FY18 saw massive impairments of >RM2.5b from its Armada Kraken FPSO and OSV vessels, plunging into huge losses. Nonetheless, core earnings were still poorer, in line with expectations, dragged by poorer OMS segment. With problems still faced in its Armada Kraken FPSO and ongoing debt restructuring negotiations, we feel compelled to downgrade it to UNDERPERFORM with a lowered TP of RM0.09.

Within expectations. While reported FY18 results came in with huge losses of RM2.3b, the numbers were dragged massively by large impairments (>RM2.5b), mainly in its Armada Kraken FPSO and OSV vessels. In fact, the huge impairments seen during the quarter (>RM1.3b) was a key risk we have previously highlighted (refer to our previous report dated 26 Nov 2018). Stripping off the impairments and other non-core items, FY18 core net profit of RM225.5m came in line with expectations at 103% and 99% of our and consensus forecasts, respectively. As expected, no dividends were announced.

Poorer FY18 results. YoY, FY18 core earnings slid 25%, dragged by: (i) poorer OMS segment (-51%) due to work completion on the LukOil project, and (ii) higher finance costs (+21%) due to the cessation of capitalisation of borrowing costs following the final acceptance of Armada Kraken FPSO, offsetting improved FPO segment (+8%) following the full-year contributions of Armada Olombendo FPSO and Armada Kraken FPSO, which commenced operations in Feb 2017 and June 2017, respectively. Sequentially, 4Q18 core earnings plunged 37% QoQ, dragged by poorer FPO (-22%) mainly on the back of lower vessel productivity from Armada Kraken FPSO, coupled with lower contributions from Armada TGT FPSO after signing an extension agreement in Aug 2018. This offset stronger OMS (+31%) from variation order for the LukOil project.

Plagued by both operational and financial problems. Operationally, its biggest asset – the Armada Kraken FPSO, continued to face problems during the quarter, having suffered system outages leading to less-than-expected production output for its client, EnQuest. We believe this may not be an isolated incident, having delayed receiving final acceptance until September last year as the vessel was not able to meet specifications. This led to massive impairments of the asset during the year (>RM1.6b), which we believe could imply either (i) massive reduction in the vessel’s assumed utilisation moving forward, or (ii) huge slash in charter rates from the clients. Meanwhile, financially, the company is still facing difficulties in securing a loan restructuring arrangement with the banks. Management is now not confident that it can meet its end-1Q19 deadline, and has pushed it back to a later date in 2Q19. With its net-gearing at an alarmingly high level of 2.7x, should it fail to secure a loan restructuring, we see no other alternatives for ARMADA as we believe cash calls or asset sales are no longer viable options in raising sufficient capital for debt repayments.

Downgrade to UNDERPERFORM. With the overhang from issues both operationally and financially, we feel compelled to ascribe an UNDERPERFORM call to ARMADA, seeing no other alternatives. With the book value suffering a huge write-down following massive impairments during the quarter, our TP has also been lowered to RM0.09, from RM0.15 previously, pegged to unchanged distress valuations of 0.15x. Post-results, no changes were made to our FY19E numbers while we introduced new FY20E forecasts. Risks to our call include: (i) completion of debt restructuring with hugely favourable terms, (ii) better-than-expected margins, and (iii) possible privatisation given all-time low share prices.

Source: Kenanga Research - 4 Mar 2019