RHB Securities 2015-08-25: GSS Energy - Time Needed To Rebuild Confidence.


Time Needed To Rebuild Confidence. 

  • Management held a briefing last week to address investor concerns. Our key takeaways: 
    1. the precision engineering (PE) division continues to outperform, 
    2. Pertamina contract cancellation was due to contractor issues, 
    3. work is ongoing to convert at least one of its oilfields to a KSO structure, 
    4. GSS-AFCO will soon begin trading operations. 
  • We conservatively value the company primarily on the PE business. 
  • Downgrade to NEUTRAL with a SOP-based SGD0.09 TP (7% upside). 

 Pertamina took issue with KUD contractor. 

  • Pertamina cancelled its contract with the village cooperative (KUD) operating the DandangiloWonocolo field due to the latter’s non-compliance with contract terms. As this KUD was GSS Energy’s contractor, the cooperation agreement broke down, prompting GSS Energy to take a SGD33m writedown on its investment in Cepu Sakti Energy (CSE). GSS Energy later agreed with CSE to: 
    1. cancel the 76m shares held by CSE, and 
    2. take over the remaining 46.3% of CSE which it did not own for a nominal SGD1 consideration. 
  • The net effect is that GSS Energy has taken over 100% of CSE, which has rights to >10m barrels of economically-recoverable oil, for SGD15m. 

 Four other oilfields still in play. 

  • Management clarified that the issue above affected only one field, and that its four other fields are unaffected. Currently, work is in progress to convert the Trembul field to a standard joint operation contract (KSO), after which the usual cost-recovery mechanisms and reserves-recognition processes will be in place. 

 Precision engineering division outperforming. 

  • This division delivered SGD3.1m PAT in 1H15, surpassing expectations, as gross margins expanded to 25.1% from 17.8% in 1H14 following changes in the product mix and improvements in the business model. 
  • We expect this division to continue generating c.SGD6m of PAT annually on strong contract flows. 

 Need to rebuild confidence. 

  • Time is required to rebuild confidence with investors. We downgrade the stock to NEUTRAL while awaiting firmer news on the KSO-conversion. Our SOP-based TP is SGD0.09 (from SGD0.65), valuing the PE business at 5x FY16F EBITDA, USD0.50/barrel (bbl) for the oilfields, zero value for GSS-AFCO, plus cash of SGD8.7m net of USD5m drilling commitments. 
  • GSS Energy has no debt. At the current stock price, the oil and gas business essentially comes free. Key risks are execution risks on the oilfield operations.

Lee Yue Jer CFA | http://www.rhbgroub.com/ RHB Securities 2015-08-25
NEUTRAL Downgrade BUY 0.09 Down 0.65