Investment Highlights

• We have downgraded MISC’s rating to SELL from HOLD with a lower sum-of-parts-based fair value of RM6.80/share (from an earlier RM7.80/share), which implies an FY21F EV/EBITDA of 8x – 1 standard deviation below its 3-year average.

• Our SOP now incorporates US$580mil (RM2.5bil) in one-off provisions arising from the recent award by The Asian International Arbitration Centre (formerly Kuala Lumpur Regional Centre for Arbitration) to Sabah Shell Petroleum Company’s (Shell) counter-claim against the delayed US$2bil Gumusut Kakap semi-floating production system (GKP).

• Recall that the arbitration centre had awarded US$352mil (RM1.5bil), comprising US$236mil defects rectification work, US$15mil liquidated damages, US$88mil refund for overpayment of additional lease rates and legal costs of US$13milto Shell. We understand that the court’s decision indicates that the liability limitation clause of up to US$200mil (RM862mil) in the GKP contract does not apply in this case.

• While MISC, which wholly owns the FPS, had secured a US$266mil award in February 2017 against Shell for disputes over outstanding additional lease rates and variation works in the construction of the Semi-FPS, this was halved to US$133mil by the new judgment.

• As MISC was over-recognizing US$88mil lease income from April 2014 to Jan 2020, we have cut MISC’s FY20F–FY22F core net profit by 4%–10% due to the expected lower GKP revenues.

• The tribunal also adjudicated that GKP’s physical handover occurred on 11 Oct 2014 even though lease revenue was being recognized up to 9 months earlier. Based on a project IRR of 12% over 25 years, we estimate that the initial 9-month lease net income could reach US$225mil (RM968mil).

• Even though MISC could appeal against this judicial decision, the worst-case scenario could mean that MISC has to pay RM1.5bil (US$352mil) cash to Shell while also reversing the lease income of RM968mil that was recognised in FY14. All in, we estimate that MISC’s FY20F net profit of RM1.7bil could reverse to a loss of RM788mil. Also, its low FY20F net gearing of 17% would rise to a still comfortable 24%.

• While the stock currently trades at its 3-year EV/EBITDA average of 9x, we expect selling pressure from the upcoming 1QFY20 massive losses. Although MISC could benefit from higher petroleum VLCC rates due to land-based storage facilities reaching full utilisation amid an unprecedented drop in Covid-19-depressed consumption globally, we do not expect any substantive near-term earnings impact as MISC has already secured long-term agreements with clients for its VLCC vessels.

Source: AmInvest Research - 27 Apr 2020