Offshore & Marine - CIMB Research 2017-03-16: Small/mid cap round-up ~ Stick to safe harbours

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CSE GLOBAL LTD 544.SI MERMAID MARITIME PUBLIC CO LTD DU4.SI EZION HOLDINGS LIMITED 5ME.SI PACIFIC RADIANCE LTD. T8V.SI BAKER TECHNOLOGY LIMITED BTP.SI

Offshore & Marine - Small/mid cap round-up: Stick to safe harbours

• Maintain crude oil price forecasts of US$45-60/bbl for 2017F. Brent/WTI prices retraced to US$52/bbl/US$49/bbl in Mar 17 (2017 peaks: US$57bbl/US$54.4/bbl).
• In our view, downside risks to valuations are low, as the industry is on better footing after two years of impairment exercises and with better FY17F crude price outlook.
• Green shoots have emerged with oil and gas contract announcements by local companies in 1Q17. However, overall industry fundamentals are still challenging.
• Stay Neutral, as industry uncertainties still act as counterweights to sector positives.
• We prefer companies with healthy balance sheets that offer safe harbour amid sector volatilities. Our top pick is CSE Global.

Small/mid cap round-up: 

Stick to safe harbours US$45-60/bbl benchmark maintained 

• The Organisation of the Petroleum Exporting Countries (OPEC) has adhered to its production ceiling of 32.5m bbls/day since Jan 17, while shale oil production appears to have stabilised at 4.1m bbls/day. Both factors support higher crude oil prices.
• However, Drilled-but-Uncompleted (DUC) well count has steadily increased to 5,443 wells in Feb 17 from 5,352 wells in Jan 17 and rig count in the shale regions/plays continued to inch up. This implies that shale drilling improved in Feb 17, spurred by increasing crude oil prices in Dec 16 onwards.
• On 10 Mar, the US inventories (excluding the Strategic Petroleum Reserve, SPR) increased 7.3% yoy to reach 528.2m bbls vs. 492.2m bbls in Mar 16.
• The Brent price has retraced to US$52/bbl after hitting the YTD peak of US$57/bbl in Jan 17. Meanwhile, the WTI price registered a more significant decline to US$49/bbl in Mar 17, after hitting the YTD peak of US$54.4/bbl in Feb 17.
• YTD average Brent and WTI prices stood at US$55.5/bbl and US$52.8/bbl, respectively (above FY16 average Brent and WTI prices of US$45.1/bbl and US$43.4/bbl).
• These ‘supply-driven’ factors lead us to maintain our US$45-60/bbl crude oil price forecast for FY17F. We believe there is potential upside to US$60/bbl, as OPEC may readdress markets and adjust its strategies to achieve optimal crude oil prices. The nearest milestone date is 25 May 17, when OPEC regroups to assess the success of its output cuts and decides if it will continue with the production ceiling. 
• We note that Russia has not seen any significant production cuts since Jan 17, although it agreed to 300,000bbl/day cuts from Jan 17 onwards. The country’s adherence to this could stimulate higher crude oil prices.   

Impairments narrowed in FY16 but risks still present 

• One of the key reasons we paid close attention to the 4Q16 results was to assess the extent of the impairments, which we believed would be narrower yoy due to crude oil prices rising at end-FY16.
• At least US$3.7bn had been recognised as impairments/ provisions in the past two years (FY15-16) by offshore and marine (O&M) names.
• In the large-cap space, impairments were lower, aided by Sembcorp Marine’s low impairments in 4Q16.
• For the small caps, total impairment of US$465.4m in FY16 (excluding Ezra’s and Swissco’s significant impairments/provisions of c.US$536.6m and US$240.7m, respectively) was narrower than the US$553.3m in FY15. PACC Offshore booked the most extensive impairments of US$310.1m, the bulk of which was for goodwill in the offshore support vessel (OSV) segment and for OSV asset values.
• We have excluded Ezra’s and Swissco’s impairments in this assessment, as both companies are experiencing financial and operational distress. Hence, they could be impairing on ‘going-concern’ basis.
• We hesitate to rule out further impairments in CY17F, especially in the small cap O&M space, as balance sheet and cashflow stresses are still present.
• Headline average net gearing for the small-cap space expanded to 1.36x at end-CY16 (vs. 0.64x at end-CY15) and certain companies continued to report negative EBITDA and operational cashflow in FY16.
• Default risks may be mitigated by: 
  1. completed loan restructuring (i.e. loan tenures extended, principal repayment holidays), and 
  2. government support via the SPRING bridging loan (companies can borrow up to S$5m each and up to S$15m per borrower group). 
  However, oversupply in various asset classes (rigs, OSVs) could cap the speed of the recovery and in turn, improvement in company financials.
• In our view, should sector weakness extend beyond CY17, the companies that could face stress in CY17-19F are Ausgroup, Falcon Energy, PACRA, Nam Cheong and Marco Polo as all have bond redemptions due in 2017-19.
• An incident similar to Swissco (that required significant provisions) may occur in the near future. We highlight that Ezra’s JV partners in its subsea business, EMAS Chiyoda Subsea Limited, recently filed voluntary petitions for reorganisation under Chapter 11 of the US Bankruptcy Code to facilitate the ECS Group’s financial and operational restructuring.

Green shoots emerging, but sector fundamentals still challenging 

• We gathered from the 4Q16 analyst briefings that companies were cautiously optimistic on CY17F prospects, largely due to the crude oil price YTD having stayed above the average crude oil price in CY16. The companies guided that utilisation and daily charter rates (DCRs) have fallen to trough and as such, can only improve from now on. The companies also believe that the contracts that were delayed extensively could return this year.
• We take heart in local industry players starting to announce oil and gas contract wins. An estimated US$142m worth of contracts was awarded YTD. These contract values are small in quantum, and may not be executed at historical peak rates but they are still green shoots of recovery.
• These contracts are signs that players with exposure to the Gulf of Mexico, shallow-water play and production, inspection, repair & maintenance (P&M) activities will continue to be the first beneficiaries of any vessel utilisation improvement.
• That said, we believe that the excess backlog of existing offshore vessels and rigs will cap any uptick in DCRs. Furthermore, there has been sparse newsflow on major offshore capex.

Maintain sector Neutral 

• We continue to remain Neutral on the sector as signs are still mixed for the near term. 
• On the positive side, we see contract flows returning and market players guiding for a trough forming. 
• On the negative side, crude oil price volatility is still present and significant offshore capex has yet to return.
• Currently, small-cap stocks are trading at 1-year forward P/BV of 0.47x, barely higher than the 0.41x in Dec 16. The share prices of selected small/mid-cap stocks rose in Dec 16 to Feb 17 but have taken a breather in Mar-17, largely due to spillover effects from: 
  1. reduction in crude oil prices, 
  2. weaker-than-expected 4Q16 results, and 
  3. negative newsflow from companies like Ezra.
• The key near-term risk for Singapore’s offshore small-cap O&M space is Ezra filing for judicial management, in our view. We believe it unlikely that the sector de-rates to the low of 0.27x forward P/BV in Aug 16, given that the Swiber surprise factor has worn off and the sector is on a better footing after the asset impairments and loan restructuring undertaken. 
• Nonetheless, Ezra’s larger headline net gearing of 4.99x at end-FY16 (in Aug 16) vs. Swiber’s net gearing of 1.57x at end-1Q16 (before it filed for judicial management) could cap the level of optimism on any recovery in the offshore small-cap O&M segment. 
• To recap, the small/mid-cap valuations dipped to 0.27x P/BV in Aug 16, when Swiber filed for judicial management (vs. the average of 0.44x in 1H16).

Valuation and recommendation 

• We believe the sector is under-owned, having bombed out in the past 2.5 years. Hence, it would provide most tactical upside in a sector rotation, in our view.
• Based on our YTD small/mid-cap stock screening, the companies with healthy balance sheets (net cash/minimal net gearing) posted the biggest share price gains (>15% as at 15 Mar 17). These included stocks like MMT, CSE Global and Baker Technology (BTL). 
• We believe these stocks were accorded a premium over peers in current market conditions, as they are deemed safe harbours to ride the current sector volatility. As such, we have a clear preference for stocks with healthy balance sheets to ride any sector upcycle.
• Among the small/mid-cap stocks that we cover, our top pick is CSE Global. We also favour Mermaid Maritime (MMT) for its balance sheet strength. We have also highlighted BTL as a Non-rated piece.

Small-cap top pick: CSE Global (ADD; TP: S$0.59) – Heralds the return of contracts 

• Our target price for CSE Global is based on 12x FY18 P/E (at historical 5-year mean). 
• We favour CSE Global for its healthy balance sheet (net cash of S$70.2m at end-16) commitment to steady DPS of 2.75Scts regardless of earnings performance in FY17F. Management implied that it could see more contract flows, stating that it could repeat FY16 net profit of US$21.1m in FY17F, despite starting the year a lower order backlog of S$163.1m (vs. S$192.7m at the start of FY16).
• We estimate FY17F order intake of c.S$350m, comprising S$60m-70m brownfield wins per quarter and the remaining S$70m-110m greenfield projects by the oil & gas and infrastructure divisions. 
• Given that it has won greenfield works of c.S$42m YTD (i.e. 38-60% of our FY17F greenfield forecast), we believe CSE Global could outperform our 2017F order intake estimate. CSE Global’s share price has performed well, posting gains of 19.8% YTD on 15 Mar 17. 
• Key risks include weaker order intake and margins, given the competitive market conditions.

Mermaid Maritime (ADD; TP: S$0.28) – Financial flexibility to ride out this storm 

• Our target price for MMT is based on 0.77x FY17 P/BV (10% premium over historical 5-year mean of 0.7x). 
• We favour MMT for its strategic industry position in the inspection, repair and maintenance (IRM) space, which makes it a likely beneficiary of opex activities kick-starting. 
• We also like its relatively healthy balance sheet compared to peers (negligible net gearing, no outstanding bonds), which gives it the flexibility to participate in any “distressed-asset” opportunities that may emerge during the year and the financial muscle to weather the current volatile industry cycle. 
• MMT’s share price has performed well, posting gains of 36.7% YTD on 15 Mar 17. 
• Key risks include weaker contract wins that would negatively affect vessel utilisation and lower associate contributions (it has a minority stake in Asian Offshore Drilling with Seadrill).

EZION (ADD; TP: S$0.45) - In cash preservation mode 

• Our target price is based on 0.5x FY17 P/BV (50% discount to historical 5-year average P/BV of 1.0x). 
• We favour EZION as it sits in the production and maintenance (P&M) section of the oil and gas value chain, which would make it one of the key beneficiaries of opex activities kick-starting. 
• We believe EZION’s impairment and cash flow risks for FY17F are low, as it has completed the debt restructuring exercise (negotiated to repay debt according to its operational cash flow) and it has indefinitely postponed the four newbuild deliveries originally scheduled for FY17-18F. This gives it breathing space in view of the upcoming bond repayment in FY18F. As such, we foresee investors becoming more comfortable to take position in the stock in the near future. 
• Key risks include weaker contract wins and DCRs that would cap EBITDA and operational cash flow.

PACRA (Reduce; TP: S$0.13) – Still tight on cash flow 

• Our target price is based on 0.25x FY17 P/BV (at 1 s.d. below its historical 5- year mean of 0.85x). 
• PACRA’s higher mix of shallow-water OSVs is likely to make it one of the first beneficiaries of heightened offshore activities. However, we remain cautious on the stock as: 
  1. the shallow-water OSV space faces a huge asset glut, which could cap any uptick in DCRs in FY17-18F, 
  2. the company was still running at negative EBITDA and operating cash flow in FY16, and 
  3. it has a constrained balance sheet (net gearing of 161% at end-FY16).
• PACRA also faces an impending S$100m (US$70.9m) bond redemption in Aug 18. 
• Key upside risks include better utilisation, DCRs and asset sales, which could result in earnings recovery in FY17F.

BAKERTECH (Non-rated) - Cash rich, and with a new asset 

• BTL provides specialised equipment and services for the rig industry. Its management team includes industry veteran Dr Benety Chang. 
• According to its 2015 annual report, BTL was constructing one liftboat scheduled for completion by 2H16. BTL’s 1H14 results briefing slides stated that it was considering sale or ownership and charter, with or without partners, for the abovementioned liftboat.
• BTL was in net cash position of S$106.9m at end-FY16 (70.3% of market cap). It currently trades at P/BV of 0.71x vs. historical 2-year average of 0.82x (2015-2016).

Risks 

• Downsides risks to our Sector rating are: 
  1. OPEC abandoning its production ceiling during the year and reverting to over-producing to gain market share (akin to the 2015 scenario), 
  2. Higher-than-expected US production that would undermine market-rebalancing efforts, and 
  3. Larger-than-expected reaction to company defaults in 2017.
• Upside risks are: 
  1. Swifter-than-expected recovery in crude oil prices, 
  2. Instability in one or more OPEC member state (thus reducing OPEC production), and 
  3. Higher-than-expected global GDP growth, which would lift demand

Peer Comparison

Cezzane SEE CIMB Research | LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2017-03-16

CIMB Research SGX Stock Analyst Report ADD Maintain ADD 0.590 Same 0.590

ADD Maintain ADD 0.280 Same 0.280

ADD Maintain ADD 0.450 Same 0.450

REDUCE Maintain REDUCE 0.130 Same 0.130

NOT RATED Maintain NOT RATED 99998.000 Same 99998.000