Highlights

Shortage of Malaysian rig… Domestically, there is a shortage of locally owned rigs. As of Sept 2013, there are 16 jack-up rigs operating in Malaysia but only 2 are locally owned (Naga 3&4). Drilling into detail, 14 foreign jacks up rig contracts are expects to expire within 1-2 years with 3 in 2H2013, 4 in 1H2014, 5 in 2H2014 and 2 in 2015. Hence, we expect tender and contract award to accelerating in next 2 years with the early call for tender by end of 2013.

New is always better… Concerns about overcapacity are overdone. Increase in the number of rigs is offset by the replacement cycle. According to RS Platou Research, at end 2013, 50% of the global jack-up fleet is expected to be 30 years or older while new rigs which are less than 10 years are expected to make up only 37% of the market (Fig 12). Domestically, the average age of jack up rigs is at around 13 year (Fig 8) as compared to UMW O&G new rigs at 0-3 years. Industry players indicated that oil majors prefer to spend more to charter newer rigs due to their speed, efficiency and ability to deal with more complex high pressure deeper wells.

Massive drilling activities planned… highest record of 38 rigs operating… Domestically, the ETP driven RM300bn capex (or RM60bn p.a. - Fig 6) to enhance exploration, EOR and marginal fields required massive level of drilling activities which the financial market has underestimated. Based on industry channel checks, there will be 38 rigs operating in Malaysia by end 2013 vs. 22 in 2012.

Only pure rig-related play with sizeable market cap… Besides well positioned to benefit from the industry trend, it is the only pure rig-related domestic play with sizeable market capitalisation. This is likely to attract premium valuations.

RM1bn war chest to expand further… UMW O&G expects to raise RM1.7bn from the IPO with RM1bn allocate to acquire drilling rigs and hydraulic workover units (HWUs). We have assume UMW O&G to acquire at least 2 more new rigs after IPO with net gearing remain manageable at 0.35x in FY14 which suggests more room for asset expansion.

Strong growth with P/E expected to fall to 14x in FY15 and <10x in FY17… UMW O&G’s earnings are expected to grow at CAGR of 51% from 2013 to 2015. In longer term, we expects P/E to fall to 14x in 2015 and <10x in 2017 (Fig 17) with our conservative assumption of additional one rig per year after 2014.

Catalysts

Secured contract for Naga 5 in near-term.

Announce to acquire more new rigs to leverage on the upcoming expiration of foreign contracts.

Risks

Global recession hitting O&G price; Technology advancement; relaxation of Petronas’ domestic Policy.

Rating

BUY (NEW)

Positives: Market leader in domestic drilling sector with strong balance sheet to expand further.

Negatives: Increased competition for the markets.

Valuation

We initiate coverage on UMW O&G with a BUY call and a TP of RM3.36 based on 20x average FY14-FY15 P/E (as the full contribution from Naga 5 and Naga 6 will only be reflected in FY15). Our TP also implied 17x FY 15 P/E, in line with average Malaysian large cap oil and gas companies (Fig 18).

Source: Hong Leong Investment Bank Research - 10 Oct 2013