SMM has rallied 50% over the past month, outperforming the STI by 29%. While we continue to view SMM as one of Singapore’s long-term gems, we see valuations as fully priced (2.9x P/B vs. trough of 1.0x). We highlight that the oil price is unlikely to lend support to the stock in the near term and potential upside from Petrobras wins is already reflected in share price. We increase our PO to S$2.10 (from S$2.00) but downgrade our rating from Buy to Underperform.

SMM trades with a high correlation to the price of oil. Banc of America Securities- Merrill Lynch commodities analysts forecast that oil will average US$49/bbl in 2Q09 and $US56/bbl in 3Q09. Since the February lows, oil has rebounded by over 50% to today’s price of $50/bbl. While, arguably, oil could still rally another 10% before meeting our 3Q09 forecasts, we believe that the share price already reflects the medium-term upside to oil.

Given the accelerated pace of E&P spending by Petrobras, we have increased our order win assumptions in 2009/10 to S$3.8bn (from S$2.3bn). However, at today’s price, the market is implying the net addition of S$6.7bn of wins in 2009/10, which we believe is too optimistic. We also highlight that unless SMM can secure in excess of S$9.5bn of new orders in 2009/10, the net order book will be on a declining trend.

We recommend switching from SMM to SembCorp Industries (SCI), where we expect the earnings stability created via the utilities division (45% earnings contribution) will see the stock outperform relative to peers. After we strip out the value of SMM and other business from the valuation of SCI, we derive an implied utilities P/E of 9x (vs. the historical implied P/E of 13x); hence, we believe the market is discounting the true value of SCI’s utilities business.