Medserv Charting choppy waters H1 results Industrial support services Medserv s diversification continues to hold it in good stead as offshore drilling programmes flex in the Mediterranean basin. New discoveries and territories could augment growth from next year as drilling activity in existing territories resumes, METS makes a full contribution and price pressures attenuate. While the Portuguese deferral adversely affects FY16, it could enhance our FY17 expectations, which remain unchanged. Year end Revenue ( m) PBT* ( m) EPS* (c) 12/14 32.4 3.1 5.0 4.3 34.0 2.5 DPS (c) P/E (x) Yield (%) 12/15 42.8 6.1 9.7 4.3 17.5 2.5 12/16e 38.1 2.3 4.4 1.1 38.6 0.6 12/17e 49.2 6.6 11.0 4.4 15.5 2.6 Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles and exceptionals. Revenue parameter has been restated see page 3. 26 August 2016 Price 1.7 Market cap 91m US$1.13/ Net debt ( m) at 30 June 2016 47.1 Shares in issue 53.7m Free float 35.1% Code MDS Primary exchange Malta SE Secondary exchange N/A Share price performance Market pressures continue in H1 H116 has seen lower activity and pricing in the ongoing base support activities, partly offset by management cost reduction measures and an in line maiden fourmonth contribution from the recent METS acquisition. As previously disclosed and despite the macro environment, the Malta base remained busy. Activity in Cyprus was much lower following the temporary suspension of ENI Cyprus s drilling programme and the mothballing of the facility at Larnaca in H1. Overall Medserv traded at just above break-even at the profit before tax level during the period. Portugal drilling delay lowers H2 expectations The delay by the Portuguese government of ENI s drilling programme defers over 3m of revenues from H216. Given the uncertainty created, we have removed the revenues and profits from our forecast. Medserv is hopeful drilling will start in H117. METS continues to meet plans, and while the Medserv base activities continue to face adverse market conditions, some sequential improvement is expected in H2. Reflecting these factors, management has lowered its 2016 revenue expectations by 14% to 38m from 44m, with a commensurate impact on profitability. We have reduced our EBITDA estimate by 25%. Prospects for 2017 strengthening FY17 estimates at present are unaltered. Apart from the potential for ENI s Portuguese drilling programme to reactivate, prospects across the group remain encouraging. Recent finds in the eastern Mediterranean are expected to increase activity offshore both Cyprus and Egypt next year. METS should also see continued growth driven by Oman. Trinidad & Tobago, Egypt and Iran also offer potential for increased activity, as does the offer of OCTG services across Medserv s bases Valuation: Room for recovery Despite the near-term reduction in cash flows, our DCF-based valuation stands at 1.90 per share. While the macro backdrop remains unhelpful, Medserv continues to pursue opportunities that could enhance this further. % 1m 3m 12m Abs (7.6) (2.9) 34.3 Rel (local) (6.8) (0.1) 28.0 52-week high/low 3.07 1.27 Business description Medserv is a Malta-based provider of integrated offshore logistics and services in support of drilling operations in the Mediterranean. The acquisition of the METS companies in February 2016 diversified the company into onshore steel tube stockholding and servicing for countries in the Middle East. Next events Q3 update November 2016 Analysts Andy Chambers +44 (0)20 3681 2525 Roger Johnston +44 (0)20 3077 5722 industrials@edisongroup.com Edison profile page Medserv is a research client of Edison Investment Research Limited
FY16 first-half results Highlights Shore base logistics activity reduced sharply as expected especially in Cyprus, which was extremely busy in H115 Pricing pressures persisted across the activities as IOC customers sought to control costs METS Oil Country Tubular Goods (OCTG) services performed in line with expectations Portuguese drilling programme deferred by government from H2 until at least 2017 Current year revenue forecast reduced by 14% to 38m Activity expected to increase offshore Libya and Cyprus in 2017 Opportunities in Trinidad & Tobago, Egypt, Cyprus, Oman and Iran expected to progress in H2 Exhibit 1: Financial summary m H115 H116 Change Shore base logistics (Medserv ongoing) 26.93 10.59-60.7% Oil Country Tubular Goods (METS) 6.45 Photovoltaic farm 0.28 0.27-5.4% Group revenues 27.21 17.30-36.4% EBITDA 6.56 3.35-49.0% Depreciation (1.28) (1.70) Operating profit (adjusted) 5.28 1.65-68.8% PPA amortisation (0.56) Operating profit (reported) 5.28 1.09 Exceptional 0.53 Finance costs (0.78) (1.34) Profit before tax (adjusted) 4.50 0.31-93.1% Profit before tax (reported) 4.50 0.28 Net income (ongoing adjusted) 3.23 0.25-92.2% Net income (ongoing reported) 3.23 0.22-93.2% Net debt 25.16 47.13 87.3% Source: Medserv report. Note: Adjusted excludes PPA amortisation and exceptionals. Pressures on shore base activity Revenues in H1 fell by 36%, due to a 61% decrease in shore-based logistics activity. The majority of the 16m decline was a very low level of activity in Cyprus, with the Larnaca facility mothballed from the beginning of May. This compared to a very active period in the prior year as ENI Cyprus executed its drilling programme. Malta and Libya also faced revenue declines, in large part due to the price reductions being sought by customers to mitigate costs in the face of the adverse operating environment in oil and gas markets. While Medserv management worked hard to reduce costs, these factors nevertheless affected gross margins during the period. The operating margins are also being affected by development costs associated with new bid activity, which is an indicator of a strengthening contract pipeline. METS initial contribution as expected Management has now completed the purchase price allocation (PPA) exercise for the METS acquisition, creating 15.8m of fixed intangible assets and goodwill of just 2.2m. The PPA intangibles are amortised over periods of 10 years or fewer. The associated amortisation is a noncash item, so we adjust our operating profits, profit before tax and earnings to exclude it. We include the charge as an exceptional item in our model. METS generated 6.5m of revenues in its first four months of consolidation, generating operating profit of 0.93m, a margin of 14%, depressed by performance in Iraq. Demand for OCTG goods and services in Oman continued to grow strongly during the period, with the UAE operations Medserv 26 August 2016 2
recovering towards the period end and returning to profitability. However, Iraq remained difficult despite a year-on-year increase in oil production, hence management is adjusting the cost base to reflect lower volumes. Financials Following the acquisition of METS, net debt increased to 47m at the half year, with gross cash standing at 7m reflecting the residual balances of METS when acquired. Working capital saw outflows during the first half, with some significant outstanding receivables. We expect these to have been recovered early in the second half of the year. Therefore, despite the lower profit expectation for the current year, we expect net debt at the year-end to be little changed from previous forecasts. No dividend was declared at the half year although an interim may still be announced with the Q3 results. Given the shortfall on previous expectations and following the completion of METS, we now feel Medserv may seek to protect capital in the current climate and, as a result, may reduce the current year pay-out ratio temporarily from the 40% level. We therefore have assumed a 25% payout level for the total 2016 dividend before reverting to 40% as earnings recover in 2017. It should be noted that the company is changing the treatment of the income from the photovoltaic farm at the Malta base. As a separate segment in reporting this will now be recognised as revenues rather than other operating income. Our previous estimates have been adjusted to reflect the move. Exhibit 2: Medserv earnings estimates revisions Year to December ( m) 2016 2017 Prior New % change Prior New % change Revenues 44.4 38.1-14.2% 49.2 49.2 0.0% EBITDA 11.3 8.5-24.8% 14.3 14.3 0.0% Depreciation (4.3) (3.6) -16.2% (4.9) (4.9) 0.0% EBITA 7.0 4.9-30.1% 9.4 9.4 0.0% PPA amortisation (1.4) (1.7) EBIT reported 7.0 3.5-50.3% 9.4 7.7-18.2% Underlying PBT 4.3 2.3-47.7% 6.6 6.6 0.0% EPS - underlying continuing (cents) 8.5 4.4-48.2% 11.0 11.0 0.0% DPS (cents) 3.4 1.1-67.6% 4.4 4.4 0.0% Net debt 42 42-1.6% 39.2 40.6 3.6% Source: Edison Investment Research.. Revenue parameter has been restated to include photovoltaic farm Update on Medserv opportunities Portugal drilling deferred Somewhat late in the day, the Portuguese government has responded to environmental concerns with respect to offshore drilling some 40km off the Algarve coast. To confirm the drilling licence awarded to ENI for an offshore well, a new environmental audit has been ordered. The result is that drilling of one wildcat well in the Atlantic that had been expected in Q416, and for which ENI was preparing, has been delayed to least into 2017. The decision defers over 3m of revenues from H216. The three-month drilling programme may commence in H117 but given the uncertainty created, we have removed the drilling revenues and profits from our forecasts. The proposed 90-day drilling programme had been a significant part of current year revenue expectations for Medserv, having created a pop-up base facility using assets transferred from Cyprus. ENI is maintaining payments for the base awaiting further developments. Medserv 26 August 2016 3
Malta contract renewed for another two years At the beginning of August Medserv announced the renewal of the support contract for a major IOC operating offshore Libya for a further two years. Linked to the Bahr Essalam gas field development, the contract helps to underpin activity levels in Malta, with a number of contractors supporting the project expected to use Malta for operations. In addition, Medserv has bid in a renewal tender for an existing customer. Together with current contracts, these developments improve the prospects for revenue development in Malta, which we expect to start recovering in H2 and to step up further in 2017. Prospects for drilling offshore Cyprus progress Prospects for a revival of activity in Cyprus next year have been enhanced by the extension of ENI s drilling licence earlier in the year and the one-year renewal of Medserv s port operation licence at Larnaca, which now runs to the end of August 2017. The latter allows operations to recommence when required, having been mothballed since May. Following talks with the Cypriot authorities, ENI Cyprus indicated in early July that it intends to restart drilling on its existing licences in 2017. A tender for base support operations for a second oil major to start drilling offshore Cyprus has also been submitted. In addition, the third round of licence bidding for Cypriot blocks has seen significant interest following the recent proximate field discoveries. ENI, Total, Statoil, Exxon Mobil, Qatar Petroleum and Cairn have all expressed interest in the licensing round. Other potential offshore opportunities The result of the tender to an IOC for an onshore base in Trinidad & Tobago is expected in the third quarter. If successful, the bid would mark a significant international expansion and provide validation of Medserv s credentials and model. In turn, this could lead to participation in other international tenders for base support. Egypt has seen further major offshore gas discoveries in 2016 and, with ENI committed to developing its Zohr field activities, Medserv is actively pursuing opportunities to support its activity. Management expects this to develop further during the second half of the year. Medserv also indicates in its interim statement that, benefiting from METS s position in Oman, it has bid to provide shore-based logistics for an offshore exploratory drilling programme in the country. METS s strong Oman performance to continue Trading for the Oman arm of METS has continued to strengthen, and significant growth is expected both this year and next. Encouragingly, the UAE operation has returned to profit in H116. The situation in Iraq remains constrained by administrative inertia as recovery terms in contracts between the concession holders and the government are being renegotiated. As a result, Medserv management is implementing a cost-saving programme to address the low volumes while maintaining longer-term capability. Overall METS continues to meet expectations, and a full six-month contribution will benefit H216, with a full year contribution also enhancing FY17. Synergy potentials between the traditional shorebase operations of Medserv and the OCTG services of METS are also progressing. Management succession and reorganisation The board has approved a significant change in executive responsibilities. The roles of the two principal director shareholders, Anthony Diacono and Anthony Duncan, have been adjusted. Mr Diacono will become group CEO as well as maintaining his role as chairman. Mr Duncan will Medserv 26 August 2016 4
maintain his responsibility for finance, but will also incorporate the new and increasingly important role of compliance. To provide a progressive succession at the company, Karl Bartolo, the current CFO, has been appointed chief executive designate with a view to him assuming the role in three years time. He has been with Medserv since 2008 and in recent years has become increasingly involved with the commercial elements of its activities. Godwin Borg has been appointed to the board and has signed a two-year consultancy agreement with Medserv, relinquishing his role of COO, which is being abolished. Instead three regional heads will serve the Mediterranean, the Middle East and other International. The reorganisation aligns management responsibility and accountability more closely with regional activity as the opportunities for Medserv continue to expand globally. Valuation Our capped DCF currently returns a value of 1.90 per share using a WACC of 7.9% and terminal growth rate of zero. The WACC has reduced slightly due to the modestly higher proportion of debt funding than we previously expected. The sensitivity of this value to differing assumptions for the WACC and terminal growth rate is shown below, with the closest value to our calculated assumption highlighted. Exhibit 3: Capped DCF sensitivity analysis to WACC and terminal growth rate ( /share) WACC Terminal growth 6% 7% 8% 9% 10% 11% 15% 0% 2.84 2.28 1.87 1.55 1.29 1.08 0.52 1% 3.43 2.69 2.16 1.77 1.46 1.21 0.58 2% 4.33 3.26 2.56 2.05 1.67 1.37 0.65 3% 5.81 4.12 3.10 2.43 1.94 1.58 0.73 Source: Edison Investment Research estimates Medserv 26 August 2016 5
Exhibit 4: Financial summary m 2014 2015 2016e 2017e Year end 31 December IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 32.4 42.8 38.1 49.2 Cost of Sales (23.2) (27.2) (25.3) (31.4) Gross Profit 9.2 15.5 12.8 17.8 EBITDA 5.9 10.3 8.5 14.3 Operating Profit (before amort. and except.) 4.2 7.6 4.9 9.4 Intangible Amortisation 0.0 0.0 0.0 0.0 Exceptionals (0.0) (0.1) (0.9) (1.7) Other (0.1) (0.2) 0.0 0.0 Operating Profit 4.1 7.3 4.0 7.7 Net Interest (1.1) (1.5) (2.6) (2.8) Profit Before Tax (norm) 3.1 6.1 2.3 6.6 Profit Before Tax (FRS 3) 3.0 5.8 1.4 4.9 Tax (0.9) (1.3) 0.1 (0.5) Profit After Tax (norm) 2.3 4.8 2.4 6.0 Profit After Tax (FRS 3) 2.2 4.5 1.5 4.4 Average Number of Shares Outstanding (m) 46.1 46.1 52.9 53.7 EPS - normalised (c) 5.0 9.7 4.4 11.0 EPS - normalised and fully diluted (c) 5.0 9.7 4.4 11.0 EPS - (IFRS) (c) 4.2 8.9 2.7 8.1 Dividend per share (c) 4.3 4.3 1.1 4.4 Gross Margin (%) 28.4 36.3 33.5 36.2 EBITDA Margin (%) 18.1 24.0 22.4 29.1 Operating Margin (before GW and except.) (%) 13.0 17.8 12.9 19.2 BALANCE SHEET Fixed Assets 23.3 24.0 49.5 46.4 Intangible Assets 0.0 0.0 16.6 14.9 Tangible Assets 23.3 24.0 32.9 31.4 Investments 0.0 0.0 0.0 0.0 Current Assets 57.5 57.1 65.9 72.7 Stocks 0.0 0.0 0.2 0.3 Debtors 13.4 12.2 14.5 18.7 Cash 1.1 1.0 9.4 11.4 Other 43.0 43.9 41.7 42.3 Current Liabilities (15.3) (13.3) (5.7) (7.3) Creditors (10.4) (9.5) (5.7) (7.3) Short term borrowings (4.9) (3.8) 0.0 0.0 Long Term Liabilities (56.1) (56.7) (85.3) (85.3) Long term borrowings (21.1) (22.4) (51.2) (52.0) Other long term liabilities (35.0) (34.3) (34.0) (33.2) Net Assets 9.5 11.1 24.4 26.5 CASH FLOW Operating Cash Flow (1.7) 10.4 7.5 8.7 Net Interest (1.1) (1.5) (2.6) (2.8) Tax (0.9) (1.3) 0.1 (0.7) Capex (13.4) (3.8) (0.5) (3.4) Acquisitions/disposals 0.0 (2.6) (31.6) 0.0 Financing (0.2) 0.5 12.4 0.0 Dividends (0.7) (2.0) (1.9) (0.6) Net Cash Flow (18.0) (0.3) (16.6) 1.2 Opening net debt/(cash) 6.9 24.9 25.2 41.8 HP finance leases initiated 0.0 0.0 0.0 0.0 Other 0.0 (0.0) 0.0 (0.0) Closing net debt/(cash) 24.9 25.2 41.8 40.6 Source: <Insert Source or Notes> Source: Medserv reports, Edison Investment Research estimates. Note: Revenue parameter has been restated to include photovoltaic farm. Medserv 26 August 2016 6
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Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE s express written consent. Frankfurt +49 (0)69 78 8076 960 Medserv Schumannstrasse 34b 26 August 2016280 High Holborn 245 Park Avenue, 39th Floor Level 25, Aurora Place Level 15, 171 Featherston St 7 60325 Frankfurt Germany London +44 (0)20 3077 5700 London, WC1V 7EE United Kingdom New York +1 646 653 7026 10167, New York US Sydney +61 (0)2 9258 1161 88 Phillip St, Sydney NSW 2000, Australia Wellington +64 (0)48 948 555 Wellington 6011 New Zealand