Malaysia Marine & Heavy Engineering TP: RM4.46 (+15.0%)

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1 A Member of the TA Group MENARA TA ONE, 22 JALAN P. RAMLEE, KUALA LUMPUR, MALAYSIA TEL: / FAX: C O M P A N Y U P D A T E Friday, November 08, 2013 FBM KLCI: 1, Sector: Oil & Gas Malaysia Marine & Heavy Engineering TP: RM4.46 (+15.0%) Ripe for Order Wins THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* Last traded: RM3.90 TA Research Team Coverage ext:1265 kyliechan@ta.com.my Hold We revise our Sell recommendation on MMHE to Hold with TP of RM4.46 based on upgraded multiple of 25x FY14 P/E (previous: 17x). At our TP, MMHE would be trading at FY15 P/E of 23x, and at a 33% discount to its average 3-year historical forward P/E of 38x (Figure 5). We believe the rerating is timely given improved earnings prospects on the back of substantial orderbook uplift in FY14/15. MMHE is a strong contender for major fabrication contracts that are ripe for award after prolonged delays. Furthermore, margin will also receive a boost on the back of: 1) recognition of Change Orders (CO), and 2) cost optimisation on the back of supply chain reforms. (1) ORDERBOOK TURNAROUND Orderbook Momentum Picking Up. MMHE s new order intake in 2013 (YTD: RM2.74bn) for offshore projects is more than triple of what it achieved in the previous year (RM658mn) and significantly higher than 2011 (RM1.8bn). This was on the back of 2 sizeable project wins, namely Malikai TLP (RM1.2bn) and Block SK316 (circa RM1.5bn). The uptick in order momentum is likely to continue over given that MMHE is frontrunner for numerous fabrication projects (Figure 1) that are ripe for award. Figure 1: Potential Projects Wins Project Zetung, Anggerik, & Kezumba (North Malay Basin) Ubon West Sepat Gas Rotan Floating LNG Bokor, Dulang and Semarang, (EOR ) Operator Hess Chevron Petronas Petronas Source: TA Research, Various Estimated Value USD3.0bn USD1.5bn (RM4.7bn) USD1.5bn (RM4.7bn) USD2.5bn (RM7.9bn) Petronas RM3.0bn Requirements WHPs (1 for each field) 20k mt CPP 27k mt CPP, WHPs FLNG Vessel CPPs (1 for each field) Expected Award (1st gas: 2017) 2014 (1st Gas: 2016) 2014 (1st Gas: 2016) 2015 Immediate Catalyst from West Sepat. We believe that MMHE-Technip stands a high chance of securing the USD1.5bn FEED+EPCIC contract for West Sepat, which also saw the submission of bids by SAKP-Saipem and THHE-McDermott earlier in June Although SAKP-Saipem was touted as frontrunner for this multi-platform gas project, we believe that MMHE has greater capacity to undertake this contract given its stronger track record and ample yard space. Given that it would require at least 2 years for fabrication of the platform, we expect this contract to be awarded by 1H14, in-time to meet Phase 1 s targeted 1 st gas by SHARE INFORMATION 3. Listing Code MMHE MK 9. Stock Code 5186 Listing Main Market Share Cap (m) 1,600 Market Cap (RM'mn) 6,240 Par Value (RM) wk Hi/Lo (RM) 4.97/ mth Avg Daily Vol ('000) 1,593 Estimated Free Float (%) 19 Beta 1.0 Major Shareholders (%) MISC Bhd 66.5 Technip SA 8.5 FORECAST REVISION FY13 FY14 Forecast Revision (%) Revised net profit (RMmn) Consensus (RMmn) TA/Consensus (%) Previous Rating Sell(Upgrade) FINANCIAL INDICATORS FY13 FY14 Net Debt/Equity (%) Net Cash Net Cash FCFPS (sen) P/FCF (x) ROA (%) ROE (%) NTA/Share (RM) P/NTA (x) SHARE PERFORMANCE Price chg (%) MMHE FBM KLCI 1 mth mth mth mth (12-Mth) Share Price relative to the FBM KLCI Source: Bloomberg Page 1 of 9

2 Boost from FLNG Sub-Contracts. Results for the FEED stage of the massive USD2.5bn Rotan FLNG with capacity of 1.5mn tpa were announced earlier in June The shortlisted contenders include two consortiums, namely JGC- Samsung Heavy Industries and Toyo Engineering-CB&I-Modec-IHI Shipbuilding. Although local content requirements are not imposed on this highly complex project, Petronas have granted bidders the option to work with MMHE for the fabrication of the vessel. Therefore, we believe it is highly plausible that MMHE may be awarded smaller sub-contracts for fabrication of the FLNG parts such as the external turret. North Malay Basin Projects Still Up for Grabs. MMHE was not prequalified for the Bergading Central Processing Platform (CPP) project in favour of other local yards including SapuraKencana (SAKP) and TH Heavy Engineering (THHE). Nevertheless, MMHE may still grab a slice of the action at the North Malay Basin as Hess will open the design competition for the Zetung, Anggerik, & Kezumba (ZAK) wellhead platforms (WHP) which will be tied-in to the Bergading CPP. Unlike the highly contested Bergading CPP, which attracted international bids (i.e. Norway s Aker Solutions, and Korea s Samsung Heavy Industries), Upstream reported that ZAK will mainly see participation from Malaysian yards. This implies even higher winning chances for MMHE. EOR Fields Delayed but not Shelved. Industry sources confirm that the Bokor, Dulang and Semarang CPP projects have been placed on the back-burner for the time being. This has been the case with most Enhanced Oil Recovery (EOR) projects, including the Angsi Chemical EOR vessel, due to project complexities. However, we understand that project feasibility studies are still fluid at this juncture, and therefore we expect FEED tenders for these projects to be announced within We believe that MMHE stands a high chance of securing 1-2 CPPs given its track record in successfully completing the Tapis EOR project. But Not Upbeat on Ubon. MMHE was shortlisted as one of the eight contenders for Chevron s Ubon project, touted as one of the largest gas projects at the Thai Malaysia Joint Development Area. However, we are not optimistic on MMHE s chances of securing the fabrication contract for this project. This is given stiff competition from acclaimed international names such as Hyundai Heavy Industries (Korea), McDermott (US), Saipem (Italy) and China Offshore Oil Engineering (China). Despite being a wildcard, any new contracts from this project would be a welcome boost to MMHE s order backlog. Low Base for Current Backlog. We estimate that MMHE s current outstanding orderbook (Figure 2) for offshore projects amount to circa RM3.05bn (including the SK316 contract, which MMHE reports to be in excess of RM1bn). This translates to roughly one year s sales visibility for MMHE s offshore segment. A new major project (CPP with WHP and jackets) win worth circa RM1.5bn would expand MMHE s current backlog substantially by 50%. Page 2 of 9

3 Figure 2: Outstanding Orderbook (end-sept 2013) Source: Company Advantage Over Local & Foreign Competitors. Despite an open tender process, MMHE managed to edge out international competitors, including Italy s Saipem, for Malikai TLP and Block SK316. This is in spite of the fact that MMHE s submission was not the lowest-priced bid. In our view, this signifies Petronas affinity for local yards to develop local talent and capabilities. In addition, we believe that MMHE also has an advantage over local peers given its Petronas parentage (owns effective 42% stake in MMHE via 63%-owned MISC Bhd) and superior track record and yard capacity. MMHE is the only local yard that has successfully completed highly complex projects, including: 1) EOR - Tapis, 2) High Pressure-High Temperature (HPHT) - Kinabalu Topside, and 3) deepwater - Gumusut Kakap. Ample Yard Capacity. There is abundant space at MMHE s Pasir Gudang yard, which is the largest fabrication yard in Malaysia (197 acres, 130k mt p.a.) vis-àvis SAKP (273 acres, 100k mt p.a.) and THHE (57 acres, 10k mt p.a.). We estimate that MMHE s yard is able to accommodate up to a total of 6 CPPs at any given time. MMHE s yard will be largely empty by 1H14 given that 3 out of MMHE s 5 projects in hand have reached advanced stages of completion (FPSO Cendor: 96%, Tapis EOR: 89% and Kebabangan Northern Hub: 94%). With the two remaining projects in hand, (Malikai TLP: 26k MT & SK316: 26.4MT), we estimate that MMHE s current yard utilisation is approximately 40%, which implies room for at least 2-3 major CPPs. (II) EARNINGS RECOVERY New Orders will Drive Earnings. Shortage of new orders in 2012, exacerbated by cost overruns and project delays, had resulted in weak earnings (Figure 3) and margin (Figure 4) in FY13 (-5% YTD). Nevertheless, we anticipate that MMHE s earnings will recover in on the back of: 1) recognition of deferred profits from Malikai TLP starting in 1Q14, 2) billings for Block SK316, a fast-track project, which we expect to materialise by 2H14, and 3) recognition of change orders (CO) from completed projects, including FPSO Cendor, Tapis EOR and Kebabangan. To recap, MMHE has been in negotiations with clients since 3Q12 for recovery of costs for additional work done on various projects. We also understand that write-back of these COs can only be recognised postcompletion of a project. We estimate that prior provisions for FPSO Cendor alone amount to a substantial RM50mn. Page 3 of 9

4 Figure 3: Quarterly Earnings Source: Company, TA Research Figure 4: Quarterly Margins Source: Company, TA Research TIP will Drive Efficiency. To recap, back in 2011, MMHE was dealing with an excessive base of more than 200 external subcontractors and vendors, whom were not selected on transparent basis. Given that 50%-70% of MMHE s costs were linked to external parties, this led to razor thin operating margins of 9% and 7% in FY11 and FY12 respectively. Therefore, to rationalize its subcontractor base and restructure its supply chain, MMHE implemented its Transformation Initiative Program (TIP) in We believe that TIP will gradually result in material efficiency gains for MMHE that will provide a much needed boost to margin. New Agreements Spur Competency. In March 2013, MMHE signed framework agreements with 5 key subcontractors on the provision of structural fabrication services. MMHE also inked long-term price agreements with 19 vendors on the supply of piping, electrical, and other materials. Under these agreements, suppliers have to fulfill MMHE s assessment criteria such as value-added services, work execution, timeliness, etc. These agreements enable MMHE to source parts and services at the best cost and quality, in-line with TIP s objectives. Page 4 of 9

5 Impact We made the following changes to our earnings assumptions: 1) pushed forward earnings recognition from Malikai TLP starting from 1Q14 (previous: 4Q14) in-line with management s guidance, 2) reduced FY13 orderbook replenishment to RM3.0bn (previous: RM3.7bn) to approximate 9M13 YTD new order wins of RM2.7bn. This results in a -6%/14%/4% change to our FY13/14/15 forecasts. Valuation We upgrade MMHE to Hold from Sell previously as we revise our target multiple to 25x FY14 P/E (previous: 17x). At our TP of RM4.46, MMHE would be trading at implied FY15 P/E of 23x, and at a 33% discount to its average 3-year historical forward P/E of 38x. We believe that the rerating is timely given enhanced news flow on new projects and earnings recovery. MMHE is a strong contender for local projects on the back of: 1) world class fabrication yard that is the largest in Malaysia, 2) only local yard with experience and track record in completing EOR, HPHT, and deepwater projects, and 3) strong Petronas parentage (42% effective stake). Figure 5: One-year Forward Rolling P/E (x) Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Forward P/E (x) +1SD:48.4x Mean:37.6x -1SD: 26.7x Source: TA Research, Bloomberg Figure 6: Peers Comparison Company Mkt Cap (RM Tgt.Price Upside PE (x) PBV (x) ROE (%) DPS (sen) Dividend Yield (%) Call Price (RM) mn) (RM) (%) CY13 CY14 CY13 CY14 CY13 CY14 CY13 CY14 CY13 CY14 MMHE Hold , Perisai Buy , Pantech Buy Pet Chem Hold , PetDag Sell , (30.8) PetGas Sell , (13.5) SK Petro Buy , Average Page 5 of 9

6 Figure 6: Earnings Summary Income Statememt Balance Sheet FYE 31 Dec (RMmn) 2011* F 2014F 2015F FYE 31 Dec (RMmn) 2011* F 2014F 2015F Revenue 2, , , , ,643.6 Fixed assets 1, , , , ,688.5 EBITDA Prepaid Land Lease Pymt Depreciation (31.6) (57.3) (35.6) (44.8) (54.9) Others Net finance cost Non-Current Assets 1, , , , ,058.2 Share of JCEs 46.8 (25.1) Pretax profit Inventories Taxation (44.9) 25.5 (26.7) (39.0) (42.1) Trade and other rcvb 1, , , , ,928.8 MI (0.3) (1.2) (0.0) (0.1) (0.1) Cash and Deposits 2, , , ,099.9 Net Profit Others * 9M FYE 31 Dec Current Assets 3, , , , ,072.4 Per Share Data Total Assets 4, , , , ,130.6 EPS (sen) Gross DPS (sen) Borrowings Book Value (sen) Deferred tax liabilities Net Tang Asset (sen) Non-current liabilities Ratios Borrowings FYE 31 Dec (RMmn) 2011* F 2014F 2015F Trade & other Payables 1, , , , ,284.7 Valuations Others PER (x) Current Liabilities 2, , , , ,309.4 Dividend yield (%) EV/EBITDA (x) Total Liabilities 2, , , , ,309.4 P/BV (x) P/NTA (x) Share capital FCF Yield (%) Reserves 1, , , , ,016.3 Minority Interests Profitability ratios Equity 2, , , , ,821.3 EBITDA margin (%) EBIT margin (%) Total Equity + Liabilities 4, , , , ,130.7 PBT margin (%) Net margin (%) FYE 31 Dec (RMmn) 2011* F 2014F 2015F ROE (%) Cash Flow Statement ROA (%) Pretax profit Depreciation Liquidity ratios Net Interest (44.0) (40.7) (26.7) (38.3) (39.9) Current ratio (x) JCEs (46.8) 25.1 (2.8) (2.9) (3.0) Quick ratio (x) Working Cap Changes (656.5) Income Tax Paid (16.1) (11.4) (26.7) (39.0) (42.1) Leverage ratios Others 11.5 (4.7) Total Debt/ Assets (x) n.m. n.m. n.m. n.m. n.m. CF from Operations (413.2) Total Debt/Equity (x) n.m. n.m. n.m. n.m. n.m. Net debt(cash)/ Equ (x) Net Cash Net Cash Net Cash Net Cash Net Cash Capex (95.4) (561.0) (338.0) (498.2) (546.5) Interest coverage (x) n.m. n.m. n.m. n.m. n.m. Interest Received Others 23.7 (101.7) Growth ratios CF from Investing (21.4) (622.1) (311.3) (460.0) (506.7) Revenue (%) n.m. 17% -32% 47% 10% EBITDA (%) n.m. -4% -15% 44% 10% Dividends (80.0) (160.0) (160.0) (160.0) (160.0) PBT (%) n.m. -25% 2% 46% 8% Others (3.0) Net Profit (%) n.m. -12% -19% 46% 8% CF from Financing (83.0) (160.0) (160.0) (160.0) (160.0) EPS (%) n.m. -12% -19% 46% 8% Net Cash Flow (1195.3) (229.7) Key Assumptions Beginning Cash 1, , , ,329.6 Order Replenishme(RM mn) 2,950 3,400 3,400 Ending Cash 2, , , ,099.9 Marine Repair Sales Growth (%) 5% 5% 2% * YE 31 Mar /** 9M FYE 31 Dec with EPS and ROE annualized. Page 6 of 9

7 APPENDIX: Ongoing Projects from Recent (Oct 2013) Yard Visit Figure 7: FPSO Cendor Figure 8: Tapis EOR Page 7 of 9

8 Figure 9: Malikai TLP Page 8 of 9

9 Figure 5: Kebabangan Northern Hub Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. for TA SECURITIES HOLDINGS BERHAD(14948-M) MENARA TA ONE, 22 JALAN P. RAMLEE, KUALA LUMPUR, MALAYSIA TEL: / FAX: (A Participating Organisation of Bursa Malaysia Securities Berhad) Kaladher Govindan Head of Research Page 9 of 9