Key takeaways from Coastal Contract’s 1QFY23 results briefing include: (1)  Papan EMC plant is expected to achieve first gas as early as Dec-2022, (2) JV  loans to CDSA are expected to peak at USD170mn, (3) outstanding amount due from CDSA is expected to reduce to USD90mn by 3QFY23, (4) the Group  intends to refinance Papan EMC’s outstanding bridging loan to a 3- to 5-year  short-term loan, and (5) The Group’s current outstanding orderbook  amounts to RM5.1bn whilst submitted tenders total RM8.7bn. We reiterate our Buy recommendation on Coastal. Our target price (TP) of RM3.06 is based on Sum-of-Parts valuation.

Papan EMC Inching Towards the Finish Line. According to management,  Papan Measurement and Control Station (EMC) is expected to achieve first gas as early as end-Dec 2022 (previous: guidance: Oct-22). Nevertheless, there may be a  slight delay to Jan-23 due to the looming year-end festive holidays. This project is currently undergoing commissioning works following completions of construction works earlier. Recall that Pemex awarded a USD219mn Engineering, Procurement,  Construction (EPC) contract for Papan’s related gas infrastructure works. To-date,  Coastal has collected approximately USD100mn (45% of total contract value) of  milestone claims from Pemex for this project. The balance of the contract value will be collected over 2Q-3Q FY2023.

JV Loans Almost Fully Disbursed. In 1QFY23, interest income from loans granted to 50%-owned joint venture (JV), Coastoil Dynamic S.A.De C.V (CDSA)  spiked 30% QoQ to RM25mn. This was underpinned by disbursement of additional loans to CDSA. Evidently, outstanding JV loans due from CDSA jumped to  USD166mn in 1QFY23 (4QFY22 estimate: USD141mn). Although Coastal has shareholders’ approval to lend up to USD220mn to CDSA, the actual loan amount is expected to peak at USD170mn. Thereafter, the outstanding loan is expected to  reduce progressively whenever Papan’s EPC contract milestone claims are collected.

Plan to Refinance Papan’s Borrowings. Given the above, the outstanding amount due from CDSA is expected to reduce to USD90mn (RM394mn) by  3QFY23. This is following full collections of Papan’s EPC billings. Thereafter, the  Group intends to refinance the bulk of this outstanding amount, which is currently funded by a bridging loan. Coastal is currently mulling various options for the latter.  At this juncture, management is inclined to refinance this loan to a 3- to 5-year  short-term loan under the Group (instead of under CDSA). This is given the Group’s lower cost of borrowing that enables Coastal to earn the interest spread from  CDSA.

Bloated Order and Tender Book. The Group’s current outstanding orderbook of RM5.1bn largely (89%) comprises Papan EMC project. This amount excludes potential contract extensions totalling RM702mn that are mainly for Agosto 12 (RM584mn) and Teras Conquest (RM126mn). Meanwhile, Coastal’s substantial tenderbook of RM8.7bn includes the following: (1) one production related infrastructure project, (2) 2 renewable energy projects, (3) large gas conditioning plant, (4) large gas storage project, (5) EPC of medium oil processing plant, (6) small gas dehydration plant. All the gas project tenders are submitted by CDSA. We believe this is likely to capitalize on Pemex’s capex spend growth, particularly at  Ixachi gas field in Mexico. To recap, for FY22, Pemex targets to deploy substantial capex of USD12.1bn (+48% YoY). This translates to a multi-year high since 2018. In  particular, Pemex plans to invest USD2bn to reduce the amount of gas lost through flaring at Ixachi field.

Buy to Leverage on Pemex Capex Growth. We tweak the following assumptions in our financial forecasts. This is after taking into account management’s  refreshed guidance as detailed above: (1) raise FY23 interest income by 32%, (2)  reduce interest expense by 14%-27% in FY23-25 as we assume Papan’s bridging loan  is refinanced at lower rates, and (3) assume full recognition of Papan’s EPC contract in FY23 with no residual amount in FY24. In addition, we raise our market value for  Coastal’s Offshore Support Vessel (OSV) fleet in our SOP (Sum-of-Parts) valuation by 6%. This is also to approximate management’s latest guidance. As a result, our  FY23/24/25 forecasts are adjusted by 60%/2%/3%. In addition, our SOP target price  (TP) is raised by to RM3.06 (previous: RM2.60).

We reiterate our Buy recommendation on Coastal on the back of: (1) the Group is a strong contender for Pemex’s new gas projects - particularly conditioning plants in Ixachi, (2) long-term earnings visibility is underpinned by sizeable outstanding orderbook of RM5.1bn, and (3) Coastal currently trades at 8.3x CY23 P/E - which is below its historical average of 11x despite enhanced earnings profile with attractive growth prospects.

Source: TA Research - 7 Dec 2022