Vard Holdings Ltd:
Lack of visibility clouds outlook;
Price Target : 12-Month S$ 0.88 (Prev S$ 1.16)
•Weak results in 2Q, in line with profit warning
•Cost overruns at both Brazil yards; margins may not recover as early as we had previously expected
•Cut FY13/14 earnings by another 39%/ 19%
•Maintain HOLD with lower TP of S$0.88
First red ink since listing. 2Q13 results were very weak as expected, with Vard recording a net loss of NOK20m – including a NOK70m impairment charge to wipe out the remaining goodwill related to the Niteroi yard in Brazil – despite 7% q-o-q growth in revenues to NOK2.9bn.
Results were impacted by: i) ongoing operational challenges at the Niteroi yard characterised by outsourcing issues, high personnel turnover and continuing overload situation leading to further delays and higher-than-expected cost overruns and ii) higher-than-expected start-up costs at the new Vard Promar yard in Brazil coupled with delays and losses from the construction of hulls of the first two LPG carriers, which had been outsourced. 2Q13 EBITDA margins hence dipped to 4.1%, compared to 11.1% in 1Q13.
Order wins in 2H13 should be within expectations. Vard has secured close to NOK4bn of new orders in 1H13, compared to our new order win assumption of NOK11bn for FY13. While we believe pipelay support vessel orders related to Petrobras tenders are imminent in 2H13, and the outlook for OSCVs remain robust in general, we believe Vard is unlikely to outperform on order win assumptions. Current orderbook of NOK14bn is the lowest level since 3Q11, and a book to bill ratio of 1.1x doesn’t leave much room for comfort.
But lack of margin visibility, maintain HOLD. While management indicated that most of the provisions and start-up costs related to Brazilian yards have been provided for in 2Q13, visibility remains low as further delays cannot be ruled out. Margins may not rebound to normalised levels anytime soon. As such, we cut our FY13/14 earnings estimates by 39%/ 19% respectively to factor in lower EBITDA margins and delays in orderbook recognition. Maintain HOLD with a lower TP of S$0.88 (pegged to 8x blended FY13/14 EPS).
Vard Niteroi is currently still suffering from a continuing overload situation, though one vessel was delivered from the yard in 2Q13. According to management, the business environment in Brazil remains challenging, with the landscape being characterized by high personnel turnover and very high pressure within the subcontracting market. While the impact of the operational issues at Vard Niteroi has been well flagged by management in the past, the surprising extent of cost overruns, losses and provisions in 2Q13 seem to be related to VARD’s dependence on the outsourcing for the construction of vessel hulls. This has resulted in significant delays to the schedule of delivery of the remaining four vessels from Vard Niteroi, as shown below. Given the lower profitability at Niteroi, management also chose to take an impairment charge of NOK70m to write down the remaining goodwill related to Vard Niteroi on its books.
Start up costs at Vard Promar higher than expected. The group’s second shipyard in Brazil, Vard Promar, has commenced operations with its first steel cutting in June 2013, in line with previous estimates. Recruitment and training are ongoing, with approximately 350 staff employed so far. The capex budget is also on target according to management, but pre-operational expenses have been higher than expected, calling for revisions to estimates of start-up costs. The other key issue revolves around the construction of hulls of the first two LPG carriers, which had been outsourced. To recap, Vard will be building a series of eight LPG carriers for Petrobras at its Vrad Promar shipyard, but in the interests of meeting the delivery schedule, had outsourced the construction of the hulls of the first two vessels to a third party yard, which has now run into cost overruns.
Brazil issue not restricted to Vard alone, though. The challenges being faced by Vard in Brazil is not unique, and other global players have reported similar difficulties, largely as a result of insufficient local resources and capabilities needed to meet the local content requirements. Recently, offshore EPC contractor Subsea 7 warned of significantly higher costs at one of its projects, blaming difficulties of doing business in Brazil and has expressed concern over its ability to operate in the country.
Improvements expected hereon. We expect 2Q13 to be a kitchen sinking quarter, as management has likely made provisions for most of the cost overruns and delays expected at its Brazil yards. Mitigating actions are being implemented at its yards, including the reorganization of production to improve productivity, stricter follow-up of subcontracted work, and increasing the usage of expatriates which will help strengthen the organization. The natural reduction of the overload situation at Vard Niteroi as a result of projects progressing and being delivered is also expected to contribute positively. The last hull that was being built outside of the Niteroi yard has also now been delivered, so some operational improvements should be expected sequentially.
New orders wins should be in line. Vard has secured close to NOK4bn new orders in 1H13, compared to our new order win assumption of NOK11bn for FY13. While we believe pipelay support vessel orders related to Petrobras tenders are imminent in 2H13, and outlook for OSCVs remain robust in general, we believe Vard is unlikely to outperform on order win assumptions. Current orderbook of NOK14bn is the lowest level since 3Q11, and a book to bill ratio of 1.1x doesn’t leave much room for comfort. Taking into account the eight vessels delivered during the quarter, VARD’s order book comprised 41 vessels, down from 46 as of end-1Q13.
Pipelay support vessel orders on the horizon. We continue to expect Vard to benefit from Petrobras’ ongoing round of tenders for long term charters of custom built pipelay support vessels. Two of the consortia bidding for the tenders – SapuraKencana- Seadrill and Subsea 7 have recently won orders for 3 pipelay vessels each- to be built at the Dutch yards of IHC Merwede. Vard remains in line to clinch vessel orders from the third bidder – Technip-DOF, with the smaller vessels likely to be built at Vard Promar while bigger vessels will be built at its European yards. The outlook for high value subsea construction vessels continue to be robust as well, and management notes improving demand-supply balance for larger AHTS for North Sea waters.
New order wins may provide short term catalysts but sustainable re-rating unlikely before margin visibility improves. While management indicated that most of the provisions and start-up costs related to Brazilian yards have been provided for in 2Q13, visibility remains low currently as further delays cannot be ruled out at the Brazil yards. Thus, we believe margins may not rebound to normalised levels anytime soon. As such, we cut our FY13/14 earnings estimates by 39%/ 19% respectively to factor in lower EBITDA margins and delays in orderbook recognition. Maintain HOLD with a lower TP of S$0.88 (pegged to 8x blended FY13/14 EPS).
Publish date: 12/07/13