Sapura Energy (SAPE) returned to the black in the fourth quarter ended 31 January 2019 (4QFY19) with a net profit of RM497.5mil. However, Macquarie Equities Research (MQ Research) said the results were a miss as the FY19 losses before tax of RM511m was 165% deeper than its expectations. Nonetheless, MQ Research maintains Outperform on SAPE (target price: RM0.560) and expects the return to profitability will be the core focus, now that SAPE’s balance sheet woes are resolved. SAPE shares closed unchanged at RM0.345 yesterday.

Event

• SAPE’s 4QFY19 results were a miss: the full-year losses before tax of RM511m was 165%/260% deeper than MQ Research’s/street expectations.

Impact

• Results were heavily distorted by the deconsolidation of the exploration and production (E&P) business as well as a number of one-offs. Nonetheless, the core operational earnings underwhelmed, particularly the engineering and construction (E&C) segment which fell back into a loss-before tax of RM176m (3QFY 19: RM40m profit before tax (PBT)). While the bulk of the segment’s losses can be blamed on a one-off provision for delays and changing job scope for a single project (~RM170m) the underlying weak margins for the segment remains the key concern. SAPE’s E&C revenue grew by 31% quarter on quarter (q/q) but the segment saw a PBT fall by an estimated –RM50m. Management also flagged that the Brazilian JV operations are unlikely to secure the 5-year extension for Sapura Diamante, Topazio and Esmeralda.
• Drilling’s deceleration was easily anticipated, as SAPE rolled off a 5-year contract that had been priced at the peak of the market (~75% EBITDA margins), normalising the segment’s earnings to ~45% EBITDA margins. With only 6 rigs working, losses widened as MQ Research expected. MQ Research is sanguine that the segment may be able to break-even by year-end if management is able to achieve 8 working rigs on comparable rates. However, MQ Research flags the risk of higher drilling-associated capex as cold-stacked rigs are restarted.
• E&P’s operational performance was in-line with 1.1mmboe net liftings, albeit dragged by the lower oil price (US$62/bbl vs 4Q18’s US$79/bbl). MQ Research expects the volatility from oil prices for the segment will be diminished going forward now that SAPE’s stake has been reduced to 50% and deconsolidated.
• One-offs: It was not surprising that SAPE would book impairments in the fourth quarter but amount was still relatively high: RM1.5bn in total which mostly offset the RM2.66bn gains on disposal of the E&P business. Of the impairments, RM1.45bn was against personal protective equipment (PPE) (RM1bn for drilling and RM394m for E&C) while RM108.3m impairment was on goodwill.

Action and Recommendation

• While SAPE’s balance sheet has been substantially strengthened, the 4Q results is emphatic of the group’s primary challenge for FY20: navigating the razor-thin margins of its sizable E&C orderbook in order to deliver earnings. For the full year FY20, MQ Research expects to see the topline grow much quicker than earnings with a possibility of converging again towards 4QFY20 as margins improve. Meanwhile MQ Research expects drilling’s weakness to persist into FY20; barely breaking even with management’s target of 8 working rigs by year-end. Finally, MQ Research estimates the ~RM350m in finance cost savings should put the group back in the black this year.
• MQ Research expects the return to profitability will be the core focus, now that SAPE’s balance sheet woes are resolved. That said, the primary short term catalyst will be contract wins. MQ Research estimates that the group should be able to bag ~20% of its US$11bn bid book for FY20. This works out to an overall orderbook growth of +18%. Note, SAPE has an RM17.2bn orderbook (RM7.5 JVco, RM1.7bn drilling, RM8bn E&C) with an RM6.9bn burn rate expected for FY20. Maintain Outperform.

12-month Target Price Methodology

• SAPE MK: RM0.56 based on a Sum of Parts methodology

Source: Macquarie Research - 26 Mar 2019