Deleum Berhad. Initiate with BUY Target Price (TP): RM1.36

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1 05 July 2016 Initiate Coverage Deleum Berhad Steady earnings in spite of tough environment INVESTMENT HIGHLIGHTS Initiate coverage on Deleum Berhad with BUY recommendation and TP of RM1.36 per share Deleum specialises in upstream oil and gas services covering small gas turbines, slicklines and corrosion solutions Offers attractive dividend payout and commendable dividend yield >5% Prevailing share price valuation of 7.8x PER undemanding with attractive potential capital gains and dividend yield Company businesses. Deleum Berhad is an upstream oil and gas service provider specialising in three core segments namely: (i) Power & Machinery; (ii) Oilfield Services; and (iii) Integrated Corrosion Solution. The Power & Machinery division offers total life cycle support for gas turbines from initial turnkey projects to aftersales maintenance repair and overhaul solutions. The Oilfield Services on the other hand offers slickline equipment and services which includes wellhead maintenance, downhole services and chemical solutions. The Integrated Corrosion Solution offers corrosion management, corrosion prevention and minor fabrication works. Key investment theses: Commendable earnings. Despite operating in a very challenging environment as an upstream oil and gas services provider, the company has managed to remain profitable growing at a compound annual growth rate of +10% over the past five years. Attractive dividend payouts and yield. The company has been consistently distributing approximately 50% of its net profit as dividends, offering a potential dividend yield of >5%. Healthy orderbook and contract visibility. Deleum s healthy orderbook of RM2.95b provides contract and earnings visibility to The large portion of the orderbook mainly consist jobs from the Power & Machinery segment. Tenderbook stands at RM300m. Initiate coverage with BUY. We are initiating coverage on Deleum Berhad with a BUY recommendation on a target price of RM1.36 per share. Our target price is based on EPS17 of 13.6sen pegged to PER17 of 10x. Our target PER17 is based on its five year historical average rolling PER. At peak valuation, the stock traded at PERs in excess of 18x. RETURN STATS Price (4 th July 2016) Target Price Initiate with BUY Target Price (TP): RM1.36 RM1.07 RM1.36 Expected Share Price Return +27.1% Expected Dividend Yield +6.1% Expected Total Return +33.2% STOCK INFO KLCI 1, Bursa / Bloomberg Board / Sector Syariah Compliant 5132 / DLUM MK Main / Trading Services Yes Issued shares (mil) Par Value (RM) 0.50 Market cap. (RM m) Price over NA wk price Range RM0.90-RM1.40 Beta (against KLCI) mth Avg Daily Vol 0.19m 3-mth Avg Daily Value Major Shareholders (%) RM0.23m Lantas Mutiara Sdn Bhd Hartapac Sdn Bhd Nathan Vivekananthan Mustaffa Zaiton 8.05 MIDF RESEARCH is a unit of MIDF AMANAH INVESTMENT BANK Kindly refer to the last page of this publication for important disclosures

2 KEY INVESTMENT THESES Revenue. Deleum s revenue has been growing at a compounded annual growth rate (CAGR) of +10.4% for the past five years. Such growth rates can be attributed to the Power and Machinery (P&M) segment which is the largest revenue contributor at 71.7% of total revenue in FY15. This is followed by the contribution from Oilfield Services (OS) and Integrated Corrosion Solution (ICS) at 21.3% and 7.0% of total revenue respectively. As for segmental revenue growth, the P&M segment has grown at a 5-year CAGR of 8% that was mainly contributed by its aftermarket sales and services being driven by its integrated facility centre in Senawang. Commendable earnings. As for earnings, Deleum recorded a robust 5-year CAGR of +9.3%. Despite tough operating environment stemming from low oil prices that led to a sluggish O&G capex rollout, Deleum still maintained to sustain its earnings for the past two years (FY14:RM59.3m; FY15:RM45.7m). This can be attributed to Deleum s deliberate decision to increase the number of operational slicklines even though operating environments was tough in FY14/15. As a result, Deleum has been able to take 50% of Malaysia s slickline market. In the same year, the maintenance, repair and overhaul (MRO) segment was renamed to ICS and the results of Deleum Rotary Services Sdn. Bhd. ( DRSSB ) were reclassified to P&M segment. Consequently, this enhanced the operating profit of the P&M segment and stabilised ICS s operating profit. We expect this to bode well for Deleum s earnings sustainability in the coming future. Manageable gearing. Deleum s balance sheet has been maintained in a modest manner reflected by gearing ratios ranging from 0.09x to 0.14x for FY2011 to FY2013, giving sufficient headroom for capex. This translated to the huge spike in gearing in FY2014 from 0.12x to 0.57x due to the term loan taken to cater mainly for the purchase of slickline equipment for the Pan Malaysia Slickline contracts. Historically, Deleum s business is not excessively capital intensive. Gearing in FY15 is lowered to 0.47x which is still at a manageable level resulting in a high level of net cash. This decrease in gearing ratio is due to the repayment of borrowings by Deleum Oilfield Services Sdn. Bhd. (DOSSB) to fulfil the Pan Malaysia Slickline contracts capital requirements. FY16 onwards, we are estimating the gearing to be maintained at a reasonable level of 0.3x to 0.4x as management guided that capex budgeted for FY16 would roughly be same as FY15. Given that, Deleum would be able to grow their cash balance which could be utilized for upcoming projects in the future. Table 1: Capex (RM m) Year FY11 FY12 FY13 FY14 FY15 Capex (RM'm) Consistent dividend payout. For the past 5 years, Deleum s dividend payouts have been steady at ~50%. The latest payout was 3.5sen single-tier dividend in 3QFY15 which gives a net payout ratio of 48%. Moving forward, we are expecting Deleum to maintain payout ratios around 50% which at current price levels, should provide investors with a dividend yield of >5% per annum. This is underpinned by capex that is expected to be roughly the same as FY2015 since capex was at its highest level in FY2014. Interestingly, the dividend yield is one of the highest in the upstream oil and gas service providers. For the past 5 years, Deleum s stock has recorded an average dividend yield of 6.01% which exceeds the risk-free rate in Malaysia (based on the 5-year Malaysian Government Securities yield). Table 2: Dividend payouts Year FY11 FY12 FY13 FY14 FY15 FY16F FY17F FY18F Dividend per share (sen) Dividend yield (%) Payout Ratio (%) Risk free rate (%) n.a. n.a. n.a. *Based on year-end price **Based on 5-year Malaysian Government Securities yield (end of year) 2

3 3 Orderbook and earnings visibility. Deleum s current orderbook stands at approximately RM2.95b with a burnrate till The large portion of the orderbook consists of long term contracts providing healthy long term earnings visibility. Notable long term contracts. Back in 2013, Deleum received a contract award from Petronas to provide aftermarket turbomachinery maintenance services for Solar Turbines Incorporated s gas turbines in Malaysia. The tenure of the contract was for seven years with a three year extension option until The contract covers approximately 300 gas turbine packages in the range of 1 to 15 megawatts. In the same year, the company also clinched awards from various production sharing contractors (PSC) operators under a joint tender exercise for the provision of slickline equipment and services for PSC operators drilling programmes and production operations. The duration of these slickline contracts is for a term of five years. Approximately 53 slicklines have been deployed with a utilisation rate of between % at a given time. Table 3: Orderbook value No. Contracts Expiry year 1 Supply of Packers and Tubular Accessories Supply of Sand Detector and Monitoring Systems Provision of Painting and Alternative Blasting Thermo-chemical Solid Deposition Treatment Technology Provision of Integrated Wellhead Maintenance Services Supply of PDC & Rock Bits Supply & Services for Casing Centralizer Equipment Provision of Slickline Equipment & Services Provision of Well Control Services Long Term Service Agreement for Gas Turbine Supply of Gas Turbine Packages 2023 Total contract outstanding value RM2.95b Figure 1: Revenue (RM m) Positive 5-year CAGR attributed to the P&M segment underpinned by strong aftermarket sales services.

4 4 Figure 2: Segmental breakdown of revenue Power and Machinery segment remains biggest contributor to revenue for the past 5 years. Figure 3: PATAMI (RM m) Earnings for the past two years since the oil price slump is a strong testament of the company s ability to sustain earnings despite operating in a difficult environment. Figure 4: Gearing (RM m) Gearing ratio to be maintained at reasonable levels moving forward with ample amount of cash.

5 5 KEY RISKS Share price weakness from broad-base negative sentiments on industry. Although the company s earnings are resilient towards movement in oil prices, an unexpected slump may pose as a threat to Deleum. The reason being is that such unexpected movements in oil price could be aggravated by a bearish sentiment for the whole industry. As a result, investors may avoid companies related to oil and gas such as Deleum despite their commendable earnings during tough market conditions. This in turn can affect Deleum s share price which will affect its attractiveness as an oil and gas service provider. Lower dividend payout. Should there be any M&A opportunities that arise, the company may not be able to sustain their consistent dividend payout at ~50%. Sluggish capex roll out by industry players. An unexpected movement in the oil price may also trigger oil production players to cut their capex rollout as they are reluctant to loosen their purse strings. This scenario may prolong unless confidence on long term recovery of oil prices is brought about among industry players. VALUATION Resilient earnings in the midst of difficult environment. Deleum s earnings for the past two years (FY14: RM59.3m; FY15: RM45.7m) since the oil price slump is a strong testament of the company s ability to sustain earnings despite operating in a difficult environment. The company orderbook is still strong, currently at approximately RM2.95b lasting through to 2023 for its long term service agreements. Apart from that, the company has been capable of distributing around ~50% of its net earnings as dividends all these many years and is still expecting to do so partly due to its strong cash position the expected dividend yield is above >5%. Current trading price offers potential upside. At current market prices, Deleum is trading at a price-toearnings (PER) ratio of 9x. The stock has been trading in the narrow band of 8-12x for the past nine months. In addition, the stock has also been trading at a price-to-book (PB) ratio of 1.5x this is undemanding compared with the period when it was trading at a PBR in excess of 2.5x during 1H15. We believe that the company has the potential to trade at higher valuations given its recurring income from the power and machinery segment along with the strong orderbook. Initiate with BUY. Given the company s reliable recurring income, consistent dividend payouts with commendable dividend yield and strong orderbook, we are initiating Deleum with a BUY recommendation on a target price of RM1.36 per share. Our target price is based on EPS17 of 13.6sen pegged to PER17 of 10x. Our target PER17 is based on its 5-year historical average rolling PER. At peak valuation, the stock traded at PERs in excess of 18x.

6 SUMMARY OF FINANCIAL STATEMENT Income Statement (RM m) F 2017F 2018F Balance Sheet (RM m) F 2017F 2018F Revenue PPE Gross Profit Others Operating Profit Non-current Asset Profit Before tax Inventory Tax expense Receivables Net Profit Others Earnings per share (sen) Cash Dividend per share (sen) Current Asset PER (x) TOTAL ASSETS Share capital Cash Flow Statement (RM m) F 2017F 2018F Reserves PBT Others (53.0) (52.5) (52.5) (52.5) (52.5) Depreciation Shareholder's Fund Finance cost NCI Tax TOTAL EQUITY OP before in WC Borrowings in inventory Others in receivables Non-current liabilities in payables Payables Cash from Ops Borrowings Interest expenses Others Tax Current liabilities Cash from Operations TOTAL LIABILITIES Puchase of PPE Others Ratios F 2017F 2018F Cash from Investment Profitability ratios (%) Return on Equity Net Borrowings Return on Assets Others Liquidity ratios (x) Dividends Current ratio Cash from Financing Quick ratio Net debt-to-equity in cash Profit margin (%) FOREX & Disposals Gross margin Beginning cash PBT Margin Ending Cash Net profit margin Source: MIDFR 6

7 7 DAILY PRICE CHART Aaron Tan Wei Min

8 8 APPENDICES Company background. Deleum Berhad ( Deleum ) was listed on the Main Board of Bursa Malaysia on 1 June 2007 after it went public the year before. Prior to that, Deleum Sdn Bhd was established in November Deleum is an investment holding company and through its subsidiaries, provides a diverse range of supporting specialized products and services to the oil and gas industry, particularly in the exploration and production sector. As at 4 July 2016, the market capitalization of Deleum stands at RM428m. Figure 5: Deleum s organizational structure Source: MIDFR, Company

9 9 Company History Deleum s venture into the oil and gas industry dates back to the year 1982 when its wholly owned subsidiary, Deleum Services Sdn Bhd established itself as a service company. Over the years, Deleum has evolved from a product oriented business to an integrated solutions Provider. This was made possible via various joint ventures between Deleum and other industry players. Starting of with a partnership with Camco Inc. to establish the provision of slickline services, Deleum has managed to strike a JV with Solar Turbines International Company (STICO) via STICO s equity participation Turboservices Overhaul Sdn Bhd in Deleum Berhad s Main Businesses Deleum has three main business segments namely, Power and Machinery (P&M), Oilfield Services (OS) and Integrated Corrosion Solution (ICS). Power and Machinery (P&M) The main divisions of P&M include oil and gas turbomachinery, provision of MRO (maintenance, repair and overhaul) and valves and flow regulator services. The oil and gas turbomachinery division provides total life cycle support for gas turbine packages. Being the revenue driver of the P&M segment, this division is backed by an integrated facility centre located in Senawang that supports its aftersales services. Besides providing gas turbine overhaul and repair services, the centre also functions as a regional training centre that is equipped with advanced simulators and training skids. The provision of MRO is operated by its subsidiary, Deleum Rotary Services Sdn Bhd ( DRSSB ) with focus on services covering mechanical equipment, electrical equipment and specialized products. The division is supported by highly skilled workers certified by the International Electrotechnical Commission Explosive (IECEX). For the valves and flow regulator services division, the division has expanded to provide total valve management activities for the oil and gas industry. Its subsidiary, Penaga Dresser Sdn Bhd ( PDSB ) formed via the joint venture between Deleum and Dresser Inc., is the sole agent of the Dresser products on control valves, regulators and safety relief valves for the Malaysian market. Services offered by PDSB include support services for control valves, diagnostic services via Electronic Valve Testing (EVT), refurbishment of control valves and training on products and services related to control valves. Oilfield Services The OS segment mainly focuses on upstream activities which is predominantly in the sub-surface section. Main activities include the provision of slickline equipment and services, integrated wellhead maintenance services, asset integrated solutions, and integrated chemical solutions. Deleum s slickline services with a wide array of running tools such as Memory Production Logging Tools (MPLT), Multi-finger Imaging Tools (MIT) and Multiple Array Production Suite (MAPS). With Deleum s dedicated workshop, personnel and storage facility, Deleum is able to provide preventive and corrective maintenance on all types of wellheads. The integrated nature of Deleum s wellhead maintenance services comprises of data and well history management, the capability of extending maintenance services up to header ball valves, providing full failure analysis report and critical spare parts management. The Asset Integrated Solution (AIS) unit covers aspects such as well stimulation, well enhancement, early production facility and idle well reactivation. Established in 2013, the AIS unit undertook the Well Enhancement Project in 2014 and was completed in mid The study involved detailed well data analysis by Deleum s geoscience team to assist oil companies in maintaining well performance and providing solutions to enhance well production. Deleum s Integrated Chemical Solutions is operated by Deleum Chemicals Sdn Bhd ( DCSB ). DCSB is a research

10 10 oriented company that provides solution to challenging and demanding chemical solutions in oil and gas industry. Strategic alliances are form by DCSB with reputable suppliers in order to package superior solution to clients. For instance, DCSB entered into a Joint Commercialisation Agreement with Petronas Technology Ventures Sdn Bhd to under commercialization activities of SolidClenz on 3 November Integrated Corrosion Solution The ICS segment is involved in the provision of services related to integrated corrosion, inspection and mitigation in the oil and gas industry. This segment was formerly known as the Maintenance, Repair and Overhaul (MRO) segment until In the same year, the MRO segment was reclassified under the P&M segment. Operated by Deleum Primera Sdn Bhd ( DPSB ), the segment is involved. DPSB also acts as the sole distributor of Sponge-Jet technology relatd products for surface preparation works in Malaysia, Indonesia, Singapore, Brunei, Turkmenistan and Iraq. Apart from that, DPSB has ventured into Rust and Paint Removal (RPR) technology, a paint and coating removal method by controlled induction heating.

11 11 MIDF RESEARCH is part of MIDF Amanah Investment Bank Berhad ( X). (Bank Pelaburan) (A Participating Organisation of Bursa Malaysia Securities Berhad) DISCLOSURES AND DISCLAIMER This report has been prepared by MIDF AMANAH INVESTMENT BANK BERHAD (23878-X). It is for distribution only under such circumstances as may be permitted by applicable law. Readers should be fully aware that this report is for information purposes only. The opinions contained in this report are based on information obtained or derived from sources that we believe are reliable. MIDF AMANAH INVESTMENT BANK BERHAD makes no representation or warranty, expressed or implied, as to the accuracy, completeness or reliability of the information contained therein and it should not be relied upon as such. This report is not, and should not be construed as, an offer to buy or sell any securities or other financial instruments. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. All opinions and estimates are subject to change without notice. The research analysts will initiate, update and cease coverage solely at the discretion of MIDF AMANAH INVESTMENT BANK BERHAD. The directors, employees and representatives of MIDF AMANAH INVESTMENT BANK BERHAD may have interest in any of the securities mentioned and may benefit from the information herein. Members of the MIDF Group and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein This document may not be reproduced, distributed or published in any form or for any purpose. MIDF AMANAH INVESTMENT BANK : GUIDE TO RECOMMENDATIONS STOCK RECOMMENDATIONS BUY TRADING BUY NEUTRAL Total return is expected to be >15% over the next 12 months. Stock price is expected to rise by >15% within 3-months after a Trading Buy rating has been assigned due to positive newsflow. Total return is expected to be between -15% and +15% over the next 12 months. SELL TRADING SELL Total return is expected to be <15% over the next 12 months. Stock price is expected to fall by >15% within 3-months after a Trading Sell rating has been assigned due to negative newsflow. SECTOR RECOMMENDATIONS POSITIVE NEUTRAL NEGATIVE The sector is expected to outperform the overall market over the next 12 months. The sector is to perform in line with the overall market over the next 12 months. The sector is expected to underperform the overall market over the next 12 months.