By Xavier Kong
UOB Kay Hian (UOBKH) downgraded SapuraKencana Petroleum Bhd (SapKen) to a “sell” rating, as well as lowering its target price to RM1.43 from a previous RM2.05, due to what the research house called “substantial intangibles”, as well as more earnings risk from core losses in oil production, idling tender rigs and Petrobras risks under stress scenarios.
The research house further noted that the current valuation of the group is effectively pricing in a high oil prices of more than US$40 per barrel, “a level where cash flow risk is material”.
“We believe current valuation reflects a high Brent assumption of more than US$40 per barrel but ignoring current levels of oil prices, heightened company risks, the high nett gearing of more than one time, and lower return-on-equities at 7%,” noted UOBKH, adding that SapKen’s share price has tracked closely to the movements of the FBM KLCI since July 2015 and has rebounded from its August 2015 low, though the correlation to oil prices weakened to 0.46 times.
The research house said that the trough target price is RM1.15 if oil prices fall to the range of US$20 per barrel, a price level where cash flow risk will be material as earnings before interest taxes depreciation and amortisation cover may decline further from the current estimate of three times.
The research house also pointed out that there were multiple earnings risks in SapKen’s financial year 2017 (FY17) . The first aspect, according to the research house, is in production drilling. Currently, SapKen has four rigs warm stacked, one rig on cold stacking and two rigs under construction, slated for delivery in the first half of 2017.
“Despite SKD Esperanza’s 18-month contract commencement from the third quarter of 2016 (3Q16), we are concerned on four more rigs that will see expiries by the first half of 2016 (1H16), and a rig (SKD Alliance) by 2H16. These make up nine rigs (50% of total fleet of 18 rigs) that may be stacked by end-FY17,” said UOBKH.
Also noted was that, from 4Q16, SapKen may incur earnings before interest and taxes losses as Brent’s has trended lower than the average year-to-date realised oil price of US$57 per barrel.
At the same time, UOBKH has expressed concerns over the continuity of the long-term contracts that SapKen has with Petrobras, despite the three pipe laying support vessels (PLSV) vessels from SapKen remaining highly utilised, with three more vessels to be delivered by the end of 2016.
This stems from Petrobras cutting its long-term production targets to 2.7 million barrels per month by 2020, from a previous 2.8 million, on Feb 12, 2015. The PLSV joint venture with Petrobras makes up 15% of SapKen’s group profit.
There is also the concern of seasonality, as the fourth quarter has historically seen the lower scope of works for SapKen.
“Most of our 30% earnings contraction estimates arise from the oil production and drilling segments. We see stable earnings momentum in the engineering and construction (E&C) division, as it represents more than 75% of the group’s RM21 billion order book, and drives the target order book replenishment rate of between RM7 billion and RM9 billion,” said UOBKH.
UOBKH also noted that the derating of the price-to-book (P/B) is on the basis of impairments and large goodwill, noting that the intangibles related to oil production assets, as well as the goodwill from Seadrill rig acquisitions and past mergers, are significant at a combined RM13 billion.
“We believe most of the nett after-tax RM641 million impairments year-to-date, had affected the intangibles, however, more impairments will follow. Due to the intangibles and earnings risks, we see further de-rating. Our target price implies a 39% discount on P/B,” said UOBKH.
While SapKen achieved RM822 million in core profit year-to-date, stripping out the RM641 million nett impairments post-deferred tax, UOBKH expects the group to post weak 4Q16 results, which will see a loss of contribution from SKD T-19, the most recently stacked rig.
Also affecting SapKen’s numbers for the quarter would be potential losses from oil production as realised oil prices may average at US$40 per barrel, assuming a lifting is done in November 2015, as well as the seasonally lower scope of works.
At closing today, SapKen’s shares trading at RM1.69, up 3 sen.
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