Armada’s 1HFY18 core profit of RM104m (-46% YoY) came in below expectations at only 23%/27% of HLIB and consensus’ estimates respectively due to unexpected additional provision subsequent to AA2 and higher operating expenses on Kraken. Following that, we slashed our FY18/19/30 earnings forecast by 58%/3%/3% respectively. Management is eyeing to hit full acceptance for Kraken soonest by end September and in the midst of securing refinancing for the RM2bn unsecured term loans. Downgrade to HOLD with lower DCF-derived TP of RM0.54 (from RM0.81) as share prices remain under pressure pending full acceptance of Kraken and debt refinancing.

Results below expectation. 1H18 core profit came in at RM103.5m, accounting for 23% and 27% of HLIB and consensus’ estimates respectively. The disappointing results were mainly due to unexpected additional provision made subsequent to the Amendment Agreement 2 (AA2) and higher than expected operating expenses incurred on Kraken.

QoQ: Core profit shrank by 61% to RM29.0m despite revenue increase by 9% after stripping off (i) RM478.9m impairment made on Armada Kraken and Armada Gema, (ii) RM103.4m impairment on long due receivables from OSV clients and (iii) RM14.8m unrealised forex loss, etc. The significant drop was largely attributed to (i) higher operating expenses incurred on Kraken to secure full acceptance and (ii) additional provision made subsequent to the formalisation of AA2. This overwhelmed better OMS segment led by stronger contribution from Lukoil project amidst marginal fall in OSV utilisation at 39% from 40% in 1Q18.

YoY: Core profit also plunged by 74% no thanks to (i) the additional cost incurred and provision mentioned above, coupled with (ii) absence of one-off revenue recognised on previous work performed on Lukoil project upon formalisation of supplementary agreement in 2Q17, (iii) higher finance cost (+21%) as well as (iv) lower vessel utilisation (39% vs 2Q17’s 53%).

YTD: Cumulatively, 1H18 core profit tanked by 46% from RM191.5m in 1H17 dragged by (i) absence of one-off gains from Lukoil, (ii) higher finance cost (+48%) and (iii) weaker OSV utilisation masking stronger contribution from FPO segment led by Armada Olombendo and Armada Kraken.

Kraken. Armada has entered into an AA2 with Enquest to work towards final acceptance which has been delayed since 2Q18. Under this contract, Armada has to pay USD15m to mutually waive their respective rights to certain claims prior to 31 July 2018. Armada aims to hit full acceptance in the near term and has estimated the negative impact at USD25m this year.

Debt restructuring. Armada is looking to restructure its debt portfolio with preferred choices being loan refinancing and its unutilised medium-term note issuance as RM2.0b unsecured debt is due in three tranches in October, December this year and May next year.

Forecast. We slashed our FY18/19/30 earnings forecast by 58%/3%/3% respectively after imputing additional cost provision of USD25m in FY18 and higher operating cost for Kraken.

Downgrade to HOLD, TP: RM0.54. Our SOP-derived TP is lowered to RM0.54 (from RM0.81) after earnings forecast adjustment as we ascribed 20% discount to DCF valuation on Kraken. Downgrade to HOLD as share prices remain under pressure pending full acceptance of Kraken and debt refinancing.

Source: Hong Leong Investment Bank Research - 30 Aug 2018