Ezion Holdings Limited - Phillip Securities 2016-11-21: Darkness before dawn

Ezion Holdings Limited - Phillip Securities 2016-11-21: Darkness before dawn EZION HOLDINGS LIMITED 5ME.SI

Ezion Holdings Limited - Darkness before dawn

  • 5 or 6 additional units will be put to work in FY17, lifting up average fleet utilisation from 65% to 78%. Utilisation rates may have seen a bottom.
  • Working fleet replenishment is expected to offset negative impact from possible further drop in charter rates.
  • Conversion of units into more economical Mobile Offshore Production Units (MOPUs), together with offshore wind sector redeployment, is expected to create new demand for these new fleet.
  • Temporary liquidity crunch will be alleviated.
  • We initiate coverage on Ezion with a Buy rating and a target price of S$0.48 based on discounted free cash flow to firm (FCFF) valuation with weighted average cost of capital (WACC) of 8.9%, implying an upside of 57.4%.

Investment Thesis

Persistent dim outlook: oil prices are not due for a sustainable recovery yet due to uncertainties of output cut 

  • The possible plan to cut total OPEC output to between 32.5mb/d to 33mb/d will be decided at the OPEC meeting by end of November 2016. If the supply cut does not fall below 32.69mb/d, the glut of oil will continue, based on estimated world oil demand for 2017.

Contagion from drilling-related activities spreading through to operational activities in the upstream sectors 

  • Capital expenditure (CAPEX) cut on exploration and production has led to operating expenditure (OPEX) reduction among the industry.

Offshore wind market sees bright prospects 

  • The upswing in offshore wind infrastructure development will pull up the demand for related facilities such as wind turbine, foundations, and vessels.

Investment Actions 

  • We initiate on Ezion with a “Buy” rating and a target price of SG$0.48 based on discounted free cash flow to firm (FCFF) valuation with weighted average cost of capital (WACC) of 8.9%.

Investment Merits 

Fleet utilisation is expected to increase, offsetting negative impact from downward pressures on chartering rate 

  • Ezion has been focusing on downstream services that are connected to exploration and drilling activities such as field development, production & maintenance, and decommissioning, and it is not immune to suffering from oil market woe. Management guided that currently the group’s average chartering rate dipped by 20% to 25% in FY15.
  • The group was relatively insulated from day rate reduction when oil price was trading above US$60/bbl, which is the level that oil companies are willing to maintain the OPEX on well service rigs and other OSVs, because costs that are incurred to reactivate idled drilling rigs and related facilities are higher than maintenance costs that are incurred to keep them active.
  • The day rate and charter value are based on the company announcement of the contracts, but they are not exactly the amount that Ezion has been collecting, because the contractors have renegotiated those rates with the group due to their reduction of operating expenditure. 
  • According to the guidance from management, the Group agreed on lower renegotiated rates for some contracts in the best interests for both parties, to prevent a default on the contracts. Considering the current and forward-looking oil market conditions, the pessimistic sentiment is still overhanging. If the oil price keeps wandering at US$40/bbl or even seeks another bottom, Ezion could be forced to accept lower rates.
  • However, there will be 5 units that are under upgrades and conversion gradually joining the working fleet no later than 3Q17. Correspondingly, the overall utilisation rate supposedly will increase by 13 percentage points from 65% in FY16 to 78% in FY17 on average. Therefore, we expect this replenishment of working fleet to offset the negative impact from contingent drop of day rate, increasing top line and improving margins.

Product mix is under transformation 

  • Ezion has scheduled conversion of several service rigs and liftboats into MOPUs and redeployment of part of the existing fleets to wind energy fields. Service rig 10, 14, and 15 will be redeployed as MOPUs in the upcoming 2 years. These three MOPUs will be allocated to South East Asia. Service rig 8 has been serving in North Sea for wind farm accommodation, which will be also applied to Service rig 11 and 16. Liftboat 13 and 24, on the other hand, are planned to be sent to China to support wind turbine and foundation installation.
  • Apparently, the group is diversifying the product portfolio in terms of value chain. Compared to conventional platforms and jack-ups, MOPUs are increasingly adopted by oil companies, which have been cutting back on cost expenditure, especially operating expenses. Being more economically and operationally feasible, MOPUs fulfil the austerity needs of oil companies. Besides, the supply of MOPUs is far from saturation.
  • The supply and demand of wind power is also much less volatile than oil. From the longterm perspective, renewable energy as a substitute for fossil fuel is still a global mainstream. Moving into offshore wind, a niche market, mitigates the impact from oil market turmoil by providing a stable income stream, since day rates for service rigs operating in wind farms have lower downside risks. 

How Do We View Ezion? 

Temporary liquidity crunch will be alleviated 

  • As of Jun-16, Ezion had US$371mn short-term loans due in a year, of which US$180mn will be rolled over, and the remaining US$91mn needed to be paid off by year end. The cash on hand in 2Q16 was reported at US$181mn. 
  • Moving to 3Q16, Ezion replenished c.US$100mn cash via right issuance in Aug-16 and repaid US$40mn borrowings. 
  • Currently, the reported cash amounted to US$255mn and the balance of short-teams amounted to US$353mn. Management expects US$51mn will be fully repaid in 4Q16. The first repayment of US$42mn to bonds will be due in Aug-18. Considering the small quantum and far repayment date from now, we do not expect this to cause financial burden on Ezion in the near term.
  • Ezion has sought debt restructuring (payment term extension) for remaining debts, and 4 out of 5 banks approved the plan. Management is positive on the final approval to be reached by all 5 banks. We expect that the group will hold US$194mn cash by end of FY16, and the amount is enough to cover working capital as well as capex for the next two quarters.

Bigger wind farm market in Europe but higher growth market in China 

  • By end of 2015, there were 84 offshore wind farms in 11 European countries, which are more mature markets. Though China failed to achieve the target of 5 GW of installed offshore wind capacity by 2015, it still aims to reach 30 GW capacity by 2020, as stated in the 13th Five Year plan. 
  • We think Ezion has more room to develop its presence in the China market. Sending two fleets to enter the China wind farm market is just a trial run for Ezion, since the group entered into a strategic cooperation agreement with China Huadian Corporation Group and formed a JV with Sinotrans & CSC Holdings Co., Ltd. Both strategies are expected to bring a higher volume of demand to Ezion on an ongoing basis.

Key assumptions & valuation 

  • Given Ezion is substantially leveraged with more than 50% debt-to-asset ratio, and the nature of the business relies on cash flow, we decide to use discounted free cash flow to firm (FCFF) to value Ezion. We derive FY16e target price of SG$0.48 based on WACC of 8.9% from cost of equity of 11.4% and cost of debt of 7.1% (after tax).
  • We initiate Ezion with a Buy rating based on TP of S$0.48, implying an upside of 57%.

Chen Guangzhi Phillip Securities | http://www.poems.com.sg/ 2016-11-21
Phillip Securities SGX Stock Analyst Report BUY Initiate NOT RATED 0.48 Same 0.48