Highlights

We believe the market is undervaluing the potential of the Drilling Waste Management (DWM) division, which is expected to grow in tandem with drilling activity and increasingly strict global and domestic environmental regulation.

We recently visited Scomi Energy’s booth in the OGA 2013 Conference. The company presented a SCM-PrimaG 4P Linear Motion Shale Shaker (Ref Figure 1) at the booth. Its main function is to remove solids from circulated drilling fluids to allow them to be reused. The 3 panels shaker cost around US$40,000 – US$50,000 and normally required total 4 units in a drilling platform.

SES provides products and services for the entire DWM process such as solids control, containment handling, treatment and disposal, and water treatment. The main function for DWM services is to reduce the waste generated during drilling activities to acceptable environmental levels.

Comment

During the drilling process, huge amounts of drilling wastes are produced including mud and cuttings. The American Petroleum Institute (API) has estimated that approximately 1.1 barrels of total drilling wastes are generated for every foot drilled.

We understand that handling drilling waste is one of the most important challenges in the petroleum industry. Old solutions such as simply dumping on or offshore are not acceptable as pollutants are destroying wildlife and contaminating the water supply. Given the dangers, globally, legislation is trending towards zero discharge as adopted in the Caspian and North Seas. Currently, local regulation bans dumping and we expect regulation to become more stringent following global trends. Thus, we see a huge potential for DWM business.

According to DWL Research, the addressable drilling waste market size for SES is estimated to be US$2.1 bn in 2012. This market includes Asia, Russia, the Middle East and West Africa. DWM only contribute to ~5% of SES’s RM5bn orderbook. As the legislation is trending towards zero discharge, we expect DWM to grow faster than drilling fluid (DF). In some developed countries, the DWM business size is even bigger than DF.

We prefer SES over the parent – Scomi Group due to i) risk of forex losses and project delays in Scomi Engineering (SEB, Not-Rated), ii) SEB currently loss making and iii) holding company discount.

Catalysts

• Potential to secure RM400m worth of contracts on top of its already huge orderbook of RM5bn.
• Contract win in DWM business given the potential addressable market size of US$2.1bn.
• On the most conservative calculations, a marginal field win could boost our TP to at least RM0.93 per share.

Risks

Global recession hitting O&G price; Technology advancement; Relaxing of drilling waste management regulations.

Valuation

We maintain our BUY call and a TP of RM0.88 based on 16x FY15/03 EPS of 0.055 sen/share.

Source: Hong Leong Investment Bank Research - 21 Jun 2013