Keppel’s 87% and SMM’s 100% YTD price appreciation is largely explained by a broader market movements, but the shares are also pricing in optimism on oil driving new orders and earnings higher. Timing the order flow can be tricky, but the magnitude of orders required to meet market expectations appears unrealistic. We lower our sector weight from Market Weight to UNDERWEIGHT.

Forward P/E and consensus earnings growth estimates are diverging. Market appears to expect over 20% earnings growth for Keppel and SMM in the next 12-months against consensus estimate of earnings contraction. Our 2010E revenue will need to be raised by 45% or operating margin increased to over 15% to meet market expectation.

We estimate Keppel and SMM require annual new orders of S$6 bn and S$4 bn respectively, just to keep revenues and earnings steady. Yearto- date orders of S$415 mn for Keppel and S$1.1 bn for SMM fall well short of this and our estimates. A broad based recovery in demand is needed to reverse current net order book and earnings contraction.

Global offshore rig orders are down 90% from US$25 bn in FY08 to US$2.4 bn YTD. We believe there will be a 30-50% structural loss in global demand from 2008 levels. History shows rig building picks up as utilisation hits 95%. With current global offshore rig utilisation at 85%, the trigger for a broad-based demand recovery remains elusive.

While we believe that valuation for Singapore O&M companies are stretched, at present, we maintain our relative preference for Keppel with a NEUTRAL rating over SMM, which is given an UNDERPERFORM rating. We remain concerned about SMM’s customer concentration risk – two customers account for 40% of its outstanding net order book – and its continued exposure to Larsen Oil & Gas related assets. We like Keppel O&M’s relatively diversified order book, ‘closer to customer’ business model and wholly owned yard in Brazil. Positive sentiment in the physical property markets and cash war chest raised from the sale of SPC further strengthens Keppel Corp’s position, in our view.