We are upgrading our target price on Coastal Contract’s (“COASTAL”) to RM3.87 (from RM2.90) as we raise our CY14 target PER to 12x (from 9x previously). The upgrade is mainly due to our conviction that the stock is due for a re-rating as its business model moves to asset ownership with the acquisition of its maiden jack-up rig. Its’ share price has rallied significantly above our target price of RM2.90 set in our Oil and Gas Sector Update dated 10 May 2013. We believe this is mainly due to the market finally taking recognition that; (i) COASTAL had been undeservedly a laggard oil and gas play; and (ii) the jack-up rig acquisition is a potential game-changer for COASTAL.  We maintain our OUTPERFORM call on the stock.

First jack-up rig is a game changer. The jack-up rig acquisition implies that; (i) COASTAL is kick-starting its move to an asset ownership business model (currently it adopts a build-and-sell business model). Hence, earnings should become more recurrent (current earnings are  lumpy as they are based on vessel orders); and (ii) there is potential for margin expansion as jack-up rigs command net profit margins of 25-30% (versus existing margin expectations of 15-25% per annum). 

Share price increase is commendable; but not enough. Whilst its share price catch-up with the market has been significant, we believe it has yet to fully reflect COASTAL’s upcoming catalysts.  We note that other offshore oil and gas asset owners are trading at forward PERs in the range of low-to-mid teens (ie. Perisai Petroleum (“PERISAI”) 12.8x; Alam Maritim (“ALAM”): 10.1x; Perdana Petroleum (“PERDANA”): 13.1x). Admittedly, these companies have more assets in their stables,  but it still does not justify the discount (~6.9-30%) that COASTAL is currently trading at (CY14 PER of 9.4x currently).  We also believe it may enjoy some spill-over interest during the listing of UMW’s O&G arm.

Strong demand for jack-up rigs in Southeast Asia enhances COASTAL’s contract success rate. According to our channel checks (with various companies’ fleet status reports and Rigzone), there are 45 jack-up rig contracts in South-east Asia (including Malaysia where there are 17 rig contracts) that are expiring from mid-CY13 to CY15. Given the abundant opportunities, it is likely that COASTAL should be able to secure some business. Another plus point is that COASTAL’s rig is brand new is of the 400ft range (most of the jack-up rigs in the region are the 300-350ft range), further enhancing its standing.

Raising CY14 target PER. Given the potential re-rating catalysts, we are raising our target CY14 PER to 12x (from the 9x previously) based on 15% discount to the CY14 PER of 14x ascribed to “PERISAI”; OP; TP: RM1.76). Whilst this seems high for COASTAL given that its 5-year average +2 std deviation level is only at 10.1x, we believe the valuation upgrade is justified as the company is on the verge of adding new earnings stream and evolving to an offshore asset owner.

Maintain OUTPERFORM call. We believe COASTAL will be one of the winners capitalising on the uptrend in the drilling segment and having been ignored for far too long, a re-rating is in the pipeline. Given the potential total return of 33.4% (31% upside to current share price and dividend yield of 2.4%) we maintain our OUTPERFORM call on the stock.

Source: Kenanga