Last week, Keppel Corporation Limited (SGX: BN4) released its full fiscal year 2020 earnings report.
It wasn’t a pretty picture.
Revenue for the full year dipped by 13.3% year on year to S$6.6 billion.
Operating profit dived 99% year on year to just S$8.4 million because of a S$651 million impairment that hit the books.
This impairment relates mainly to the offshore and marine (O&M) division.
High interest expenses and other losses at its subsidiaries resulted in Keppel recording a net loss of S$505.9 million.
Excluding this impairment, the group would have been profitable, with net profit coming in at S$446 million versus S$828 million in the previous year.
A final dividend of S$0.07 was declared, down over 40% from the S$0.12 declared last year.
For the full fiscal year, Keppel’s total dividend added up to S$0.10, half of what it paid out in 2019.
However, the most stunning piece of news was the group’s announcement that it intends to exit the offshore rig building business.
As part of Keppel’s ongoing strategic review, it was decided that the O&M division should undergo a significant transformation to better align it with Keppel’s Vision 2030.
What are the implications of this shocking move? Here are three things that investors need to know.
Restructuring of O&M
The O&M division will be split into three parts.
The first component is an operating company (known as “Op Co”) that will be both asset and people-light.
This entity will not own any of Keppel’s legacy oil rig assets but instead focus on higher value-adding design, engineering and procurement services.
Fabrication will be subcontracted to third parties and the O&M division will gradually shed lower-value repair works that have poor margins.
The second company, named “Dev Co” for “Development Company”, will focus on completing rigs that are under construction.
It will also prioritise completing projects with firm contracts.
The completed rigs will then be transferred to the third company, known as “Rig Co”.
Rig Co is the asset-heavy company that owns Keppel’s portfolio of completed rigs, and will also accept future completed jobs from Dev Co.
The premise is to eventually spin off or monetise (read: sell) Rig Co when the oil and gas market recovers.
Rig Co will be working with Keppel Capital, the group’s asset management arm, to seek further funding from external investors.
In the interim, both Rig Co and Dev Co will still require around S$500 million in funding to complete the rigs.
Also, if the oil and gas market does not recover meaningfully, it may mean that Keppel has to continue funding the construction of the oil rigs for the foreseeable future.
Further impairments and layoffs
The entire restructuring is expected to be executed over the next two or three years.
The O&M division’s yards will be streamlined and may involve divestment of part of its global network of yards.
Investors should note that there is still S$2.9 billion worth of legacy completed and uncompleted rigs sitting in both Rig Co and Dev Co’s balance sheets.
Should the oil and gas market remain depressed, we cannot rule out the possibility of further impairments from this amount.
On a separate note, Keppel O&M had entered into a second framework agreement with Borr Drilling, a key customer, to defer its 2022 scheduled delivery to between May 2023 and December 2023.
However, the division also retains the option to sell the rig to third parties if Borr had been informed of the intent to sell and if the client chose not to purchase the rig.
The above deferment is a sign that all is still not well with the sector.
Meanwhile, Keppel O&M currently has a headcount of 10,500.
CEO Loh Chin Hua remarked that the division will have a “significantly reduced headcount”, though the extent of the layoffs has not been quantified.
Pivot towards renewable energy
Keppel had been slowly positioning its O&M division to handle more contracts for natural gas and renewables.
As the world moves in the direction of cleaner sources of fuel, the importance of oil is diminishing.
The focus now is on electric vehicles, using natural gas to generate electricity (as it is a cleaner fuel), and on renewable energy sources such as solar, wind, nuclear and hydroelectric.
Op Co has an order book of S$3.3 billion, of which 82%, or S$2.7 billion, is in renewables and gas solutions.
CEO Loh has reiterated that this major energy transition means that Keppel will focus on cleaner fuels in the future, which is what clients are looking at.
Such a focus will also be in line with Keppel’s Vision 2030.
Get Smart: A plethora of options considered
Keppel did not arrive at this decision lightly.
The group was bold enough to recognise the malaise that the oil and gas industry is in and acted decisively to steer away from it.
A whole host of options were considered for the O&M division, including an outright sale of the division.
With continued depressed valuations for the industry, this option will probably not yield the best value for shareholders.
Keppel’s exit marks a turning point in the group’s evolution and represents an important new strategic direction that it is taking.
However, investors need to be patient, as the benefits from this shift will probably not accrue to Keppel anytime soon.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.