MISC’s 1H18 core profit of RM622m was below our expectation and consensus dragged by weak performance from petroleum and heavy engineering divisions. While LNG segment is expected to stay resilient on firm long term charters, we expect petroleum segment to improve in 2H18 on charter rates recovery. We reduce FY18/19/20 earnings forecast by 15%/10%/3% on lower petroleum tanker rate assumption and higher operating cost for heavy engineering segment. Maintain our HOLD rating with lower TP of RM6.17.

Results below expectations. At 40%/36% of our/consensus full-year estimates, 1H18 core net profit of RM622.3m came below expectations due to weaker-than expected contribution from petroleum and offshore segment. Second interim dividend of 7.0 sen/share (ex-date: 17 Aug; payment date: 14 Sep), as expected, was declared (vs. 7 sen in 2Q17), bringing its YTD DPS to 14sen.

QoQ: Despite revenue improving by 6% QoQ, 2Q18 core earnings remained flattish at RM310.6m as (i) widening losses for petroleum segment on lower charter rates, (ii) weaker heavy engineering segment dragged by higher cost provision for unrecognised VOs as well as (iii) higher finance cost masked stronger offshore segment led by maiden contribution from FSO Benchamas which commenced operations in May this year.

YoY: Core earnings dropped by 42% from RM532.5m in 2Q17, no thanks to (i) lower contribution from all three core businesses and weakening of USD against MYR. Petroleum segment doubled its losses to RM54.4m in 2Q18 as a result of higher bunker, depreciation charge and weaker currency while LNG segment operating earnings decreased by 51% in the absence of early termination fees of Tenaga Lima in 2Q17 coupled with lower charter rate upon renewal of LNG Puteri Firuz in October last year.

YTD: 1H18 core earnings also plunged by 40% from RM1.0bn mainly bogged down by (i) weaker petroleum tanker rates, (ii) weaker USD against MYR, (iii) weaker LNG charter rate upon contract renewal for LNG Puteri Firuz and absence of additional deferred revenue recognised from Seri Balhaf and Seri Balqis offsetting maiden earnings from three Seri C Class LNG fleets.

Outlook. Most of the MISC’s LNG carriers are on secured long term charters and hence are shielded from volatile spot market. For petroleum segment, although tanker rates are its lowest since 2014 in 2Q18, we expect rates to recover in 2H18 helped by increasing oil production by OPEC and higher demolition activities but margins are still under pressure with higher bunker costs amidst strong crude prices.

Forecast. We reduce FY18/19/20 earnings forecast by 15%/10%/3% respectively after lowering down petroleum tanker rate and factoring higher operating cost for heavy engineering segment.

Maintain HOLD, TP: RM6.17. Our SOP-driven TP is reduced to RM6.17 (from RM6.25) after earnings forecast adjustment and incorporating lower value for heavy engineering as a consequence of cutting our MMHE’s TP to RM0.77/share from RM0.82/share previously. Post 2Q18 results conference call, the management is still maintaining its guidance of 10% YoY decline in its core operating cash flow to USD1.2bn and thus, we are maintaining our FY18 DPS forecast of 30 sen premising on stronger earnings outlook in 2H18. Maintain HOLD recommendation as near term earnings risk would be cushioned by strong balance sheet (net gearing of 0.19x as of 2Q18) and dividend yield of 4.6%.

Source: Hong Leong Investment Bank Research - 8 Aug 2018