1H18 results came in below expectations, dragged by lower FSO segmental earnings as Armada Kraken FPSO faces continued delays in final acceptance. Meanwhile, we are negative on AA2 as we believe it implies that Kraken is still not close to final acceptance, coupled with likely lowered charter rates. Downgrade to MP, with lowered TP of RM0.51, as we turn bearish on Kraken’s earnings visibility coupled with the group’s high debt levels.

Below expectations. 1H18 core net profit of RM103.5m (arrived after stripping-off impairments of RM478.9m and other non-core items) came in below expectations at only 24%/23% of ours/consensus full-year earnings forecasts. The earnings disappointment was due to poorer- than-expected performance from its FSO segment, caused by lower- than-expected earnings contribution from Armada Kraken FPSO. No dividends were announced, as expected.

Overall weaker earnings. 1H18 saw its core earnings plunging 46% YoY, on the back of (i) lower OMS segmental earnings (-56%) due to the absence of booster profits recognised in 1H17 from supplementary agreement with LukOil for additional works completion, (ii) higher finance costs by 48% due to cessation of capitalisation of borrowings costs following the completion of Armada Olombendo FPSO, offsetting (iii) better FSO segmental earnings (+46%) as Armada Olombendo FPSO and Armada Kraken FPSO commenced operations in Feb-2017 and June-2017, respectively.

As for the individual quarter of 2Q18, core net profit of RM29m plunged 74% YoY, similarly due to (i) aforementioned absence of booster profits from LukOil, coupled with (ii) lower contribution from Armada Kraken caused by compensation payments. Sequentially, core earnings plunged 61% QoQ, dragged by (i) lower FSO segmental earnings by 42%, due to lower contribution from Armada Kraken FPSO as a result compensation payables, masking (ii) better OMS segmental results (by 1.4x) from higher contribution from LukOil project.

Amendment agreement for Kraken. Separately, ARMADA also announced the “Amendment Agreement Number Two” (AA2) with EnQuest Heather Limited (Charterer) regarding Armada Kraken FPSO, in which includes (i) compensation payment of USD15m (RM60m) from ARMADA to the charterers, and (ii) re-agreement of criteria for final acceptance as more rectification is required to the FPSO. All-in, this is expected to lead to a negative one-off earnings impact of USD25m (or approximately RM100m) towards FY18E. Overall, we are negative on this development as we believe it implies (i) renegotiated lower charter rates, thus leading to the impairment of RM477m recognised this quarter, and (ii) that Kraken is still not close to reaching final acceptance (as compared to previous assumptions of end-June). Post- results, we slashed FY18-19E earnings by 55-41% after accounting for lower earnings contribution from Armada Kraken FPSO.

Downgrade to MARKET PERFORM, as we turn bearish on (i) earnings and timeline uncertainty from Kraken, coupled with (ii) alarming borrowings levels, with short-term debt standing at RM6.2m as at end-2Q18 and total net-gearing of 1.9x, which may lead to capital raising or refinancing efforts in the near-term while also hampering its ability for further job bids. We lowered our SoP-derived TP to RM0.510 (from RM1.10 previously) following the earnings cut, coupled with readjustment of our previously conservative FSO segment discounting rate to 8.4% (from 5.9%) on the back of the increased risks.

Risks to our call include (i) sooner-than-expected final acceptance of Armada Kraken FPSO, and (ii) better-than-expected margins.

Source: Kenanga Research - 30 Aug 2018