- We initiate coverage on UMW Oil & Gas (UMWOG) with a HOLD rating and a fair value of RM2.00/share, pegged to an FY15F PE of 17x. This is below its average of 30x, given the slowing capex cycle and near-term earnings weakness.

- UMWOG provides drilling and oilfield services to the upstream O&G sector. The group’s core drilling services, which account for 97% of FY14 earnings, comprise six jack-up rigs, a semi-submersible rig, and five hydraulic workover units (HWU), which are used for maintenance activities for offshore platforms and structures. UMWOG will further take delivery of a jack-up rig in September 2015.

- Given the current level of crude oil prices, oil and gas companies have indicated a reduction in capex for 2015. Drilling contractors are among those hurt by the fall in oil prices as operators cut down on drilling activities, especially for exploration. This is exacerbated by an influx of uncontracted newbuilds for shallow and deepwater rigs which suppressed dayrates.

- Based on IHS Petrodata, average dayrates for jack-ups in Southeast Asia are now below US$150k/day, from its historical rates of US$150k-US$170k/day. UMWOG foresees dayrates for jack-ups in this region to slide further, amid the continued weakness and slowdown in activities. The group estimates that the activities in the market that it operates in (Southeast Asia) have declined by ~25%, based on the number of tenders currently available. The situation is expected to be protracted until 2016.

- We project FY15F earnings to contract marginally by 1% on the back of 7% and 12% contraction in dayrates and utilisation, respectively. This would be partially offset by contributions from Naga 7 that joined its fleet in January 2015. Note that four out of seven rigs are currently on spot charters and will expire this year, while Naga 7 is uncontracted currently.

- We expect FY16F-17F earnings to recover by 14%-26%, with full-year contribution from Naga 8 in FY16F and the gradual recovery of dayrates and utilisation in FY17F, in line with management’s expectation of a pick-up in drilling activities towards end-2016.

- The stock is currently trading at a valuation of 19x PE of FY15F earnings. Our FY15F earnings are 20% below consensus. We believe UMWOG may likely experience earnings weakness in the quarters ahead, which would lead to a collapse in consensus earnings.

Source: AmeSecurities Research - 5 May 2015