Oil Services & Equipment Providers 2016 Outlook - DBS Research 2015-12-17: Survival of the fittest

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EZION HOLDINGS LIMITED 5ME.SI  MERMAID MARITIME PUBLIC CO LTD DU4.SI  PACC OFFSHORE SVCS HLDG LTD U6C.SI  NAM CHEONG LIMITED N4E.SI  VARD HOLDINGS LIMITED MS7.SI 

Oil Services & Equipment Providers - Survival of the fittest 

• 2016 a test of survival for oil & gas service companies 
• OSV companies with strong balance sheets, cost advantages, long-term charters at decent rates and more exposure to production side of the value chain would have an edge 
• Ezion and Mermaid are our preferred picks, for better growth prospects and favourable industry positioning 

Outlook 

 A sustained lower oil price averaging US$50-60/bbl will make 2016 a test of survival for oil & gas service companies. 

• Most players in the market are bracing for ‘lower for longer’ oil price range of US$40-60/bbl in 2016. 
• Oil majors slashed 2016/17 capex and opex budgets further, setting the stage for a poorer offshore service sector outlook. 
• In 2015, OSV owners responded to weakness by cutting dayrates to keep utilisation high, with some AHTS charters priced near the rock-bottom US$1/bhp level. Further rate reduction is possible and utilisation could be next in line. 
• We expect OSV utilisation in 2016 to drop to 60-70%, from ~70-80% currently. 
• Built-to-stock shipyards for OSVs should remain significantly affected while built-to-order shipyards could also see lower order wins. 

 Supply dynamics for OSV sector still benign though. 

• Unlike the last crisis when oil prices crashed in 2009, the orderbook-to-fleet ratio of OSVs is much lower – AHTS orderbook-to-fleet is only 7% currently compared to 38% in Feb-08. Hence, the supply situation is more reassuring and should prevent utilisation from falling too drastically. 

 Positioning is paramount. 

• We prefer companies with stronger balance sheets, cost advantages, more exposure to the production side of the value chain, longer-term contract coverage, and higher exposure to National Oil Companies (NOC). 
• We reckon these stocks will be a better bet to ride out the current volatility. 

 M&A activity could accelerate. 

• The sector’s depressed valuations could catalyse more M&A activity, which has been brisk this year. Ezion and Dyna-Mac are potential candidates: Ezion offers access to an under-penetrated liftboat segment in Asia Pacific, while Dyna-Mac could be strategically bought over by Keppel Corp, which holds a 0.0% 24% stake. 

Risks 

 Prolonged dip in oil prices. 

• If oil prices remain depressed at below US$50/bbl, offshore E&P spending will remain low, intensifying the weakness in the offshore service sector, putting severe strain on companies with high debt and negative cashflows. 

 Risks of contract deferment and cancellations. 

• This risk is most salient to the shipbuilders given the low front-end payment terms seen in recent years. We think shipbuilders would not hesitate too much in agreeing to delivery deferrals given the current climate, in order to avoid outright cancellations. 
• There is also risk around OSV charter cancellations as oil majors scale back on their offshore rig count. 

 Balance sheet strength will be tested. 

• The average gearing of SGX-listed oil & gas companies has risen over the last few years as companies took advantage of the upcycle to expand their OSV fleets. That leverage will create risk in this environment. Nam Cheong and Swiber are the most vulnerable, with bond/perpetual maturities due through 2017 that should put strain on their cash flows; Swiber also has deteriorating credit metrics. On the flipside, we think Ezion and Mermaid Maritime are relatively well placed to weather the crisis in terms of lower leverage ratios and no immediate debt maturities. 

 Asset impairment. 

• SGX-listed OSV owners could follow in the footstep of their regional peers, writing down vessel book values, which have been scarce in 2015 despite global OSV newbuild prices falling by ~14% since end-2014. 

Valuation & Stock Picks 

 Are we near the bottom? 

• The small-mid cap oil & gas services stocks have been sold down sharply over the last months as oil prices nosedived. We reckon most of the bad news has been factored in, with most of the stocks losing 60-80% of their market values. 

 BUY Ezion (TP S$1.00). 

• We believe Ezion would be able to weather the crisis with strong cash flows backed by medium-term charters (3-year revenue coverage), and its exposure to the more stable accommodation/maintenance requirements of producing fields. 
• The earnings recovery with resumption of vessels under repair/upgrade and deliveries of new rigs; as well as diversification of customer base into non-O&G sector are key re-rating catalysts. 
• While we see new entrants coming into the liftboat space, demand growth should outpace supply growth given the under-penetration of liftboats in the region. 
• Key risks lie in the rate reduction for renewals, as well as customer-initiated rate renegotiations. 

 BUY Mermaid Maritime (TP S$0.27). 

• The stock is among the cheapest Oil & Gas plays at 5.5x FY16F PE 0.3x P/BV, which does not do justice to its exposure to the maintenance and repair phase of the value chain – one of the few brighter spots in this industry. 
• Mermaid had managed to keep its subsea fleet utilisation high at 80% as of 3Q15. 
• Its associate, Asia Offshore Drilling (AOD) has contracts with Saudi Aramco that extend until 2017, including options, which provide a steady stream of income.

Sector Valuations: 

Suvro SARKAR DBS Vickers | HO Pei Hwa DBS Vickers | http://www.dbsvickers.com/ 2015-12-17

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.00 Same 1.00

BUY Maintain BUY 0.27 Same 0.27

HOLD Maintain HOLD 0.35 Same 0.35

HOLD Maintain HOLD 0.15 Same 0.15

FULLY VALUED Maintain FULLY VALUED 0.27 Same 0.27