Company Insight

We recently met management for an update on the company after share price has appreciated since our initiation report titled ‘Transforming..and this is just beginning’ dated 04 June 2013. The company remain optimistic on the prospects of drilling fluid (DF) and drilling waste management (DWM) services.

The management shared their bullish view on DWM. Until the 80s there was little or no DWM practice and legislation on disposal. Excess cuttings and fluid typically discharged overboard. However, legislation nowadays is trending toward zero discharge as practised in Caspian and North Sea. We understand that the company is in the vanguard of the development of Microwave technology for the treatment of oilcontaminated drill cuttings and has developed a unique 5- panel shaker for the land rig market.

The company guided margin pressure in the next 2 quarters due to ramp up in initial cost as the new projects secured last year starts to roll out. We also understand that the total final project revenue is normally 20-30% higher than the original contract value due to additional features and services along the contract period, potential surprise on the upside.

Comment

We came away from the visit even more optimistic given the huge opportunity from the DF and DWM business. We believe the market is underestimating the potential of DF and DFM as drilling fluid is a key component in the drilling process amid increasingly strict global and domestic environmental regulation.

DWM only contribute to ~5% of SES’s RM5bn orderbook. As the legislation is trending towards zero discharge, we expect DWM to grow faster than drilling fluid (DF). In North Sea, the DWM business size is 10-15% larger than DF. Margin for DWM is also more lucrative with gross profit margin >30% versus DF at 20-26%.

Despite margin pressure for next 2 quarters, full year margin guidance of 26% (is inline with our forecast). We expect margin expansion in future attributed to high profit margin projects and increasing DWM contribution.

We are positive on the company move to adopt asset light strategy and focus on core business as there is plenty of opportunity such as expanding existing market share and cross selling products to existing customers.

According to DWL Research, the addressable drilling waste market size for SES is estimated to be US$2.1 bn in 2012. This market includes Asia, Russia, the Middle East and West Africa. Thailand, Mynamar, Indonesia and Malaysia are the core market to look at given the huge capex spending on exploration and production.

Catalysts

• Potential to secure RM400m worth of contracts on top of its already huge orderbook of RM5bn.
• Contract win in DWM business given the potential addressable market size of US$2.1bn.

Risks

Global recession hitting O&G price; Technology advancement; Relaxing of drilling waste management regulations.

Valuation

We maintain our BUY call and a TP of RM0.88 based on 16x FY03/15 EPS of 5.5 sen/share.

Source: Hong Leong Investment Bank Research - 3 Jul 2013