Review

• Sapura Energy Bhd (SEB) reported FY17 core net profit of RM396mn (- 61% YoY). This was above expectations, accounting for 130% and 120% of our full-year forecast and consensus. The variance was mainly due to higher-than-expected contribution from the drilling segment, Petrobras contracts, and Sapura 3000. In addition, oil production 4.1mn boe (FY16: 4.8mn boe) and cost savings surpassed our expectations.

• FY17 headline net profit of RM204mn includes:- 1) net FX gain of RM44mn, 2) writeback in provisions of RM1.2mn for O&G fields, 3) asset impairments for Drilling (RM161mn) and E&C (RM123mn), and 4) impact from cessation of Berantai RSC (estimate: RM47mn).

• Total asset impairments of RM1.1bn nearly halved compared to a year ago (FY16: RM2.0bn). This is reflective of an improved oil price environment. Note that the current book value of SEB’s O&G assets incorporate oil price assumption of less than USD45/bbl. Therefore, there is a possibility of write backs moving forward.

• We deem FY17 results as resilient, particularly when compared to SEB’s peers. We attribute this largely to:- 1) increased contribution from Petrobras pipelaying contracts (~RM280mn), as the 6th and final vessel was delivered in Aug-16, and 2) cost savings of circa RM800mn (with management pushing for an additional RM200mn in FY18). To a lesser extent, bottomline was boosted by one-off reimbursement from Berantai RSC (ceased: 2QFY17), which is estimated at RM37mn (net of tax).

• Accordingly, the lower costs were reflected in:- 1) current high EBITDA margin of ~50% for working rigs, and 2) lower EBITDA oil breakeven price of USD30-35/bbl in FY17 (FY16: less than USD50/bbl). The cost measures more than offset lower oil production and lifting price (FY17: USD46/bbl, FY16: USD52/bbl). According to management, SEB is the lowest cost oil producer in Malaysia. Additionally, cost savings also partially cushioned profit decline at the Drilling segment, which suffered from a drop in fleet utilization.

• SEB declared FY17 DPS of 1 sen (FY16: 1.4 sen), which was above our expectations.

Key Takeaways from Analyst Briefing

• General:

1) Management maintained its subdued outlook on oil price and the industry environment. SEB expects oil price to average at USD55/bbl in 2017, and opined that it is unlikely to breach USD60/bbl in 2017-18. Meanwhile, as a desperate measure to lock-in contracts, competitors are still ‘throwing prices’, even at loss-making rates. Therefore, management alluded that “the worst is not over”. 2) Outstanding orderbook of RM16.7bn (including JVs) slipped 22% YoY versus FY16 (RM21.3bn). About one-thirds of the total will be recognizedin FY18. Meanwhile, tenderbook amounts to USD7bn. 3) Stable new order wins of RM6.3bn in FY17 (FY16: RM6.2bn) was commendable. This was in spite of a competitive environment, coupled with lower capex spend (-14% YoY) by global oil majors in 2016. The bulk of secured contracts originate from SEA (76%). 4) SEB expects higher capex in FY18 after subdued spend in FY17 (RM390mn). This will be largely driven by residual development costs for B15 and to a lesser extent, for SK408. Capex will also be expensed for a 7- well campaign that includes infill drilling at PM323, and 2-3 exploration wells at SK408.

• Balance Sheet:

1) SEB’s balance sheet improved in FY17, underpinned by:- (i) net gearing: 1.2x (FY16: 1.3x), (ii) cash: RM3.5bn (FY16: RM1.9bn), (iii) Operating CF: RM3bn (FY16: RM2.6bn). 2) Robust operating cash flow enabled SEB to finance FY17 capex via internal cash, without the need to draw down on debt facilities. 3) We understand that interest rates remain unchanged for the Mar-17 refinancing of RM1.1bn in short term (ST) debt to long term Sukuk Murabahah. Current ST Debt/Total Debt ratio remains manageable at 0.2x. 4) Cash levels will receive a boost in Jun-17, when SEB receives its final payment tranche (USD63mn) from Petronas for reimbursement of Berantai RSC’s cessation.

• Drilling:

1) Currently, SEB has 8 out of 16 rigs working. Current fleet utilization of 50% will improve slightly, following commencement of SKD Alliance’s 5+5 year contract with Shell Brunei in Apr-18. 2) In the worst case scenario, according to management, only 5 rigs will be chartered out by end-FY18. Nevertheless, management expects fleet utilization levels to hover at circa 50% in FY18-19. This is underpinned by 2-3 prospective bids in FY18 at SEA and Africa. 3) Management acknowledged that jack-up rigs are now competing in the medium water space traditionally occupied by tender rigs. However, in management’s defense, jackups are primarily deployed to drill exploration wells, whereas tender rigs are used for development wells. Additionally, tender rigs have managed to penetrate the deepwater market. This is evident from the upcoming deployment of SKD Esperanza to Malikai field. 4) On the bright side, DCRs appear to have bottomed out and stabilized since 1QCY16, at current levels of USD70K-90K (tender barge), and USD120K-150K (semi tenders).

• Energy:

1) Development of SK310 B15 gas field is on track for 1st gas in Oct-17. Production is expected to fully ramp up within a brief period of 1 month thereafter. 2) After additional discoveries of 3 tcf from SK408, SEB’s total net reserves and resources has increased to 243mn boe (FY16: 154.5 mn boe). 3) Despite ballooning O&G reserves that have yet to be monetized, SEB is still keen to acquire new fields. We are positive on this, given that it benefits SEB’s internal EPCIC fleet. Recall that the latter is a keybeneficiary of E&P jobs dished out by the Energy segment via open tender.

Impact

• Major changes to our earnings forecasts include:- 1) incorporating FY17 unaudited figures, 2) increasing contribution from Brazilian operations (Sapura Navegacao), 3) lowering depreciation costs due to cessation of Berantai RSC, 4) increasing E&C order replenishment, and 5) lowering costs at Energy and Drilling segments. Following this, our FY18/19 forecasts are raised by 13%/5%. Additionally, we introduce FY20 forecast of RM688mn (+46% YoY).

• We expect a weaker FY18, underpinned by:- 1) loss of contribution from Berantai RSC, 2) lower oil production of as per guidance of 3.7mn boe (- 10% YoY), 3) lower drilling fleet utilization, and 4) slowdown in E&C works, due to completion of projects secured before the oil price downcycle.

Valuation

• We prefer to remain on the sidelines for now, as earnings visibility remain weak at this juncture. In the near term, the bulk of SAKP’s current earnings are mainly derived from engineering and drilling. Contract flows for these segments remain tepid due to:- 1) oversupply of assets (Feb-17 SEA jackup/tender rigs utilization: 50%/48%), and 2) oil majors are still holding back on capex spend (FY17E: -8% YoY). Meanwhile, orderbook replenishment lags burn rate.

• Whilst oil prices are stabilizing at improved levels, it is unlikely to stage a V-shaped rally in the near term. This is on the back of:- 1) ramp-up in US production (YTD:+150k bpd) may prompt Saudi to arrest production cuts (YTD: -600K bpd) , 2) inventory levels remain at all-time historical highs amidst YTD build-ups (OECD: +6.5mn bbl, US: +36.5mn bbl), 3) expectations of high USD Index by Federal Reserve, 4) possibility that 6-month extension of production cuts at non-OPEC nations will not be exercised in 2H17, and 5) US rig counts at shale fields have been progressively inching up since its trough in May-16 (Jan-17: +19% YoY).

• Following the revision in our forecasts, our TP for SEB is now raised to RM2.02 (previous: RM1.92) based on unchanged 0.9x CY17 P/B. This implies 28x CY17 P/E (+1.6SD above historical mean). Maintain Hold.

Source: TA Research - 4 Apr 2017