the frenzied global shipbuilding for offshore vessels. The ship repair market is counter-cyclical, but shipbuilding is highly cyclical. It is worth keeping this in mind, and to balance the current optimism in the industry with the inherent risks historically (not too long ago it was seen as a sunset industry). On the supply side, there is inevitable upward rise of factor prices --- steel, labour. In particular, there has been reports of skilled labour shortage given the construction work taking place across Singapore (building construction, oil&gas facilities construction); there is a great deal of labour overlap with the marine industry in terms of job requirements. Indeed, recent profit trends over 1Q06 and 2Q06 for Labroy suggest such margin crimp: the rise in order book has been unable to work its way down to gross profits which have remained the same, suggesting gross margin drop (and possibly overly-aggressive bidding?).
Coming to the offshore rig segment, which has provided, in my opinion, most of the excitement surrounding the stock over the past year, the recent orders of two more rigs brings rig-related order book to ~S$950M. From the HY06 results, it is quite difficult to tell the performance of the new rig sub-segment by itself. The willingness of the Norwegians to order two more rigs recently must suggest that they are satisfied with the construction progress of the first two. However, two main questions still linger: firstly, whether the steep learning curve (highlighted earlier this year, seemingly forgotten) might translate to initial bad bottomline performance, and secondly, whether recent oil price downtrend could slow down the pace of new rig orders. Note that there has been a trend of speculators ordering new rigs in the hope of being able to sell them at higher future prices; these would be the first to go when the oil market downturns. Keppel, the world leader, has seen a slowdown in rig orders since 1Q06; Sembcorp Marine has recently been downgraded by one of the ang-moh brokers due to a seen slowdown in the rig market. Sembcorp Marine is probably trading at 20-25 times forward FY06 PE; it is a much bigger player than Labroy.
If you ask me, at 20X PE and for the same businesses and growth drivers (eg. offshore rigs), Cosco is a much better bet given its comparative strengths (eg. cheap labour), positioning (in the largest growth economy in the world) and backing (strong parentage and technical links with Sembcorp Marine).
I agree that Labroy Marine is a hot-stock-not: Yes/No