- We maintain our BUY recommendation on SapuraKencana Petroleum (SapuraKencana), with an unchanged fair value of RM4.65/share - based on an FY15 PE of 22x, which is the 2007 peak achieved by Kencana Petroleum.

- As highlighted in our past reports, we are positive on SapuraKencana entering into a conditional sale & purchase agreement to acquire Newfield International’s oil & gas production blocks in Peninsula Malaysia, Sabah & Sarawak for US$898mil (RM2.8bil). The assets encompass a 50% interest in Block 318, 60% in PM323, 70% in PM329, 50% in AAKBLNP, 30% in SK310, 40% in SK408, 50% stake in new oil production and facilities in Tembungo off Sabah, 40% in Block 2C and 25% in Block SK319.

- These blocks have an estimated proven and probable resource of 36mil barrels of oil equivalent (boe) with a daily production rate of 23,000 boe. If this deal is successful, the contribution from this acquisition will begin to retroactively accrue to SapuraKencana from 1 July 2013 onwards.

- But the consideration price could be adjusted if some of the assets are taken up by the blocks’ other production sharing contract (PSC) partners who have preferential rights. Management has not revealed further information at this juncture.

- Assuming breakeven costs at US$50/barrel, sales royalty of 10%, Malaysia’s petroleum income tax of 38% and average crude oil price at US$100/barrel, we estimate that the daily production rate could yield a net profit of RM128mil – which translates to a highly EPS-enhancing acquisition PE of 4.3x (similar to the assets’ estimated production years) vs. SapuraKencana’s current FY14F PE of 19x.

- This leads to a potential FY15F earnings increase of 43% assuming interest costs at 6% (See Table 1). We maintain SapuraKencana’s FY14F-FY16F earnings for now pending clarification from management.

- While the proposed acquisition will raise the group’s FY14F net gearing from 1.2x to 1.5x, there is a likelihood that the company could raise the larger part of the funds from ring fenced project financing as the assets are already income generating. At this juncture, we are uncertain what is the additional capex required to further raise the existing blocks’ reserves and enhance the naturally declining production rate.

- Besides this exciting entry, SapuraKencana together with its existing risk-sharing contract (RSC) partner Petrofac is looking to tender for Petronas’ blocks PM-6 and PM-9 as well as two more marginal fields. If these are successful, SapuraKencana could be further elevated to become a truly formidable regional O&G upstream operator.

- Valuation remains attractive at the current FY15F PE of 19x, which is at a 14% discount to Kencana Petroleum’s peak in 2007.

Source: AmeSecurities