Hibiscus Petroleum (Hibiscus), which had previously against the imposition of Sabah sales tax (SST) on its two operating assets in Sabah, reported that it has proceeded to pay the tax amounting to RM85.7m to Sabah state government. Management clarifies that this is to create a stable environment for continuing investment and smooth operations in Sabah. We view this development positively as it removes the lingering uncertainty in its Sabah operations that could affect its operational efficiency. Having this issue resolved, the Group is expected to pay 5% Sabah sales tax annually going forward. Our projection suggests that it is expected to pay an estimated amount of ~RM44.8m per year, by assuming crude oil sales of around 2.1 mbbls from North Sabah and 700 mbbls from Kinabalu field. Subsequently, we lower our FY23-25 earnings forecasts by an average of 10.2%. Our TP is adjusted higher to RM1.18 (from RM1.05 previously) nonetheless, as we remove the 20% discount that we ascribed to our SOTP valuation given the resolution of this issue. We upgrade our rating to Trading Buy due to attractive upside potential amid its lucrative earnings from the consolidation of Repsol assets’ earnings, which we believe the market has yet to price in the earnings appropriately at this juncture.

• Sabah Sales Tax issue. To recap, the Sabah state government has issued a notice to Hibiscus that working permits for North Sabah and Kinabalu fields will be cancelled on Oct 1, 2022, as the Group has discontinued the payment of sales taxes after taking over the Kinabalu asset from Repsol. The North Sabah asset, meanwhile, has not been paying the SST to the state.
  Earlier on, the Group disagreed with the payment of the tax, arguing that it sold its crude oil at the Labuan Crude Oil Terminal (LCOT) facility which is outside the sovereignty and jurisdiction of the state of Sabah, thus, should not be subject to the SST.

• Issue presumably resolved. The Group, nevertheless, in its Corporate and Business Update stated that it has made the appropriate accruals for all liabilities amounting to RM85.7m. This is after the state government accepted its proposal, i.e., to pay the claims imposed on revenues for the sale of crude oil under the North Sabah PSC and the Kinabalu PSC respectively, on 27 Sept 2022. Management indicates that this is to create a stable environment for continuing investment and smooth operations in Sabah.

• Our view. We view this development positive as it removes the lingering uncertainty in its Sabah operations. The dispute with the Sabah state government may potentially cause prolonged disruptions to its Sabah operations with issues involving manpower movement and/or shortages which eventually will limit its operational efficiency, affecting its output. During an analyst briefing on 20th July, management confirmed that it is already facing issues with slower approval for working permits by the state authority. Having this issue resolved, we believe its productivity from the Sabah oilfields will improve given the smooth operations, reflecting in higher uptime. Settlement of the arrears is not an issue given the Group’s cash holding of RM549.4m.

• Earnings impact. With that, the Group is expected to pay 5% Sabah sales tax annually going forward. Based on our forecasted potential crude oil sales of around 2.1 mbbls from North Sabah and 700 mbbls from Kinabalu field, the Group is expected to pay an estimated amount of ~RM44.8m per year, by assuming c. 300,000 and 350,000 bbls of oil to be sold per offtake for the North Sabah and Kinabalu fields respectively at USD80/bbl. Subsequently, we cut our FY23-25 earnings forecasts –by an average of 10.2%.

• Proposed capital reduction and share buyback. On a separate note, the Group announced a proposal which entails a reduction of RM800m of the issued share capital of Hibiscus. The credit arising from the reduction will be used to offset the accumulated losses of RM690.6m. Less the estimated expenses for the exercise of RM880,000, the remaining RM108.5m will be credited to the retained earnings, which will be used to facilitate a proposed share buy-back. The Group highlighted that the rationale of this exercise will help to eliminate the accumulated losses, allowing it to further enhance its ability to declare dividends and be better positioned to undertake the proposed share buy-back out of its retained earnings in the future. That said, this exercise has no impact to our earnings estimates.

Source: PublicInvest Research - 5 Oct 2022