We  met  with  management  recently  and  emerged  positive  on SapuraKencana’s  business  developments.  Our  FY15/16  earnings forecasts now reflect estimated Newfield upstream asset contributions. Maintain  BUY,  albeit  with  a  lower  SOP-based  FV  of  MYR5.33  (from MYR5.61). We still like the company for its potential, yet-to-be-unlocked value, good partnership with Seadrill and excellent job execution.

Positive  on  operations. We  met  with  management  recently  and  came out  positive  over  ongoing  developments.  All  six  of  SapuraKencana Petroleum (SapuraKencana)’s  pipe-laying  support  vessels  (PLSVs)  will be  ready  ahead  of  schedule with  the  first,  Sapura  Diamante,  scheduled to begin operating by at least 4QFY15. The second, Sapura Topazio, is slated  for  deployment  by  1QFY16.  We  also  earlier  estimated  the  total contingent gas resources (2C) for the SK310 and SK408 gas fields to be in  the  2.5-3.0trn  cu  ft  (tcf)  range.  However,  following  the  recent successful 4-well drilling campaign at SK408 and management’s update, we believe total resources may now amount to 3.5-4.5tcf. Meanwhile, the existing four oil producing wells are estimated to have another 6-8 years of life. This may be extended further with infield drilling.

Forgoing s h a riah  status? Management has expressed that it is willing to  give  up  its  shariah  status  if  the  cost  of  maintaining  it  outweighs  the economic  benefits.  The  group  remained  on  the  shariah-compliant  list during  the  May  revision  by  the  Securities  Commission,  but  may  risk exclusion come November, due to non-MYR denominated loans.

Maintain  BUY,  with  a  SOP-based  FV  of  MYR5.33  (from  MYR5.61). We  lower  our  FY15  earnings  estimate  by  6%  as  we  conservatively included  only  a  quarter’s  contribution  from  the  Brazilian  pipe-laying contracts. We also raise our FY16 earnings forecast by 8% as we expect the  second  PLSV  to  start  contributing  by  2QFY16. We  expect  activities from  the  5-year  transport  and  installation  (T&I)  contracts  to  be  in  full swing.  Our  FY15/16  earnings  estimates  now  reflect  the  potential contribution  from  Newfield  Exploration  (NFX  US,  NR)’s  Malaysian assets. We  also  reiterate  our  BUY  call  but  lower  our  SOP-based  FV  to MYR5.33 (from MYR5.61), implying a target FY16F P/E of 18.4x vs other big-cap  stocks  under  our  coverage  that  trade  at  14x-29x.  We  still  like SapuraKencana as: i) we believe there is still much long-term value to be unlocked, ii) it has the capability to properly manage another risk service contract  (RSC),  and  iii)  its  relationship  with  Seadrill  (SDRL  NO,  NR) continues to expand its geographical footprint.

Meeting Highlights

We met with SapuraKencana’s management recently and came out positive over its ongoing developments:

Contingent  gas  resources  may  increase.  We  earlier  estimated  that  the  total contingent gas resources (2C) for both the SK310 and SK408 gas fields to be in the  range  of  2.5-3.0tcf.  However,  following  the  recent  successful  4-well  drilling campaign  in  SK408  and  the  update  from  management,  we  believe  the  total resources may amount to 3.5-4.5tcf. We understand that SapuraKencana has a 10-well drilling campaign for SK408, as signed in the production sharing contract (PSC) with Petronas. 

Gas sales agreement (GSA) soon to be signed. Management is hopeful about inking  the  GSA  for  SK408  by  the  end  of  this  year,  which  would  turn  the resources  from  2C  to  proven  and  probable  (2P).  The  development  cost, expected  to  be  incurred  by  SapuraKencana  in  developing  the  said  field,  was earlier  estimated  to be  at  USD88m  (c.MYR282m)  based  on  its  working interest (WI) of  40%.  On  the  other  hand,  the  development  of  SK310,  based  on  a WI  of 30%, would entail an estimated cost of USD510m (c.MYR1.63bn).

Cost  of  development  is  a  concern.  Management  also  addressed  the  worries surrounding the cost of developing the gas fields. The development cost will be partly  funded  by  its  MYR16.5bn  restructured  loan.  We  also  believe  that  the capital recovered from the development of the Berantai marginal field under the RSC  may  be  recycled  into  developing  these  two  gas  fields.  The  total development cost for Berantai was estimated to be c.USD800m (c.MYR2.56bn), of which SapuraKencana was required to fork out half of the amount for its 50% share.         

Producing wells have 6-8 years of reserve life. The existing four oil producing wells  are  estimated  to  have  another 6-8  years  of  life  with  an  expected  average 10% rate of decline per year. The existing producing fields are currently capable of producing a total of 25,000 barrels of oil per day (bpd). 

Bidding  on  its  own  for  new  RSCs.  On  RSCs,  management  shared  that  it  is now able to bid on its own without a foreign partner. This is mainly attributable to the  additional  skill  from  the  acquisition  of  the  Newfield  upstream  assets.  We believe the chance of garnering a second RSC is high following the success of Berantai.  

New  fabrication  infrastructure  contract  awards  expected.  Management  is hopeful  to  win  approximately  MYR10bn  worth  of  new  contracts  this  year following  a  total  of  MYR8bn  won  last  year.  We  believe  this  is  mainly  driven  by the  platform/enhanced  oil  recovery  (EOR)-related  fabrication  infrastructure contracts  that  are  expected  to  be  awarded  by  Petronas  by  the  end  of  the  year. Management noted  that  such contract award  flow  has  been  slow  at  the  current juncture,  which  is  in  line  with  our  expectation,  as  highlighted  in  our  previous 
sector  reports.  It  fabrication  yard  is  currently  40-50%  utilised,  implying  there  is ample capacity to handle more fabrication jobs.  

Limited  forex  currency  exposure.  Management  shared  that  there  is  little exposure  to  the  volatility  of  the  BRL  as  most  of  the  revenue  derived  from  the Brazilian  contracts  are  USD-denominated.  Certain  costs  like  labour  expenses are  in  BRL,  but  management  assured  that  it  has  built  in  cost  escalation assumptions into the project to offset these minimal negative impacts, if any. 

PLSV  will  be  ahead  of  schedule.  We  expect  that  all  six  of  the  pipe-laying support vessels (PLSV) will be ready ahead of schedule. However, management cautioned  that  the  actual  deployment  of  the  vessels  may  not  coincide  with  the date  of  their  respective  availability  to  Petrobras.  The  first  PLSV,  Sapura Diamante,  is  scheduled  to  start  operation  by  at  least  4QFY15.  The  second vessel, Sapura Topazio, is expected to be deployed for operation by 1QFY16.   

Shariah  compliance may not be top priority. In regards to its  shariah status, management has expressed that it will forgo its status if the cost of maintaining it outweighs  the  economic  benefits.  The  group  remained  in the  shariah-compliant list during the May revision by the Securities Commission but may risk exclusion come November. 

Earnings revisions

We  believe  that  SapuraKencana’s earnings growth  will  be  underpinned  by:  i)  the inclusion of contributions from Newfield’s upstream assets going forward, ii) its strong tender  rig  business  where  FY15  will  be  the  first  full-year  earnings  recognition following  the  completion  of  the  acquisition,  and  iii)  improvement  from  its  offshore 
construction  and  subsea  services  (OCSS)  division  following  a  poor  FY14 performance.    

Our  FY15/16  forecasts now  incorporate  estimated: i)  normalised 12-month  earnings from  the  Newfield  upstream  assets,  and  ii)  full-year  earnings  contribution  from  the tender  rig  business.  Our  revised  FY15  earnings  estimate  is  now  6%  lower  than  our previous forecast, as we conservatively included only one quarter’s contribution from 
the Brazilian pipe-laying contracts.  

Our  FY16  earnings  have  been  increased  by  8%  as  we  expect  the  second  PLSV  to start  contributing  by  2QFY16.  We  are  also  expecting  activities  from  the  5-year  T&I contracts  –  worth  approximately  MYR4bn-5bn  in  total  –  awarded  by  Petronas  to SapuraKencana to be in full swing.

Valuation

We  reiterate  our  BUY  recommendation  but  lower  our  SOP-based  FV  to  MYR5.33 (from MYR5.61) following the revisions above. We value:  

i)  the  OCSS and  fabrication  & hook-up  construction  & commissioning  (Fab  & HuCC)  divisions  at  a  target  FY16  P/E  of  20x  (from  18x  and  20x respectively),  ie  at  25%  premium  over  smaller  oil  &  gas  (O&G)  servicing 
players  like  Dayang  Enterprise  (DEHB  MK,  BUY,  FV:  MYR4.80)  and  Petra Energy  (PENB  MK,  NEUTRAL,  FV:  MYR2.71).  We  opine  that  such  a premium  is  warranted,  as  SapuraKencana  is  better  equipped  than  its comparable  peers  of  similar  businesses.  Most  of  the  assets  employed  for the use of the related contracts are owned by the group,

ii)  the  tender  rig  business,  a  sub-division  of  the  energy  and  drilling  (E&D) business  is  now  valued  at  27x  (from  35x),  similar  to  its  comparable  peer, UMW Oil & Gas (UMWOG MK, NR), which is currently trading at 27x CY15, 

iii)  the  existing  oil  producing  fields  of  Newfield’s  upstream  assets  at MYR0.12/share.  We  have  imputed  an  estimated  oil  price  of USD105.00/barrel vs current WTI price of USD106.71/barrel,

iv)  the 15-year Berantai RSC at MYR0.09/share using a WACC of 9%, and 

v)  we  included  only  a  partial  of  the  expected  FY16  year-end  total  borrowings into  our  FV,  ie  MYR4.7bn  out  of  MYR10.5bn.  We  believe  about  55%  of these  loans  are  for  the  construction  of  the  PLSVs  and  the  development  of the  Newfield  gas  fields.  These  assets  are  not  expected  to  bear  any contributions  to  the  bottomline  in  FY15/16,  Hence,  we  believe  it  fair  to exclude these loans.    

We  still  like  SapuraKencana,  as  we  believe  there  is  still  substantial  value  to  be unlocked, especially from the gas fields that are yet to be developed. We also believe that  it  is  capable  of  clinching  another  RSC,  due  to  its  proven  track  record.  Also, SapuraKencana’s relationship with Seadrill, a committed long-term  investor  in  the former, may open inroads to places still foreign to the group (like Mexico). 

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

SapuraKencana Petroleum is an integrated oil and gas services and solutions provider. 

Recommendation Chart

Source: RHB