Nam Cheong Ltd - DBS Research 2016-03-30: Perdana terminates contract for AWB

NAM CHEONG LIMITED N4E.SI

Nam Cheong Ltd - Perdana terminates contract for AWB

Nam Cheong issued notice of termination for one of two AWBs for client Perdana Petroleum.
Profit reversal on cancellation alone would lower profits by ~RM8-9m; further downside to earnings possible.

Nam Cheong has received a notice of termination/cancellation from Petra Offshore Limited, a subsidiary of Perdana Petroleum Berhad, relating to a contract for delivery of one 500-man AWB, entered into in June 2014. This AWB was one of two that were ordered by Perdana for a total contract value of US$84m, and is the first in line for delivery (last scheduled for sometime this year).
The contract on the second AWB remains intact with Perdana, which of course poses some risk of an additional cancellation. It is hard to say at this time though, as the exact reason for cancellation on Perdana’s part has not been ascertained.

We think the vessel in question is about 80% completed.
Due to the high back-end payment structure (20%/80%) inherent in offshore vessel contracts these days – only 20% of construction costs have been collected from Perdana – Nam Cheong is unlikely to just stop construction of the vessel, as it would be worth more alive than dead.
The company could therefore either
1. find another buyer for the AWB, which would be the ideal scenario, or
2. assimilate the vessel into its charter fleet.
We think finding another buyer is not impossible despite the weak environment, as the accommodation segment has remained relatively healthy compared to the exploration and development segments of the market.
In the meantime, the delivery timeline of the vessel will be prudently pushed back; Nam Cheong’s long-standing relationship with its Chinese yard partners means that such a deferral is unlikely to incur penalties.

Assuming a ~80% completion on the cancelled vessel and 10% build-to-order margins, this would translate into ~RM5-8m in profits already recognised that would have to be reversed.
If the second AWB is cancelled as well, we could potentially see another RM3-5m in profit reversals.
Further earnings downside could arise from
1. lower sale value if an alternate buyer is found, and
2. asset write-downs if the vessel is absorbed into the charter fleet, given that the initial contract for both vessels was entered into when oil prices were near their peak (mid- 2014).
Given that we were expecting ~RM13m in profits prior to this announcement, we think we should see barely breakeven profits in FY16, with potential for losses depending on the outcome of the cancelled AWB.

Although this marks Nam Cheong’s first order cancellation since the oil price collapse, we think outright cancellations should continue to be fairly rare for one key reason: Nam Cheong’s partner yards in China have been quite understanding of the offshore oil & gas situation and have either not been charging fees for deferral of vessels, or have given discounts on those fees.
There is therefore low incentive for clients to cancel their vessels at the yards due to the upfront capital already invested and the ability to benefit from an upswing in oil prices for minimal penalties.

We lower FY16 earnings from ~RM13m to RM4.7m to account for the termination of the first AWB contract.
We have not assumed further write-downs/provisions in the model yet as these are hard to predict at this point in time.
We maintain our FULLY VALUED call with TP of S$0.07.

Suvro SARKAR DBS Vickers | http://www.dbsvickers.com/ 2016-03-30

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