Even after accounting for a 20% holding discount to Keppel Corp’s (KEP) RNAV, we still find value. While the stock has been plagued by news of order cancellations and returns (ROIC and ROE) are set to taper, these seem overly discounted from an earnings, P/BV and EV perspective. Furthermore, sound offshore oil exploration fundamentals lend weight to our view that KEP’s current valuation is unjustified.

We undertook a study of offshore oil fundamentals. Opportunities for deepwater oil are still prevalent, forming only 15% of global oil production. Oil majors are still focussed on this and, done correctly, the unit cost of exploration can plunge if a large oil discovery is made.

The outlook for deepwater rigs raises the possibility of tight supply until 2011 and we believe KEP will continue to be a beneficiary of this. Charter rates for deepwater rigs have risen and stayed buoyant even as oil prices have steadily declined. However, the situation is not rosy for shallow-water rigs, which should be in oversupply in 2009 and will require scrapping or cold-stacking to keep rates healthy.

The possibility of near-term negative news flow for KEP in the form of orders being jeopardised by financing difficulties remains. In a worst- case sensitivity analysis, KEP will find its net cash position eroded to a net gearing ratio of 0.2x by end-2009 with EPS declining by 8%. However, this is unlikely as it requires three clients – Seadrill, Rowan and Skeie – to default at the same time. As KEP has good recovery options in the event of default, it is an opportunity to accumulate.

On a SoTP and 1.6x P/BV basis, we find that KEP offers decent upside with yields hovering at 6%. Our view on KEP is largely a valuation call as upside catalysts will probably require some time to gestate in our view.