Singapore O&M stocks ended 2008 down 65%, underperforming the STI which fell 49%. Stocks rallied mid year on the announcement of several large order wins, however proceeded to underperform in the second half as oil price collapsed and news emerged over potential order cancellations. In 2009, we expect i) limited new order wins due to depressed oil price and capex reduction by oil majors, ii) potential cancellation/deferment of orders and iii) opportunistic acquisitions.

After 4 consecutive years of record order wins for the Singapore yards we expect a slowdown in new additions to order book in 2009/2010. With oil price remaining below the break even price for new investments, we expect oil majors will continue to cut E&P capex plans. This combined with constrained yard capacity is likely to result in limited positive news on order wins. In line with BAS-ML view that oil price will recover in 2010, we expect order momentum to return only in 2011.

Recent developments in the sector have heightened concern over potential order cancellations and/or deferment of payment for existing orders. Incremental news on order cancellation will be negative for share price. However, we do not expect order cancellations to have a material impact on valuations as current projects are cashflow positive, deposits taken for new orders are greater than expected profits and any potential renegotiations will likely be done on commercial terms.

SMM, SCI and KEP were all opportunistic acquirers in previous down cycles. Most notably, SCI bought its UK utilities operations from Enron, KEP bought back listed shipyard subsidiaries, while SMM acquired a stake in Cosco’s China yards and PPL. With SCI and SMM both in net cash positions, we believe they are well positioned to take advantage of distressed assets and/or companies that are likely to emerge over the course of the next two years.

Sembcorp Industries (SCI) is our preferred pick in the sector given its relatively resilient utilities business which is expected to provide earnings support. We also have a Buy rating on Sembcorp Marine (SMM) for its strong balance sheet and ability to withstand a 1-2 year period of slowing order wins. We have a Neutral on Keppel Corp as we expect the performance of its associates and subsidiaries will continue to drag on earnings. We are reducing our PO for Keppel to S$5.00 from S$5.25/share due to changes in BAS-ML valuations for SPC, changes in share price of Keppel T&T and k1 Ventures as well rolling forward our DCF valuations for the group. We have an Underperform on Cosco Corp given the continued deterioration of the ship building cycle and recent profit warning.