Keppel Corporation will retrench even more staff

As Singapore business sentiments soured, retrenchments seem to be the buzzword nowadays.  This is certainly the case for Keppel Corporation, the world’s largest oil rig builder. The difference is that after letting go 8000 of its workforce for the first nine months of this year, Keppel Corporation will retrench even more staff.

The sheer magnitude of this “right-sizing” exercise illustrates the current state of the offshore and marine industry. The reduction in the workload resulted in the shrinking workforce needs and required Keppel Corp to be lean. In the 3QFY16 financial report, the CEO highlighted that the culling of workforce will continue due to the weak demand for oil rigs.

Wind of changes

The root cause of Keppel Corp’s decline is the collapse of the oil price since 2014. The CEO suggested that it could be a “long winter” for the oil rig giant but I see it differently. I don’t work in the oil and gas industry but the emergence of USA’s shale oil may be the ultimate game-changer for the industry.

The discovery of new drilling method in USA to produce oil from shale rocks created a huge capacity boom and this led to the current oversupply issue. Brent crude oil has even dropped below the support level of USD30 per barrel in 2016, making extraction of oil economically unviable. In light of this drastic situation, many analysts were also frustrated that Saudi Arabia, the leader of OPEC, refused to cut supply. This is because the OPEC hoped that such a move would destroy its USA oil competitors.

However, OPEC’s game plan backfired royally as the price war did not wipe out the USA shale oil producers, which surprisingly remain resilient. This means that USA shale oil is here to stay and days of cheap oil has returned. In this context, the price of oil will probably hovers around USD50 to USD70 per barrel for the next decade. Arising from this, there is lesser need for new oil rigs because the current low price will deter potential investments by oil producers.

Keppel Corp’s destiny

The current changes in the landscape is beyond Keppel Corp’s control but investors must be able to read the game well. Because of this unforeseen headwind, there may be two possible outcomes for Keppel Corp. The major shareholder, Temasek Holding, may consider merging the oil rig capabilities of Keppel Corp and Sembcorp. The merger will make sense because of the cost saving that is expected to derive from business consolidation. Given that demand for new oil rig will remain weak going forward, the market will not be big enough to cater to the world’s two largest oil rig builders.

The chances of Temasek Holding delisting Keppel Corp is extremely remote because the sovereign wealth fund currently only holds 20.43% of Keppel Corp as of 16 May 2016. With such low stake, it is also unlikely that Keppel Corp will issue rights to raise capital because that will further dilute the major shareholders’ stake.

Second scenario could be the re-alignment of its key business segments. With its core engineering capabilities, it is possible to transfer its workforce skill-set in the oil and gas sector to its property and infrastructure businesses. The current weak market provides a good opportunity to venture into emerging fields like data centres, power-plants and waste-to-energy plants. Even if the oil price do recover, it is unlikely that Keppel Corp will witness the kind of explosive growth in yester-years. So it is time opportune for Keppel Corp to grow new business opportunities in other areas.

Of course, the above are just pure speculations and Keppel Corp has not reached such a drastic state yet. Nonetheless, financial performance for 3QFY16 was disappointing – net profits plunged 43% year-on-year to $641 million. Net gearing ratio was 0.57, with long-term liabilities at eye-popping $7 billion. The current assets amounted to $16.2 billion and current liabilities was $9.3 billion. On this note, Keppel Corp is still a healthy company to invest in but growth will be weighed by its huge amount of borrowings.

My strategy

Many investors are waiting on the sideline and expect Keppel Corp share price to drop further before buying on the cheap. For me, I will not invest in Keppel Corp until there is visibility of business turnaround. Although this blue chip is still making profits, the balance sheet looks shaky with net gearing ratio at 0.57 and debt of $7 billion. While I understand that the oil and gas industry is a capital-intensive sector, the management may want to reduce the risk of potential interest rate hikes towards the end of the year.

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Magically yours,

SG Wealth Builder