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Ezion Holdings - UOB Kay Hian 2016-08-12: 2Q16 Earnings Likely Bottomed, But Risks Abound On The Horizon

Ezion Holdings (EZI SP)  - UOB Kay Hian 2016-08-12: 2Q16: Earnings Likely Bottomed, But Risks Abound On The Horizon EZION HOLDINGS LIMITED 5ME.SI

Ezion Holdings (EZI SP) - 2Q16: Earnings Likely Bottomed, But Risks Abound On The Horizon

  • Ezion’s 2Q16 core net profit was a dismal US$6.1m, below our expectation. 
  • Earnings pressure appears to be abating, and with 5-6 units being redeployed within 2H16, earnings are likely to be at an inflexion point. However, significant risks from the macro environment remain, including liquidation risks from its associate Ausgroup, contagion from further business failures as well as asset impairment risks. 
  • Slash 2016-18 earnings forecasts further by 30-43%, and cut target price to S$0.31, pegged to 0.4x 1-yr forward P/B. 
  • Maintain HOLD. Entry price: S$0.25.



RESULTS


Core 2Q16 net earnings below expectations. 

  • Ezion reported headline 2Q16 net profit of US$19.8m, down 32% yoy but up 28% qoq. Excluding one-offs (a US$14.6m gain from the disposal of a 51% stake to Unit #4 and a US$0.8m forex loss), core net profit was US$6.1m for 2Q16. This was a 65% qoq decline from core net profit of US$17m in 1Q16.
  • The poor earnings were largely attributed to a 88% decline (US$1.1m) in earnings from associates/JVs, which was impacted by impairments from two entities.

Top-line pressure easing. 

  • Turnover fell slightly by 7% yoy to US$83.7m, but saw a 2% qoq improvement from US$82.1m in 1Q16. Ezion continues to offer lower dayrates to its client in the lower oil price environment. Downward pressure from clients on its service rigs’ dayrates is easing while oil prices stay above US$40/bbl.

Gross margin down 3.9ppt to 21%. 

  • This was attributed to units that underwent modifications and routine class surveys.

Net gearing down slightly from 1.22x to 1.20x. 

  • Gross debt fell from US$1.60b to US$1.59b during the period, lowering net gearing from 1.22x to 1.20x. This had the effect of lower finance expenses which declined 14% qoq from US$8.7m in 1Q16 to US$7.5m in 2Q16. 
  • Ezion expects to pare down its debt with operational cashflow going forward.


STOCK IMPACT


Earnings likely bottomed out. 

  • Ignoring the one-off effect from its associates/JVs earnings in 2Q16, Ezion’s earnings appear to have bottomed out. While oil prices remain at or above US$40/bbl, clients are less likely to press for further dayrate cuts. 
  • Service rig deployment also appears to have stabilised, with the working unit count of 17 in 2Q16 unchanged from 1Q16. That said, this may change abruptly given the volatility of the current environment.

Operational cash flow remains stable. 

  • Operational cash flow remained relatively stable at US$27m for 2Q16, down 11% qoq. While cash collection from the PEMEX units remains problematic, cash flow from its other working units appear to be stable.

2H16 to see working unit count rise from 17 to 22. 

  • 2H16 should be the inflexion point for Ezion’s earnings, with as many as 5 units expected to return to work. First up, is Unit #8 which is currently enroute for a wind farm project in the North Sea and is expected to contribute to earnings in 3Q16. Another 4 more units (#5, #13, #18 and #33) are expected to start work by end-4Q16. 
  • Assuming no further downturn in oil prices or operational hiccups, the working unit count should reliably rise from 17 to 22 by end- 2016. Management expects 22/23 units to be at work by end-16, and we note this represents a revision from 1Q16 guidance of 24/25 units by end-16.

Assuming only another 4 units re-deployed in 2017 and beyond. 

  • We are factoring only an additional four more units entering service in 2017 and beyond. The uncertain oil price environment has left management uncertain of their fleet deployments beyond 2016. Thus, we are only building in deployment of another 4 units (Units #7, #22, #24, #31) into our 2017- 18 forecasts. These are units which, based on our channel checks, will reliably enter service within 2017.

Ausgroup a possible swing factor to earnings. 

  • Ezion currently holds a 17% stake in Ausgroup with a carrying value of US$14m (as of end15), and has a A$37.2m (US$28.7m) loan with the associate. 
  • Ausgroup is currently in the midst of a financial restructuring, having defaulted on its bond in May 16. In the event that Ausgroup is forced to liquidate, Ezion will likely have to make a significant provision for it, estimated at US$43m. This will severely impact our reported earnings forecast of US$63m.


EARNINGS REVISION/RISK


Slash earnings forecasts by 30-43% for 2016-18. 

  • We have reduced our earnings forecast for 2016-18, factoring in the disposal of its 51% stake in Units #4 and #6, as well as accounting for changes in the deployment schedule. 
  • Our revised core earnings forecasts over 2016-18, excluding one-offs, becomes US$52m (-31%), US$79m (-37%) and US$101m (-42%) respectively.

Impairments risk. 

  • Should oil prices fall below US$30/bbl in 2H16 and stay at that level, Ezion will likely face another round of dayrate cuts for its service rigs. This may require another round of asset impairment for 2016 as the dayrate assumption in its asset valuations (DCF-based) becomes challenged.


VALUATION/RECOMMENDATION

  • Maintain HOLD and cut target price to S$0.31, pegged to 0.4x 1-yr forward P/B. This represents the sector mean for OSV owners who have minimal balance sheet issues, but face earnings headwinds. 
  • While earnings are on the cusp of a turnaround, significant risks from bankruptcies or a downswing in oil prices could present challenges to its share price.
  • Stable oil prices above US$50/bbl coupled with demonstrable earnings improvement are contingent to an upgrade in recommendation. Entry price is S$0.25.
  • Key risks: Another company liquidation event within the Singapore O&G space, or oil price revisiting the US$30/bbl level and remaining so for a prolonged period.




Foo Zhi Wei UOB Kay Hian | Andrew ChowCFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-08-12
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 0.31 Down 0.51


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