Bumi Armada’s (BAB) share price fell by 22% after an impairment surprise in its 2Q18 results following disclosure of the latest amended agreements (AA2) entered with EnQuest for FPSO Kraken. BAB is also required to pay an additional sum of US$25m to EnQuest (which we believe will be the final sum). We believe the sell-off was overdone, as 2Q18 core profit was flat sequentially, and we believe the worst is definitely over with better clarity now on Kraken’s final acceptance. As such, we maintain our BUY call, but with a lower TP of RM0.66.

AA2 Seen as a Problem, But Actually Helps in Faster Acceptance

The impact from AA2 signed is 2-fold – a RM478.9m impairment charge (relating to client contigent liabilities over Kraken’s contract period in the event modification work fail to happen), and an additional US$25m to be payable to EnQuest in 2018. BAB recognized US$12.5m with the remainder to be spread across the following two quarters in 2018. To our knowledge, the old contract was very rigid with difficult conditions to be met in order to receive acceptance. The revised AA2 provides better clarity with amended terms, making it much easier to achieve the final milestone. While Kraken’s final acceptance date was not penciled down in the agreement, management is, however, more optimistic on achieving within 2 weeks. While appearing negative on the surface, this short-term pain will bear fruit with a quicker final acceptance, in our view. We also gather that BAB will be able to write back part of the impairment charge once the modification work on Kraken has been completed. Although impairments were provided following the AA2 signing, the work does not fall under the final acceptance scope and as such does not affect the delivery date.

Deriving the 2Q18 Core Profit

We have excluded a few irregular items to derive our core net profit: RM117m net allowance for impairment losses relating to the OMS segment, RM479m impairment on FPSO Kraken and Gema, and RM28m forex losses. In addition, we have also chosen to add back the US$25m additional payable to EnQuest to 2018, which we deemed as one-off, as a result of the renegotiated terms. All in, BAB’s 2Q18 core profit amounted to RM91m (-0.8% qoq, -27% yoy). This brings 1H18 earnings to RM182m (-4% yoy), which missed our and consensus estimates, representing 39% and 41% our and consensus full-year forecasts respectively. The underperformance was mainly impacted by the delay in Kraken final acceptance and weaker-than-expected margins.

Better Sequential Revenue, Margin Drop Viewed as One-off

2Q18 revenue grew 9%, mainly driven by a higher contribution from the LukOil project, which saw OMS revenue rise 48% qoq. This was slightly offset by slightly lower FPO segment (-3%) results, which were affected by the additional payable sum to EnQuest and a lower contribution from the FPSO Malta. As a result of the payment, the EBITDA margin came down 6ppts to 50%.

Stronger FCF Generation as Capex Reaches Tail End

Free cash flow (FCF) in 2Q18 improved 11% qoq as the OMS segment improved on higher LukOil activities coupled with the capex cycle coming to a tail-end. In 1H18, BAB incurred RM114m with the aim to spend just an additional RM10m to bring the FPSO Kraken to final acceptance.

Strengthening the Books by Monetizing FPSOs by Early-2019

This is the first time that BAB has formally guided that it is looking to monetize its FPSOs by early 2019, as a way to free up its capital for future projects. It is reported to be the frontrunner for ENI’s Zaba-Zaba in Nigeria.

More Clarity on Debt Repayment Schedule

We estimate that BAB will have a RM670m total debt repayment due in October and December 2018. The last tranche of the debt amounting to RM660m will be due in May 2019. All of these are not related to FPSO Kraken, but rather normal corporate facilities. These payments have already been factored into our forecasts, and as such are not much of a concern.

Lower Margins Led Us to Cut Earnings

We cut our FY18-20E earnings by 25%/25%/20% mainly to factor in a few changes: i) lower FPO and OMS margins, ii) higher interest costs, and iii) lower capex assumptions.

Maintain BUY; Cut TP to RM0.66

All in, we reiterate our BUY rating but lower our SOTP-based target price to RM0.66 (from RM0.98). We believe the current share price overhang should be lifted once the FPSO Kraken receives its final acceptance, which will drive stronger earnings and cash flow deliveries.

Key risks to our view include: (1) weaker-than-expected OSV fleet utilization, and (2) termination of existing FPSO contracts.

Source: Affin Hwang Research - 30 Aug 2018