Samsung Heavy Industries:Reduce,2Q17review –demanding valuations

Weak margins in 2Q17 (0.9% OPM): SHI reported sales of KRW2.3trn and
operatingprofit of KRW20.6bn in 2Q17. Sales fell 15.5% y-o-y due to
contraction of commercialbacklogs (its commercial exposure fell back to
45% vs. 50% in 1Q17). OPM wasweaker at 0.9% vs. 1.1% in 1Q17, mainly due
to one-off costs related to a cranecollapse incident back in May,
totalling KRW125bn. SHI also recorded one-offchange orders from two
offshore projects. Without one-offs, the company guided thatoperating
profit could have been as high as KRW60bn (2.6% OPM).

    SHI’s order outlook is long-term optimistic but we think they are
very selective.

    Offshore drilling: Ensco’s request to shorten the drillship delivery
date to Sep. 2017from Mar. 2019 is positive but we think new orders for
yards should remain weak givenutilization rates of drilling units is
currently at 65% (140 units under operation out of215 units available).
In addition, SHI is still in talks with Seadrill over two drillships
onpotential delay or price renegotiation.

    LNG carrier: The spot rates have been rising since June, and
speculative inquirieshave also picked up. Mozambique Area 1 and Shale
projects in US (e.g. LakeCharles) should drive up long-term demand but
new order momentum in 2017 shouldremain weak.

    LNG FSRU: Final investment decisions (FID) on few projects are
currently delayedbut SHI expects 2 new orders in 2H17. The company
targets 3-4 FSRU units/year.

    Tanker – Tankers orders inflow in 2H17 is expected to be subdued and
profitabilityshould remain under pressure at current vessel pricing.
This is in-line with our view onHyundai Heavy’s declining margins on
tanker orders in 2017 (1 June 2017, “HyundaiHeavy Industries – Downgrade
to Hold: No earnings upside visibility”). SHI will focusmore on shuttle
tankers.

    Estimate changes: We slightly increase our 2017e/18e NP estimates by
8.7% and 4.8%respectively with the lower than expected FX valuation
loss.

    Least preferred: We maintain our Reduce rating but raise the target
price toKRW7,300 from KRW7,000 to reflect slight NP adjustment. With the
lack of a recoveryin drilling units and relatively weaker margin profile
on commercial segments, wecontinue to see a growing risk of backlog
erosion and revenue decline. Besides, we donot see significant upside
from current valuation despite the fact that our analysissuggests ROE
recovery to 4.3% in 2018e vs. current valuations at 0.8x 2018e PB.

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