Oil & Gas sector (Part I) - OCBC Investment 2016-11-30: 2017 To Be As Newsflow Heavy

Oil & Gas sector - OCBC Investment 2016-11-30: 2017 To Be As Newsflow Heavy Singapore Stock Market Oil & Gas Sector

Oil & Gas sector - 2017 To Be As Newsflow Heavy

  • Low sector valuations.
  • More M&A/privatisations to ensue.
  • Recovery of sentiment in 2H17? 



2016 marked the start of defaults 

  • Our year-end report last year was titled “Patience needed; expect more trading opportunities”. This followed an earlier report, “Go for quality in 2015” when we sounded caution on the broader oil and gas sector.
  • Unlike 2015, however, 2016 saw a gathering of momentum in debt restructuring and company defaults in the sector.


Mostly trading below half times book with a few exceptions 

  • Currently, many companies are now trading at about 0.5x book or lower, with a few exceptions. At current levels, however, we believe that most of the negatives have been priced in, and downside risk is now less than a year before – the challenge lies in 
    1. picking companies with the ability to ride the downturn, and 
    2. identifying the inflection point in which a sustainable recovery would begin. 
  • As such, it is not surprising to see distressed funds being set up to scoop some bargains when the time is right.


Recovery in sentiment in 2H17? 

  • When, then, is the right time? To start off, investors must understand that there are different sub-sectors in the broader oil and gas industry, and when you recover depends on where you are on the value chain.
  • Our sense is that should there be a sustained recovery in oil prices, E&P companies stand to benefit first as they are regarded as more direct proxies of the oil price. The drillers and vessel charterers could then be next in line, as well as the service providers. Asset fabricators (i.e. the yards), that depend on new order flows, could take a longer time to see earnings recovery, as their clients first have to regain confidence in the market before ordering new assets from them.
  • Meanwhile, the downstream players are still doing relatively well amidst the doom and gloom in the broader industry.


More privatisations and M&A 

  • In 2017, we could also see more corporate finance activities after Otto Marine and VARD received privatisation offers this year. Other possible candidates to look out for include PACC Offshore Services Holdings, Mermaid Maritime, PEC Ltd, Baker Tech, Dyna-Mac Holdings and possibly Pacific Radiance at a later point in time. 
  • In this report, we also update on our earlier stock take of companies’ financial positions and debt servicing abilities. 
  • Maintain NEUTRAL on the broader sector given the dim outlook and depressed valuations; our preferred pick for now is Sembcorp Industries given its more diversified business operations and undervaluation of its utilities segment.




TRENDS AND OUTLOOK 


FINANCING MARKET 


What is happening in the offshore financing market? 

  • Despite the plunge in asset values since the onset of the market downturn, it has been a difficult time for project financiers in the offshore market due to the challenge in searching for segments in the industry that can generate a return on investment that will attract investors to place their equity.
  • The traditional sale and leaseback arrangement that used to be popular several years ago is hardly used nowadays, mainly because of the quiet charter market. A charter market is required to generate a positive cashflow to the shipowner after deducting financial and operating costs.
  • At the same time, investors need to be comfortable with the counter-party risk and the residual value exposure at the end of the charter, unless there is a put option/purchase obligation with a bankable counterpart. In today’s market, ticking the boxes just seems a bit more difficult.

A question of timing 

  • That said, there are opportunities in the offshore market, but is the timing right yet? There is still a large order book with low scrapping numbers, and the charter market remains very quiet. Many offshore owners are looking for alternative sources of funds and many funds are looking for distressed offshore deals. However, most of the financial challenges so far have been sorted out between the senior lenders/bondholders and the owners, if they were sorted out at all. There have only been a few cases of direct equity purchases, some of which are merely nibbles of beaten down company stocks.
  • So far, owners or lenders who will sell for desperate consideration are still rare, and it is difficult for buyers to justify paying more than a token price for an asset – however promising its long-term potential – which could be sitting idle for an indeterminable period and consuming cash in the meantime. On the other hand, unless forced by lenders, owners are reluctant to sell, and lenders are loath to liquidate loans at fractions below par.
  • Under such circumstances, transactions are likely to involve equity consideration, or equity-like securities such as warrants or convertibles, or transfer of debt, rather than pure cash considerations.
  • Bond market largely closed to many companies now Till the end of 2018, the maturity schedule for energy and offshore marine issues totals ~S$1.5b. With bond markets remaining largely closed to offshore marine issuers, it remains challenging for some of the issuers to refinance their bonds. In the next exhibit, we also look at related bonds that are coming up for maturity in 2017 and 2018.



DISTRESSED-FOCUSED FUNDS SNIFFING AROUND 


New fund targeting Norway’s OSV sector 

  • In Jun this year, a newly launched US$250m fund by Norwegian investor Kristian Siem (Siem Offshore) and US-based Elliott Management Corporation was reported to be seeking distressed assets in Norway’s debt-ridden OSV sector. 
  • The fund, known as Siem Oil Service Invest, aims to carry out a restructuring of the sector through asset acquisitions to form a big consolidated market player with greater market clout. 
  • Elliott, with an estimated market value of US$23b, has built up a reputation as a “vulture fund”, having invested in state debt at risk of default in countries such as Peru and Argentina.

First step for the new fund 

  • In Nov, a company in Siem Industries Group inked a non-binding letter of intent with Farstad (OSV company seeking a refinancial deal), whereby it, or Siem Oil Service Invest, would become a key equity investor in Farstad.
  • Understand that Norway’s OSV sector is effectively controlled by several huge shipowner families, and Siem’s plan is to set up a new Oslo-listed umbrella entity that would be jointly owned by the shipowning families, following consolidation in the industry.

Others making their moves 

  • Investment outfit Aker, backed by billionaire Kjell Inge Rokke, also recently pumped in US$60m in equity and convertible loan to help push through a merger with rival Rem Offshore. 
  • As early as Jan this year, distressed debt investors were seen targeting the high-yield market to sift through collapsed bond prices, such as Blackstone Group’s GSO Capital Partners. 
  • Billionaire John Fredriksen has also set up a company (Sandbox) to acquire distressed oil rigs at the right time. 
  • Looking ahead, we expect more corporate actions as owners become more realistic of the options they have.

Some action starting to be seen in the US? 

  • Over in the US, more than 48 oil and gas producers have filed for bankruptcy (and over 80 E&P bankruptcies since the beginning of this cycle), according to US law firm Maguire Woods. For the greater part of this cycle so far, investors have been generally reluctant to scoop up distressed oil and gas assets, preferring to keep their dry powder due to uncertainties in identifying the bottom of this market. Some of the hesitance on the part of PE groups may be also partly due to their own troubled energy portfolio companies.
  • However, some investors seem to be starting to make their moves. WL Ross & Co, the investment firm of Wilbur Ross (known for big investments in downtrodden industries), purchased hundreds of millions of dollars in distressed energy debt of Breitburn Energy Partners and Permian Resources a few months ago, according to the Wall Street Journal6 .
  • Blackstone in Jul also paid about US$500m for acreage in the Permian, and EIG Global Partners agreed to invest US$500m as well in preferred shares of a unit of Rice Energy, a natural gas explorer7 .

In Singapore, investors want affirmation from banks 

  • In Singapore, as in elsewhere, all eyes are on the banks, being the traditional lenders of the O&G/O&M companies. Investors want reassurance from the banks that they will continue to support the O&G/O&M company. 
  • Our feel is that unless absolutely necessary, none of the financiers want to be the first to invoke their legal rights which would force the company into bankruptcy, thereby forfeiting the bank’s loans less collateral value. The government has also announced measures to help the O&M industry, such as more loans for cash-strapped firms. There are also expectations that more measures (e.g. lower rent for JTC facilities, relief from foreign worker levy) would be announced in the Feb budget next year.
  • Finally, it would also be useful to review some nearer-to-home casualties of the oil price collapse so far, as well as the financial positions and debt servicing abilities of companies in the sector.



Continue Reading: Oil & Gas sector (Part II) - OCBC Investment 2016-11-30: Taking Stock Of The Singapore Scene



Low Pei Han CFA OCBC Investment | http://www.ocbcresearch.com/ 2016-11-30
OCBC Investment SGX Stock Analyst Report HOLD Maintain HOLD 0.350 Same 0.350




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