Nam Cheong first to benefit from OSV rebound

Shipbuilder also to reap handsomely from Petronas and Bumi Armada investments.

Overall, Nam Cheong leads its competitors in taking advantage of what is shaping up to be a full upswing in OSV demand and production. 

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Well positioned in a sweet spot. We see Nam Cheong as a key beneficiary of: a) Petronas’ RM300b capex plan, b) Bumi Armada’s “Steel on Water 2” vessel expansion programme, and c) an imminent shortage of PSVs in Asia as E&P activities move to deeper waters. We forecast 3-year (2011-14F) EPS CAGR of 21.7%.

Lucrative BTS model. Using a lucrative build-to-stock (BTS) business model, Nam Cheong identifies trends ahead of market and builds vessels in anticipation of future demand. As a result, the group is able to price its BTS vessels at a 10-20% premium over similar build-to-order (BTO) vessels. Since adopting this business model in 2007, Nam Cheong has maintained an impressive track record of selling all BTS vessels prior to completion.

Beneficiary of Petronas’ RM300b capex plan. Malaysia’s O&G sector is set to enter a cyclical upcycle, driven by Petronas’ RM300b 5-year capex scheme to stem a decline in domestic oil production. Under this scheme, the national oil company will invest RM50b-55b annually over the next five years, 35-50% higher than the 5-year average for 2007-11. We believe Nam Cheong will be first in line to benefit from more domestic offshore activities and an upswing in OSV newbuilds.

More “Steel on Water”. Nam Cheong is set to benefit from its largest customer Bumi Armada’s “Steel on Water 2” vessel expansion programme. In our view, this could be a billion-ringgit, multi-year scheme surpassing its predecessor programme which saw an investment of RM1.0b in 20 vessels. Under the new initiative, Nam Cheong recently secured a Letter of Intent (LOI) to build four multi-purpose PSVs worth US$130m (RM403m), with an option for four additional units.

Rise of PSVs in Asia. Nam Cheong is well poised to ride on a regional shortage of PSVs as the group will complete 16 PSVs-to-stock in 2012 and 2013. In Asia, we see a structural shift from multi-functional AHTS vessels to purpose-built PSVs as offshore E&P activities move to deeper waters. In our view, there will be a supply gap for larger PSVs as regional operators have yet to build up an ample fleet to meet rising demand.

Outsourcing strategy reduces fixed overheads. Nam Cheong subcontracts construction work of lower-specification OSVs to three China yards, while its yard in Miri, Sarawak undertakes construction of customised, higher-specification vessels. This strategy allows Nam Cheong to keep fixed overheads low during a downcycle while enabling the group to scale up capacity quickly during an upcycle.

Cabotage raises barriers to entry. Under the cabotage rule, vessels operating in Malaysian waters must be Malaysian flagged or registered. To fulfil this criterion, the vessel must be: a) built by a shipyard incorporated and managed out of Malaysia, and b) majority-owned by Malaysians. As shipyards are required to assume ownership of BTS vessels prior to sale, foreign-owned shipyards cannot build Malaysian-flagged vessels to stock. Thus, Malaysian shipyards are the preferred partners of choice for vessel owners operating in Malaysia.

Authorisation letter differentiates local shipyards. Malaysian yards also have an advantage over foreign yards in their ability to issue authorisation letters, which allows customers to bid for Petronas’ domestic contracts before physical vessel delivery. This is a significant benefit for customers as it allows them to market their vessels before completion and, in turn, mitigates vessel charter risk. As a result, vessel owners operating in Malaysia usually opt to place newbuild orders with local shipyards.