An Oil Stock for Asian Demand

09/22/2011 10:30 am EST

Focus: GLOBAL

Yiannis Mostrous

Editor, The Capitalist Times

The US is not the only oil-driven nation out there, and in some regions with increasing demand, there are very enterprising companies finding ways to exploit that demand, notes Yiannis Mostrous of Global Investment Strategist.

Singapore-based multinational Keppel Corp (KPELY) remains one of our top plays on the global energy and infrastructure boom underway across the globe. The company operates three main business divisions: offshore and marine (O&M), property, and infrastructure.

The company’s first-half results were solid, as profit rose 9% year-over-year, to $310 million. The main contributor to earnings growth was the O&M division, which delivered the second-highest quarterly profit margin in Keppel’s history. The company’s infrastructure business line booked $27 million in profits for the second quarter, indicating that the segment is on track to deliver further growth.

Keppel has booked $7.3 billion worth of new orders, and the firm could secure an additional $2 billion should ongoing contract negotiations play out. As the chart below indicates, the company has a solid backlog that will support profits for the next two years.

Keppel’s balance sheet is strong, with $2.6 billion in cash and low net gearing, which will allow for smooth operations amid a tightening global credit environment.

As 60% to 70% of the company’s net income is derived from its O&M division, Keppel’s stock price is correlated to the price of oil, which also affects its valuation. High oil prices generally result in more orders from drillers, which benefits Keppel’s mighty O&M division.

Oil prices have been volatile recently, but the industry’s fundamentals remain strong. According to Royal Dutch Shell (RDS.A), oil prices of $70 to $80 per barrel are strong enough to allow companies to develop most oilfields—even smaller and deeper fields.

In fact, most oil companies factor in lower prices for oil—in the neighborhood of $60 to $80 per barrel—when they perform their modeling for new projects. This means that the current price of about $90 per barrel should be strong enough to support further spending by oil companies.

Furthermore, recent statements by large rig contractors, such as Transocean (RIG), suggest that rig demand may even be rising.

That being said, Keppel may see some order cancellations if global economic growth loses steam—as happened during the 2008 credit crunch. Should this be the case, we expect Keppel to build the ordered rigs with the aim of selling them at a later date.

Keppel is a growth stock. But the company’s strong financial position enables it to weather any financial crisis. Companies such as Keppel will be the first to emerge from a downturn, and will do so stronger than ever.

We’ve long advocated that investors accumulate stocks of rock-solid companies during times of uncertainty—a strategy that will allow investors to make gains when the markets turn around.

Keppel’s stock trades at about two times book value, with a return on equity of about 22%. By comparison, Keppel traded at 0.7 times book value during the 2001 market upheaval, and about 1.3 times book value in the most recent 2008-09 debacle.

These may not be trough valuations, but Keppel’s shares still trade at a discount to the stock’s long-term average of 2.4 times book value—a good entry point for long-term investors. Keppel’s stock trades at an undemanding 13 times projected earnings, and the company’s share price should climb as the market recognizes the company’s rock-solid fundamentals.

Keppel Corp remains a buy up to $20. [KPELY was trading around $13.25 at midday on Wednesday—Editor.]

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