The Sabah state government recently demanded Hibiscus Petroleum to pay a total sum of RM97.3m, comprising of: (i) RM66.0m in SST; and (ii) RM31.3m in penalty incurred for late payment. We understand that this development occurred on the heels of a few events, namely: (i) Hibiscus has not paid SST for its North Sabah assets since the implementation of the tax in April 2020; and (ii) recently on 8th June 2022, Hibiscus announced publicly that its newly-owned FIPC Kinabalu assets will not continue to pay SST under protest. Post-briefing, we came to an opinion that the entire debacle will require more time to solve and is inconclusive at the moment, pending further negotiations with the Sabah state government. We maintain BUY on Hibiscus Petroleum with a lower TP of RM1.54/share after increasing the WACC for both its FIPC Kinabalu Oil and North Sabah assets to 15% (from 10% previously) from this development.

What happened? The Sabah state government recently demanded Hibiscus to pay a total sum of RM97.3m, comprising of: (i) RM66.0m in State Sales Tax (SST); and (ii) RM31.3m in penalty incurred for late payment. We understand that this development occurred on the heels of a few events, namely: (i) Hibiscus has not paid SST for its North Sabah assets since the implementation of the tax in April 2020; and (ii) recently on 8 June 2022, Hibiscus announced publicly that its newly-owned FIPC Kinabalu assets will not continue to pay SST under protest.

Key briefing takeaways. We summarise the analyst briefing’s key takeaways, as below:

1) Hibiscus consistently highlighted throughout the briefing that the group have received a couple of written advice from its legal advisors that it does not need to pay SST on a few grounds: (i) while the extraction and production of oil is done operationally in Sabah, the oil is typically sold in Labuan; and (ii) Labuan has a maritime border and jurisdictions of its own and does not require Hibiscus to pay SST.

2) From the tone of the key management team throughout the entire discussion, Hibiscus sounded rather bent on assessing its options rather than caving in to pay the SST. The group views the total sum of c.RM70m to be paid annually to be a pretty hefty sum (based on the assumption of US$100/boe lifting price) as it can be used in other meaningful ways.

3) Based on our understanding, the total of RM66.0m stems from a non-payment for its North Sabah oilfield. However, Hibiscus has mentioned that the total figure is inaccurate and is very far off – but did not comment on a specific sum.

4) Hibiscus is in a unique situation compared to other oil producers in the region mainly because Hibiscus’s oil goes directly to Labuan and not into the Sabah state. Hibiscus is the only company landing oil in Labuan.

5) In regards to the termination of work passes, the group expects operational hiccups to occur, but contingency plans are in place. Based on our understanding, the work permits only affect non-Sabahan workers and currently, 24% of Hibiscus’s total workforce are Sabahans. So, even on a worst-case scenario, there will not be a complete shutdown of operations assuming work permits are not renewed. However, the group expects capex and maintenance planning to be deferred and delayed if this problem persists in the long term.

6) Management guided there should not be any provisions or impairments required for this development.

7) We came to an opinion that the entire debacle will require more time to solve and is inconclusive at the moment, pending further negotiations with the Sabah state government.

Forecast. Unchanged.

Maintain BUY, lower TP: RM1.54/share. We maintain BUY on Hibiscus Petroleum with a lower TP of RM1.54/share after increasing the WACC for both its FIPC Kinabalu Oil and North Sabah assets to 15% (from 10% previously) to reflect the heightened risk premiums from this Sabah SST development, which we believe will weigh on the group’s sentiment for the time being. Our TP of RM1.54/share is derived based on NPV of all its producing assets’ future free cash flows (FCF) – after accounting for each asset’s targeted lifespan. At about only 3x FY23F P/E, we believe that Hibiscus is a compelling case and is conspicuously undervalued given its strong foothold in the upstream energy space.

Source: Hong Leong Investment Bank Research - 21 Jul 2022