MISC’s 1HFY23 results tracked expectations in spite of surprise pretax losses at the marine and heavy engineering segment. This was because bottomline was largely cushioned by resilient earnings at the petroleum and product shipping segment which absorbed hefty cost provisions for heavy engineering projects. We maintain our forecasts, TP of RM7.60 and MARKET PERFORM call.

Tracked expectations. Its 1HFY23 core net profit was within expectations – coming in at 46% and 51% of our full-year forecast and the full-year consensus estimate, respectively.

YTD expansion as Mero-3 normalized. 1HFY23 topline expansion was mainly driven by the heavy engineering segment following the recovery of volumes for dry-docking and repair activities. Bottomline growth was largely driven by the petroleum and product shipping segment due to higher margin on freight rates. We believe this was because MISC’s petroleum fleet was largely insulated from weak spot rates in 2QFY23 due to its higher proportion (88%) of term charters. To a lesser extent, earnings were also boosted by the offshore business segment given a low earnings base. Recall that FPSO Mero-3 was hit by a surge in construction costs in 1HFY22 following global supply chain interruptions and lockdowns in parts of China. Nevertheless, progress on the project has since normalized since 1QFY23.

Hefty pretax losses at the marine and heavy engineering segment. We understand that the segmental EBIT losses in 2QFY23 were due to additional cost provisions for two projects, particularly for Kasawari. This was because extra onshore works requested by the client had caused a delay in project delivery dates. As a result, QoQ profits declined in spite of improved contribution from the gas and asset solutions segment. We attribute the latter to an expanded fleet that includes full-quarter contribution from LNG newbuilds, Seri Daya and Seri Damai that were delivered in end-Jan 2023.

Briefing highlights. Key takeaways from MISC’s analyst briefing include the following:

1. As at 2QFY23, Mero-3 has achieved overall completion of 89%. Hence, it is on track to sail away by 1QCY24, and reach its designated offshore site at Brazil by 2QCY24. Thereafter, subsequent to Mero-3 achieving first oil and receiving cashflows from its charter contract, MISC will finally submit bids for new FPSO assets. This will be in partnership with other FPSO players to diversify risks and capex outlay. Meanwhile, the group is still actively pursuing an equity partner for Mero-3.

2. MISC is mulling over plans to extend the commercial life of its ‘experienced’ LNG vessels that are aged above 20 years. Therefore, instead of divesting these assets (as per initial plan), the group intends to extend their useful life via a normal drydocking exercise. This is because the company believes that the actual useful life of LNG vessels may stretch up to 25-30 years. As this juncture, MISC plans to execute such plans for Puteri Nilam Satu and Puteri Delima Satu. In particular, for the latter, it is currently prospecting for a new contract from a ‘platinum’ client.

3. The company alluded that its marine and heavy engineering arm recognized chunky cost provisions amounting to c.RM375m for the two projects mentioned above. Nevertheless, Kasawari has since sailed-way after meeting the client’s requirements. Moving forward, the group will attempt to recoup the additional costs from the client.

Cloudy outlook for petroleum freight rates. According to OPEC, the tanker market drifted lower in July with Aframax and Suezmax spot freight rates approaching their lowest YTD levels. This was mainly attributed to diminished activities for these vessels in the Atlantic basin. In particular, average Aframax spot rates in July (MoM: -19%, YoY: -43%) continued to decline on all routes for the 2nd consecutive month. Against this backdrop, we are cautious of sustained weakness in tanker freight rates, particularly in the small-midsized segment. Recall that MISC has a larger fleet of 26 Aframax and Suezmaxes (VLCCs: 10 units). Furthermore, we believe that OPEC+ will likely maintain its production caps given expectations of soft crude demand from a weak Chinese economy. In turn, this may translate to lower demand for crude transportation.

Forecasts. Maintained.

Maintain MARKET PERFORM, with unchanged SoP-TP of RM7.60. There is no change to our valuation based on ESG given a 4-star ESG rating as appraised by us (see Page 7).

We like MISC due to: (i) recent fleet expansion and modernization, (ii) success in securing mega FPSO projects (i.e. Mero-3) and new contracts from international clients and (iii) margin expansion coupled with improved earnings visibility following diversification to less commoditized specialist vessels (e.g. DP Shuttles, VLECs). However, demand for petroleum tankers will likely be subdued due to lingering production caps by OPEC+.

Risks to our call include: (i) lower-than-expected utilisation and spot rates for petroleum fleet, (ii) additional cost overruns and project delays for Mero-3, and (iii) production cuts by major oil producers.

Source: Kenanga Research - 25 Aug 2023