Review

• UMW Oil & Gas Corporation Bhd (UMW-OG) registered FY16 core net loss of RM420.9mn, which was below ours and consensus expectations.

• The main cause for the variance was lower than expected DCRs for UMWOG’s working jack-ups and higher finance costs. Note that NAGA 1, the sole rig working in 3Q, is a semisub rig and is able to command higher DCRs. We understand that only two rigs were utilized in 4Q.

• As previously anticipated, UMW-OG made a huge impairment of RM780.2mn. RM764.4mn was impaired by the drilling segment whereas the oilfield services segment registered an impairment of RM15.8mn. The total impairment was circa 13% of UMW-OG’s PPE base. This is a prudent measure given discounted DCRs, coupled with low fleet utilisation.

• UMW-OG was once again EBITDA loss-making in 4Q16, which is unsurprising given its underutilized fleet. To recap, only NAGA 6 and NAGA 8 were chartered out in 4Q16.

• Cash levels have fallen to RM553.5mn, as RM336.5mn was ring-fenced in the bank. We understand that this is the reserve account for the holding co. loan.

• On a brighter note, UMW-OG currently has 4 rigs contracted. We understand that NAGA 2 will be sent to the Ophir field in 2Q17 to begin operations. Meanwhile, NAGA 6, 7, 8 have already began operations in Sept-16, Jan-17 and Nov-16 respectively.

• According to management, there are a few more contracts that may be clinched in 1Q. We deem this as mildly positive, although we believe the contracts will likely be remunerated on “pay-per-use” basis.

Impact

• After incorporating FY16 numbers into our model, our FY18 earnings is tweaked lower by 12.5%. In addition, we introduce FY19 losses of RM176.9mn.

• Note that we have not factored in consolidation of Icon and Orkim pending completion of the merger. We also maintain other assumptions pending an analysts’ briefing later today.

Outlook

• We expect the challenging environment to persist on the back of the current oversupply of jack up rigs in the market. Although tender activities have increased, we believe award of contracts and recognition of earnings will still be slow.

• On the bright side, Petronas favors local players, and hence any local contracts would likely be awarded to UMW-OG. That said, we expect DCRs to be heavily discounted and remunerated under “pay-per-use” basis. Hence, UMW-OG’s earning remains uncertain going forward.

• We note that the consolidation of Orkim and Icon Offshore, if completed, should be able to generate sufficient cashflow to support UMW-OG’s rigs. Additionally, we expect Petronas to further support the merged entity given its advocacy of industry consolidation.

Valuation

• Following the major impairments done in 4Q, we upgrade our target P/B multiple to 0.6x (previous: 0.45x). We believe the discount should be lower post-impairment, given less inflated asset values that are more reflective of real valuations. Following this, our TP is reduced to RM0.54. 
   
• A largely idle fleet that burns cash remains a key challenge for UMW-OG. Furthermore, the consolidation exercise has minimal positive synergies, despite pricey valuations. Maintain Sell as we continue to see earnings headwinds in the near term.

Source: TA Research - 28 Feb 2017