• 2QY20 bodes well for MISC
• Still a beneficiary of floating storage demand
• Management is focused on time charter
• Heavy Engineering is another casualty of COVID-19
• Going forward, the outlook for spot rates of petroleum tankers is downhill
• Trim FY20E/FY21F/FY22F earnings estimates
• Maintain Trading Buy with TP of RM8.20 per share

2QY20 bodes well for MISC. In 2QFY20, MISC Berhad (MISC) reported a profit after tax of RM186m. After excluding exceptional items such as impairment loss and asset disposal, the normalised profit was RM478.6m (+17.0%yoy). This exceeded our core and consensus’ net profit estimate by 7.0% and 12.4% respectively. The positive surprise came on the back of higher revenue recorded from LNG and Petroleum segment (+5.2%yoy and +9.8%yoy) and lower than expected operating cost (S&GA at -17.9%yoy) during the quarter under review.

No dry-docking for LNG boost profitability. The revenue and normalised PBT of the LNG segment in 2QFY20 both increased by +5.2%yoy and +10.5%yoy respectively. The growth in revenue and PBT was mainly attributable to higher earning days following no dry-docking activities in the current quarter. As a result, the impact of softening freight rates for LNG vessels were muted.

Still a beneficiary of floating storage demand. The petroleum shipping segment recorded a PBT which was almost +600%yoy higher in 2QFY20 continuing the exceptional PBT result from 1Q20 (~+300%yoy). However, we believe that this exceptional level will not sustain going forward. This is evidenced from the declining revenue and PBT on QoQ basis for MISC’s petroleum segment (-11.2% and -40.0%). Furthermore, petroleum tanker spot rates are on declining trend for the past few months, strongly indicating return to normalcy in the horizon.

Management is focused on time charter. We like the continued commitment of MISC on focusing to increase its exposure on time charter rates in comparison to the volatile nature of spot rates. To note, in 2Q20, the ratio of time charter to spot, by vessel types, was at 96:4, 91:9 and 71:29 (VLCC, Suezmax, Aframax). We understand the trade-off for the continued prudence is that MISC’s will potentially miss out the surge in rates and the revenue spike, but we believe this is the right step as time charter rates are climbing steadily for petroleum tankers, inching closer to the level of spot rates.

Heavy Engineering is another casualty of Covid-19. For the 2Q20, Heavy Engineering segment record a dismal PBT of -RM100.2m (<- 100%yoy and %qoq). This poor performance was the consequences of lower revenue from on-going heavy engineering projects and lower number of secured vessels due to the yard shutdown during MCO period hence restricting the docking of international clients’ vessels into the yard. Strong rebound in business activities and good cost management will be crucial to ensure minimal drag on MISC’s bottom line.

Outlook for tanker rates in the medium term. In our opinion, petroleum tankers rates will likely normalise. We note that on the recent of report from EIA, that US domestic crude supplies fell for a third week in a row, as of August 7, as OPEC+ and non-OPEC countries are committing on the production cut. However, on the demand side, EIA also revised their oil demands forecast further downwards, from 7.9 mil bbl/day drop to a gloomy 8.1 mil bbl/day. Because of this, we opine that petroleum tankers rates will face downward pressure on lukewarm demand coupled with the waning interest in floating storage as oil inventories are drawn down, medium term. Near term, we do not discount on the volatility of tanker rates will continue to whipsaw and MISC’s to continue to be one of the beneficiaries of such circumstances.

Earnings estimates. Despite earnings exceeded our expectation, we exercise cautious optimism on the prospects of MISC going forward. We trim our earnings estimate for FY20E/FY21F/FY22F by -24.0%/-15.0%/-8.0%. This is to take into account on our view of softening LNG and petroleum tanker moving forward. We remain hopeful on meaningful recovery of oil market dynamics, improving demand vis-a-vis lower crude production for FY21 and FY22. Meanwhile, we note that our forecasts at this juncture have not incorporated the potential job wins related to FPSO segment by MISC pending announcements which will probably be announced in the latter part 2HFY20.

Target price. Our TP is derived by pegging our FY21 book value per share to a 1.0x price-to-book value which is its fiveyear average at RM8.20 per share.

Maintain Trading BUY. We remain encouraged by its long term prospect of MISC’s exposure to the time charter contracts which will shield MISC from huge fluctuations seen in the spot market. Valuations are expected to be higher if the potential job wins for the offshore segment in FY20 worth around USD4.0b which includes FPSO Mero 3 and FPSO Limbayong. In terms of the provision for litigation claims for GKL made in 1QFY20, management guided that this is sufficient, barring any unforeseen circumstances. Aside from that, MISC via GKL is advised that it has legal merits to challenge the award by the Arbitral Tribunal related to Sabah Petroleum dated 8 April 2020 and the company has done so with the outcome expected to be announced in the coming weeks. While we expect tanker rates to normalise, the time charter contracts will provide a shield to MISC’s earnings. Therefore, we are maintaining our Trading BUY call on MISC. Risks to MISC are: (i) further downward movement of tanker rates and; (ii) lack of demand for floating storage.

Source: MIDF Research - 14 Aug 2020