- We recently met up with Kencana Petroleum (Kencana) andcame away reaffirmed in our conviction that its merger, likely to be completedbefore the end of May this year, with SapuraCrest Petroleum (SapCrest) into thenew entity SapuraKencana Petroleum (SapuraKencana) will transform the playingfield of the industry. We maintain BUYs for both Kencana and SapCrest as theirmerger will enhance their capabilities in securing larger order prospects andreenergize earnings growth momentum. Besides additional contract newsflow, thegroup is eager to secure two additional risk-sharing marginal field contract,similar to Berantai in which the merged entity will have a 50% stake.

- The merger will transform Malaysia's O&G services asthe resulting entity will have a dominant 70% market share of offshore installationwork with stakes in four derrick lay vessels (excluding five pipelay/derrickvessels under construction), sole tender rig owner/operator with a fleet of 6units, one of two current marginal field contract concessionaires and one ofonly two major fabrication yard (the other being Malaysia Marine & HeavyEngineering Holdings) in the country. Other services which provide a completeintegrated solution for oil majors include marine services via a fleet ofdiving/support vessels, survey vessels, remote-operated vessels, accommodationworkboats and anchor handling tug supply vessels. 

- SapuraKencana's order book of RM13.5bil remains thelargest in the country, larger than Bumi Armada's RM10bil which includes RM3bilrenewable options. With a yard utilisation of only 50% currently, Kencana'sorder book is still set to grow with a tender book of RM5-6bil of which over55% stems from Australia's huge offshore gas fields and the rest from Malaysia.Additionally, both SapCrest and Kencana are jointly bidding for over RM1biltenders for engineering, procurement, construction, installation andcommissioning (EPCIC) projects in Southern China. 

- SapuraKencana's potential market capitalisation of overRM10bil rivals Bumi Armada and will likely lead to its inclusion in theFBMKLCIand MSCI indices. As foreign institutional funds are still in the low teens forthe two companies, the inclusion in themajor indices will naturally likelyretain the group's premium valuations of over 20x despite a proforma netgearing of 0.4x (compared to 0.5x for Bumi Armada). We expect its net gearingto be manageable at 0.3x-0.5x despite the US$1.5bil capital expenditureprogramme for both SapCrest and Kencana as the spending will be progressiveover the next three years while Seadrill will bear half of SapCrest'scommitment to build three flexible pipelaying support vessels in Brazil. 

- We have upgraded Kencana's FY12F-FY14F net profit by11%-15% by incorporating the contributions of Allied Marine & Equipment,which was acquired in July last year. We have also raised SapCrest'sFY12F-FY14F earnings by 7%-11%, largely due to the turnaround in the group'smarine operations which have been suffering losses until 3QFY11.

- The higher earnings forecasts translate to a 15% increasein our fair value to RM2.68/share (from RM2.43/share previously) forSapuraKencana, which is still pegged to an unchanged CY12F PE of 22x, at parityto Kencana's 2007 peak (See our report dated 12 July 2011). This translates tothe raising of our fair value for Kencana to RM3.86/share (from RM3.54/share earlier)and SapCrest to RM5.94/share (from RM5.44/share earlier). But our top pickremains MMHE - a laggard with muted expectations - but expected to surprise onfresh order newsflows.