We downgrade Sapura Energy (SAPE) to a SELL as we foresee the group continuing to record losses. We also see potential risk of impairment in 4Q18E. Operationally, the engineering & construction (E&C) and drilling divisions will likely continue to see challenges in terms of fewer activities. To make matters worse, annual depreciation and finance costs remain high to the extent that operating cash flow was only sufficient to cover interest payments in 9MFY18. We lower our 12-month SOTP-based target price to RM0.73.

No Improvement at E&C and Drilling Divisions

SAPE booked a headline net loss of RM274.4m in 3Q18. After excluding the unrealized forex gain of RM33m and disposal loss on Sapura 3000 amounting to RM46m, core losses narrowed slightly to RM261.3m. The disappointing results can be attributed to a few reasons: i) revenue at the E&C and drilling segments declined by 48% and 45%, respectively, ii) which affected margins (-3.2ppts decline in EBITDA margin), iii) share of associate/JV profit fell 70% mainly due to SapuraAcergy recording a RM15m operating loss, and iv) a higher tax charge despite posting a loss.

Only Positive Is the E&P Division

E&P was the only division, which saw an improvement as it benefited from a higher lifting volume (0.9mmboe in 3Q18 vs 0.8mmboe in 3Q17) and a realised lifting price of US$58/bbl in 3Q18 vs US$45/bbl in 3Q17. The current outstanding order book remains unchanged qoq at RM15.1bn. Meanwhile, the gearing level continued to balloon from 1.18x in 2Q18 to 1.26x in 3Q18.

Downgrade to SELL

We slash our FY18-19 earnings forecasts from profits to losses to reflect the challenging environment for both the E&C and drilling divisions. We also cut our earlier FY20 profit forecast by 93%. We downgrade the stock to a SELL as we see no signs of improvement in the near term. Our target price is also lowered to RM0.73 from RM1.35. Key upside risks include a recovery in contract wins and a higher-than-expected drilling rig utilisation.

Source: Affin Hwang Research - 8 Dec 2017