Investment Highlights

• Our BUY recommendation is maintained on Sapura Energy (Sapura) with unchanged forecasts and fair value of RM1.00/share, based on a 50% discount to FY19F book value.

• Currently, the drilling division's utilisation is below breakeven at 33% while the engineering and construction segment will only begin to be profitable next year from the newly secured Pegaga central processing platform and additional 3 wellhead platform jobs.

• However, with crude oil prices now trading above US$70/barrel, the limelight has returned to Sapura's exploration and production (E&P) operation, with its proposed listing becoming much more likely and reinvigorates the group's overall re rating process.

• The group’s commencement of 100mil cu ft/day gas production from the SK310 B15 development in October last year is expected to generate EBITDA of US$25mil assuming oil price of US$65/barrel, which will more than offset the natural decline of Sapura’s oil producing assets, raising production by 23% YoY to 4.3mil boe in FY19F.

• E&P’s FY20F production is expected to fall by 12% YoY from natural decline. Subsequently, the Gorek, Larak and Bakong gas fields in the US$200mil Phase 1 of the SK408 production sharing contract are targeted to commence production in FY21F, radically transforming annual gas output from 2mil boe by 10x to 12mil boe and propel overall hydrocarbon production to 13.4mil boe, up 3.8x from 3.5mil in FY18.

• While final investment decision for Phase 2 for the Jerun field in SK408 has not been reached, its commencement in FY24F is expected to boost the group’s overall production even further to 20mil boe, 5.7x current output.

• Sapura is also actively exploring E&P prospects overseas, which includes its 30% stake Block 30 in the Sureste Basin and Blocks 11 and 13 in the Burgos Basin, Gulf of Mexico together with farm-in agreements to 5 offshore exploration permits in Taranaki Basin, New Zealand.

• Currently, 95% of E&P's wholly local net reserve of 253 mil boe is based on gas fields off Sarawak with the balance oil off Terengganu. Assuming Brent crude oil price of US$65/barrel, oil production cost (including royalties and petroleum taxes) of US$55/barrel, gas price of US$3.25/mmbtu and gas production cost of US$1.50/mmbtu, our revised E&P asset value of US$2bil is 56% above the segment's FY17 net asset of RM5bil.

• This translates to sum-of-parts (SOP) of RM2.76/share, which is 73% above book value and 3.8x above the current share price. Even though the share price has rebounded by 80% from the all-time low of RM0.41 in mid-March this year, there is still ample upside to further raise our fair value given that the stock is currently trading at a huge 73% discount to our SOP.

RAMPING UP GAS PRODUCTION

• Retain BUY recommendation

Our BUY recommendation is maintained on Sapura Energy (Sapura) with unchanged forecasts and fair value of RM1.00/share, based on a 50% discount to FY19F book value.

Besides the RM2.7bil contracts secured so far this year which raised its order book by 10% QoQ to RM16.6bil, more EPCIC jobs are expected, possibly from a central processing platform for the KG-DWN-98/2 deep-water project off India's east coast and 3 more wellhead platforms for Sapura’s own SK408 project.

This is underpinned by the 37% QoQ increase in the group’s prospective tenders to US$13bil as at 31 Jan 2018 from new markets in the Middle East, Latin America, India and Africa.

Even though the share price has rebounded by 80% from the all-time low of RM0.41 in mid-March this year, we highlight that there is still ample upside to further raise our fair value, given that the stock is currently trading at a huge 73% discount to our sum-of-parts (SOP) of RM2.76/share.

• E&P in the limelight

Currently, the drilling division’s utilisation is below breakeven at 33% while the engineering and construction segment will only begin to be profitable next year from the newly secured Pegaga central processing platform and additional 3 wellhead platform jobs.

However, with crude oil prices now trading above US$70/barrel, the limelight has returned to Sapura’s exploration and production (E&P) operation, with its proposed listing becoming much more likely while reinvigorating the group’s overall re-rating process.

• Maiden gas contribution from SK310 B15 more than offset oil natural decline

The group’s commencement of 100mil cu ft/day gas production from the SK310 B15 development in October last year is expected to generate EBITDA of US$25mil assuming oil price of US$65/barrel, which will more than offset the natural decline of Sapura’s oil producing assets, raising production by 23% YoY to 4.3mil boe in FY19F.

Based on a capex of US$200mil (down from an earlier estimate of US$330mil), depreciation over 5 ½ years and allin cash costs at US$1.50/mmbtu, we estimate that the B15 gas production could account for 40% of FY19F E&P earnings, which has already incorporated a 60% increase based on crude oil price of US$65/barrel.

• But gas will dwarf oil contribution by FY21F

E&P’s FY20F production is expected to fall by 12% YoY from natural decline. Subsequently, the Gorek, Larak and Bakong gas fields in the US$200mil Phase 1 of the SK408 production sharing contract, which has yet to achieve final investment decision at this juncture, are targeted to commence production in FY21F.

This will radically transform annual gas output from 2mil boe by 10x to 12mil boe and propel overall hydrocarbon production to 13.4mil boe, up 3.8x from 3.5mil in FY18. The net gas production from Phase 1 of SK408 will be 6.7x of SK310 B15.

Based on depreciation over 15 years, we estimate that this could thrust E&P’s pre-tax profit to US$80mil, which is 3.8x of current oil contribution. We highlight however, that our earnings forecasts have not incorporated any contributions from SK408 pending achievement of first gas.

• More gas on the way

Phase 2 of the Jerun field in SK408 is expected to commence in 1QFY23, which will boost the group’s overall production even further to 20mil boe, 5.7x current output. This field’s reserve is estimated at 3-3.5 tcf, compared to Phase 1’s 2.5 tcf.

Hence, while final investment decision for the Jerun field has yet to be reached, the capex is likely to be slightly higher. While the SK310 B14 field has a huge estimated 2.7 tcf reserve, its high hydrogen sulphide (H2S) content and likely higher capex and opex engender viability uncertainties at this juncture.

Without a field development plan nor a gas sales agreement at this stage, the B14 reserve is not included in the E&P’s 2P reserve estimates but 2C as a contingent resource.

• More yet to come

Besides Peninsular Malaysia and Sarawak, E&P has a 50% stake in SB331/332 blocks off Sabah, which will only undertake seismic studies in FY19F.

The group has a 25% stake in SK319, which is an exploration block located 120km offshore Sarawak and in 91m of water. The block is operated by Sarawak Shell which owns a 50% stake, with the remaining 25% owned by Petronas Carigali.

Sapura is also actively exploring E&P prospects overseas. Sapura, which has a 30% stake in a consortium with DEA (40%) and Premier Oil (30%), has recently secured Block 30 in the Sureste Basin and Blocks 11 and 13 in the Burgos Basin, Gulf of Mexico in Mexico’s Round 3.1 bidding exercise.

Early this year, the group also secured farm-in agreements to 5 offshore exploration permits in Taranaki Basin, New Zealand.

• SOP is 3.7x current share price

Currently, 95% of E&P’s wholly local net reserve of 253 mil boe is based on gas fields off Sarawak with the balance oil off Terengganu. Assuming Brent crude oil price of US$65/barrel, oil production cost (including royalties and petroleum taxes) of US$55/barrel, gas price of US$3.50/mmbtu and gas all-in cash cost of US$1.50/mmbtu, our revised E&P asset value of US$2bil is 56% above the segment’s FY17 net asset of RM5bil.

This translates to an SOP of RM2.76/share (See Exhibit 5), which is 73% above book value and 3.8x above the current share price. In our computation, we maintain goodwill at RM7.9bil, as the auditor has seen no deterioration of the group’s going concern prospects.

Source: AmInvest Research - 19 Apr 2018