Oil Services & Equipment Providers - 2017 Outlook ~ Still caught in the doldrums
- 2017 to remain challenging for oil services operators despite gradual oil price recovery.
- We prefer OSV players with positive operating cash flows and no near-term bond maturities.
- Ezion remains our preferred pick on favourable industry positioning and strong cash flows.
- Privatisation theme in play – provides support for POSH and Mermaid Maritime.
Oil prices to edge higher in FY17, but oil services sector could remain work-starved.
- Despite oil prices having received a welcome boost from the recent OPEC-led agreements to cut supply, we believe price levels could be capped at around US$60-65/bbl in the medium to long term, as US shale producers would ramp up production in response to higher oil prices.
- The latest capex budgets for 2017 for the global oil majors – announced back in October/November before the OPEC meeting – are up to 15% below 2016’s budgets, and about 43% below the pre-crisis spend in 2014 by our estimates. Capex budgets for national oil companies (NOCs) in SE Asia for 2017 also show no growth. We think it is unlikely that the current rebound in oil prices above US$50/bbl would catalyse a significant upward revision to 2017 budgets. Thus, there is no immediate rebound expected for OSV owners, though we could see a recovery from mid-2018 onwards if capex budgets for 2018 are revised upwards.
- Cutthroat competition has reduced day rates for AHTS vessels to below US$1/bhp (vs. ~US$2 in good times) while mid-sized PSVs now go for US$8-12k/day (vs. >20k/day in good times). While downside risks in rates are limited, utilisation rates – currently around 50-60% for our coverage companies – could dip further in 2017. OSV yards should also remain significantly affected by low order wins as well as deferment of delivery dates.
Supply-side pressure intensifies downturn.
- Despite orderbook-to-fleet ratios having retreated substantially from their peaks, the associated deliveries of OSVs into the global fleet, coupled with a comparatively slower pace of vessel retirements, have pushed the AHTS-to-rig and PSV-to-rig ratios to their all-time highs, creating an unfavourable supply-side dynamic for OSV owners.
Positioning is paramount.
- We prefer companies with i) stronger balance sheets, ii) no bonds outstanding, iii) more exposure to production activities, iv) longer-term contract coverage, and v) higher exposure to NOCs.
M&A more likely for asset-light players and shipyards; privatisation could be a theme in 2017.
- Outright M&A activity in the service asset segment has been close to non-existent, as firms conserve cash and significant price gapping remains; we think M&A in 2017 would be more likely for asset-light players and shipyards due to synergies achievable and lack of asset-ageing risk.
Privatisation could be a theme in 2017.
- We have already seen some privatisation moves (e.g. Otto Marine and Vard) this year, and going forward, we think POSH and Mermaid Maritime are potential candidates.
Liquidity positions will be tested.
- Negative operating cash flows at many of the SGX-listed oil & gas players have whittled down companies’ cash balances. As we do not expect a significant improvement in the operating environment in 2017, we expect to see another year of strain on cash balances. The immediate plug will be higher bank debt or asset sales, though the former is dependent on lenders’ risk appetites and the latter has proved difficult amid thin second-hand markets.
- Companies with bonds coming due in 2017/2018 are particularly at risk; among our coverage, these are Nam Cheong, Ezra, and PACRA.
Risks of contract deferment and cancellations.
- This risk is most salient for the shipbuilders given the low front-end payment terms seen in recent years. Additionally, given the current climate, shipbuilders are largely agreeing to delivery deferrals in order to avoid outright cancellations.
- There is also risk around OSV charter cancellations as oil majors continue scaling back on their offshore rig count.
Further asset impairments.
- SGX-listed OSV owners have generally taken impairments in the c.10% range in terms of book value. With vessel utilisation and day rates having weakened further within the year, additional impairments may need to be taken.
Valuation & Stock Picks
Are we near the bottom?
- Valuation in the current context is tricky as the market seems to be pricing in a certain degree of default, but sector stocks also seem to have troughed since mid-2016 at the 0.2x-0.5x P/BV valuation range.
- We believe the market has priced in much of the risk at this point, but at the same time we are cognisant that insolvency is a real risk for some of the weaker names given the expected prolonged drought of work and impending bond maturities. Funds seeking to position for the long term should look at the less leveraged names with long-term contracts in place and good management.
BUY Ezion (TP S$0.56).
- Ezion is among the stronger layers with good assets, positive operating cash flow and decent cash balances. Re-rating catalysts stem from oil price rebound, earnings recovery with the resumption of service rigs currently under repair/upgrades in 2017, and successful diversification of its customer base to win new charter contracts.
- The key risk is further rate reduction for contract renewals; we have assumed a 15% rate cut in 2016 and a further 10% in 2017.
BUY POSH (TP S$0.41).
- POSH is a more stable long-term bet versus peers, with no immediate debt concerns and positive operating cash flows YTD. The company has also demonstrated its ability to secure work for its vessels amid an anaemic market (e.g. long-term contracts in the Middle East for 13 vessels).
- Additionally, POSH is a potential privatisation candidate with high ownership of 81.89% by majority shareholder, Kuok (Singapore) Ltd.