Investment Highlights

• We upgrade Hibiscus Petroleum (Hibiscus) to BUY from HOLD as the share price has fallen by 34% over the past 3 months. Our sum-of-parts based fair value remains at RM1.42/share, which also reflects a premium of 3% for an ESG rating of 4 stars.

• It also implies an enterprise value (EV)/proven and probable reserves (2P) valuation of US$7.63/barrel, at a discount of 38% to EnQuest's US$12.4/barrel and 37% to the regional average of US$12.2/barrel.

• Sabah’s Finance Minister II Datuk Masidi Manjun was quoted as saying on 19 July that the state government will be terminating workers’ permits for Hibiscus’ 2 companies operating in in the state involving its 50%-owned North Sabah profit sharing contract (PSC) and 60%-owned Kinabalu PSC if the group does not settle outstanding state sales tax (SST) and penalties of RM97.3mil (34% of FY22F net profit) within the stipulated deadline. This comprises RM66mil in SST and RM31.3mil in late payment penalty.
• We attended an analyst briefing yesterday on the SST issues and these are the key takeaways:
  • The company is standing firm by its earlier decision of not paying the 5% SST backed by 2 legal bases:
    i. It does not own the oil produced before the point of sale – the legal ownership of the oil produced is held by Petronas from the point of extraction until the eventual point of sale. Hibiscus, as the independent contractor, is then entitled to receive a pre-agreed portion of the oil as settlement-in-kind for services provided to Petronas.
    ii. The point of sale takes place outside Sabah as Hibiscus’ share of oil is offloaded and sold via crude oil tankers at a single buoy mooring located 5km offshore from Labuan crude oil terminal, which is outside of Sabah’s tax jurisdiction.
  • The potential termination of workers’ permits will only affect non-Sabahan workers going in and out of the state. We also gather that the company is already seeing a slowdown in workers’ permit approval lately.
  • Management highlighted that both PSCs’ operations will be able to continue its production with some temporary operation disruptions due to manpower bottlenecks. To minimise any potential production impact, Hibiscus may reallocate its workforce composition by diverting more ancillary workers that are involved in maintenance and other supporting activities to production-related roles.
  • The outstanding RM66mil sales tax largely comes from the North Sabah PSC as the Kinabalu PSC has been paying the SST under protest prior to Hibiscus’s acquisition of Repsol.
  • Petronas Carigali, which holds the remaining 50% ownership of the North Sabah PSC, has been paying the SST given that all its other PSCs in Sabah are under Sabah’s jurisdiction. Management also clarified that North Sabah and Kinabalu PSCs are the only 2 PSCs that undertake oil lifting activities in the Labuan territory.
  • Despite the lack of clarity at this juncture, assuming a worst-case scenario where the company is eventually obligated to pay the SST by the Sabah state government, management expects an annual SST payment of at least RM70mil (11% of FY23F earnings) in total for both North Sabah and Kinabalu PSCs.
  • Moving forward, the company remains committed to resolve the SST dispute by through extensive discussions with the Sabah state government to ensure minimal disruptions to its operations in the state.
• Assuming a crude oil price of US$100/barrel as well as an annual production of 3.2mil barrels of oil produced from both North Sabah and Kinabalu PSCs, we estimate that the company’s FY23F core net profit may be reduced by 7% if it were to pay the SST. For now, we maintain our FY22F–24F forecasts pending more clarity on the SST issue.

• We expect the upcoming 4QFY22 to stage a sharp earnings recovery with an additional North Sabah shipment and full contribution of Repsol assets (which doubles the group’s daily production to 18.5K boe and increase its 2P reserves by 72% to 81mil boe). Currently, Hibiscus is trading at an unjustified EV/2P reserve discount of 66% to its closest peer, UK-listed EnQuest and 65% to regional average (Exhibit 2).

Source: AmInvest Research - 21 Jul 2022