Company Insight

Share price has appreciated 62% (vs. KLCI return of 0.3%) within a month since our initiation report titled ‘Transforming..and this is just beginning’ dated 04 June 2013.

Recall that our main buy thesis on the stock were: i) Misperception by the market – The market views SES as a coal logistic provider and not a drilling related play; ii) RM5bn orderbook – This translates to 3.7x HLIB FY03/14 revenue projection and provides revenue visibility until 2017; iii) Massive drilling activities planned – Based on industry channel checks, there will be 38 rigs operating in Malaysia by end 2013 vs. 22 in 2012; and iv) Low PEG ratio – Traded at 0.3x FY03/15 PEG ratio, (when we initiated with a buy call at RM0.605), we expect change in market appraisal on the stock to drive P/E expansion.

Comment

Share price outperformed market strongly (+62% return in a month vs. KLCI +0.3%), hit and exceeded our target price last Friday. We recognised the strong share price rally was attributed to changing market appraisal toward the company (FY03/15 P/E has expanded from 11x to 18x) since our initiation. As there is no change to the company underlying fundamental, share price has run ahead of fundamental in short run, hence we advise investors to take some profit off the table and downgrade the stock to HOLD.

However, in long run, we still like the company as it is one of the top pick in the drilling sector given the huge prospect from drilling fluid (DF) and drilling waste management business (DWM). We also like Perisai (BUY) and SapuraKencana (BUY) who are also proxies to the boon in drilling related activities.

DWM will be the main booster for long term growth as legislation is trending towards zero discharge as adopted in Caspian and North Sea. In North Sea, the DWM business size is 10-15% larger than DF. Margin for DWM is also more lucrative with gross profit margin of more than 30% vs. DF at 20-26%.

DWM now only contribute to ~5% of SES’s RM5bn orderbook. According to DWL Research, the addressable drilling waste market size for SES is estimated to be US$2.1bn in 2012. This market includes Asia, Russia, the Middle East and West Africa. Thailand, Mynamar, Indonesia and Malaysia are the core market to look at given the huge capex spending on exploration and production.

We also remain positive on the company’s asset light strategy to focus on core business as there is plenty of opportunity such as expanding existing market share and cross selling products to existing customers.

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.

Risks

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

Valuation

We downgrade from BUY to HOLD with unchanged TP of RM0.88 based on 16x FY03/15 EPS of 5.5 sen/share.

Source: Hong Leong Investment Bank Research - 8 Jul 2013