Malaysia Marine and Heavy Engineering Holdings’ (MMHE) core 1HFY14 earnings  of  MYR64.4m  were  below  our  and  consensus  estimates,  at 24.6% and 28.4% of the respective full-year forecasts. The disappointing results  were  due  to  higher-than-expected  operating  costs  at  the offshore division and low operating margins from the marine business. Downgrade to SELL (vs Neutral), with a lower FV of MYR3.10.

1HFY14  results  below  expectations.  MMHE’s  1HFY14  revenue  fell 3.3% y-o-y, mainly due to a 4% y-o-y decline in revenue at the offshore division (91.8% of total revenue). The company attributed this to the fact that  its  projects  were  nearing  completion.  The  smaller  marine  division (8.2% of revenue) saw a  6.2% y-o-y increase in revenue due to a higher number of repair projects during the period, but this was insufficient to offset the overall decline in group revenue. Core earnings were further dragged  down  by:  i)  higher  operating  costs  at  the  offshore  division;  ii) lower-margin  projects  undertaken  by  the  marine  division;  and  iii)  the load-out of three major projects in 1HFY14 as most of the earnings had been booked in. All in, 1HFY14 core earnings fell 34.7% to MYR64.4m.

Current  orderbook  worth  MYR1.8bn.  56%  of  MMHE’s  MYR1.8bn orderbook  is  contributed  by  SK316  integrated  topside  jobs,  while  the Malikai  tension  leg  platform  job  makes  up  33%.  The  company  is  now bidding for  MYR3bn-MYR4bn  worth  of  projects,  and expects  to  secure about 50% of this.

Downgrade earnings.  In light of the disappointing earnings, we cut our FY14F/FY15F net profit estimates by 41% and 10% respectively. We are factoring  in:  i)  a  lower-than-expected  orderbook  replenishment  rate,  ii) closure of MMHE’s main marine repair dock  for upgrading,  and iii) lower margins from offshore projects, which we estimate are only fetching high single-digit gross margin.

Downgrade  to  SELL,  FV  of  MYR3.10.  We  downgrade  our recommendation to a SELL, with a lower FV of  MYR3.10  (vs MYR4.08), pegged to a FY15F P/E  of 18.7x. This represents  a 10%  discount to the big-cap  oil  and  gas  counters  in  our  universe,  as  we  feel  MMHE  lacks earnings  visibility  as  it  continues  to  be  weighed  down  by  operational inefficiencies. 

Key Highlights
Successfully  delivered  Tapis  R  topsides  to  Exxon  Mobil  Exploration  and Production Malaysia after a hiccup in delivery in late March. The structure was found to be uncompromised after careful inspection.

Successful  load-out  and  sailaway  of  Kebabangan  topsides  to  Kebabangan Petroleum Operating Company.

Malikai Tension Leg Platform (TLP) was 30% completed as of June 2014. The structure is due to be completed in mid-2015.

Fabrication of SK316 is 13% completed. The central processing platform (CPP) jacket is being built in the West Yard   while the rest of the structure is being built in the East Yard. The CPP is tentatively slated to be completed by mid -2015.

On average, the yards are 50% utilized.

Management  informed  of  the  change  in  profit  recognition approach  for  EPCICprojects. Profit will be recognized on a “square” method (on a more conservative basis) upon  reaching certain completion  milestones.  Applicable  to  TLP  Malikai and SK316.

Risk.  Delays in replenishing orderbook as well as cost overruns from major projects would be detrimental,  as MMHE is already operating with razor-thin margins. Failure to raise operating efficiency could see margins continue to be pressured.

Source: RHB