SKPETRO’s 1Q17 was disappointing, which was bogged down by weaker than expected margins, especially in E&C segments. Near term outlook remains challenging with margin compression concern and slower contract replenishment. However, we are positive on its medium to longer term prospects being an integrated service player and a gas producer upon monetisation of gas fields. Retain MARKET PERFORM call with lower TP of RM1.48 peg to 0.7x FY18 PBV.

Below our expectations. In 1Q17, SKPETRO posted core net profit of RM116.3m which came below our expectations at only 15% of our full-year estimates. However, it was within expectations at 23% of consensus full year forecast. The variance from our forecast was largely due to weaker-thanexpected margins, especially in E&C segments and overestimation of its contract replenishment. No dividend was declared as expected.

Margin compression in E&C segment. Sequentially, 1Q17 earnings improved to RM116.3m from a core net loss of RM135.9m in 4Q16 despite a 13% drop in overall revenue due to better JV and associate contribution led by higher utilisation in Sapura 3000 and PLSVs chartered to Petrobras as well as improvement in both drilling and energy segments. Note that the improvement is affected by seasonality given fourth quarter has lower activities due to monsoon. On YoY basis, earnings fell 53% from RM248.4m in 1Q16, in line with a 14% decline in topline, largely marred by all divisions but partially offset by stronger JV and associate contribution and lower effective tax rate 12% from 22% in 1Q16. Energy segment earnings contribution was lower YoY due to lower average lifting oil prices at USD38/bbl vs USD58/bbl in the corresponding period a year ago. Meanwhile, we also observed a steep margin erosion in E&C segment from PBT margin of 17% in 1Q16 to 7% this quarter owing to higher percentage of lower-margins work scope being carried out.

Slower orderbook replenishment. SKPETRO’s latest order-book stands at RM19.8b, mainly comprising tenders for its E&C division. The company expects RM4.9b and RM3.9b to be recognised in the remaining quarters of FY17 and FY18. On a separate note, SKPETRO announced new contracts win for drilling and E&C divisions amounting RM513m. Despite so, we are seeing slower contract replenishment in the next two years in the absence of fabrication and offshore jobs as a result of cautious spending by oil majors. Meanwhile, drilling segment is expected to be weaker in FY17 given its average economic rig utilisation to deteriorate to 60%-70%.

Slashed earnings. We cut our FY17/18E earnings forecast by 66%/62% to RM255.7m and RM316.8.5m after factoring: (i) lower EBITDA margins largely from drilling and E&C segments to 30.9%/32,6% from 35.8%/37.8% previously (ii) lower new contract win by RM400m, and (iii) 10% reduction in DCR for new drilling contract secured.

Maintain MARKET PERFORM call. Post earnings adjustment, we decided to switch our valuation model to PBV from PER due to the significant deterioration of near term earnings prospect. Our TP is now reduced to RM1.48 from RM1.65, pegged to 0.7x FY18 PBV, higher than the current sector valuation of 0.6x PBV. We believe a higher premium is warranted to encapsulate its long term positioning as an integrated service player as well as a gas producer with decent gas reserve. Risk to our call: (i) Unexpected further sharp drop in oil price, and (ii) unexpected delays of projects on hand. 

Source: Kenanga Research - 28 June 2016