This article first appeared in The Edge Financial Daily on September 13, 2018

Bumi Armada Bhd
(Sept 12, 55.5 sen)
Maintain buy with an unchanged target price (TP) of 66 sen: Bumi Armada Bhd announced that it had received the final acceptance certificate for floating production storage and offloading unit (FPSO) Kraken. This is in line with management’s timeline shared during the second quarter of financial year 2018 (2QFY18) analyst briefing.

The positives from this acceptance is that earnings and cash flow certainty will be enhanced. The key focus moving forward is to rectify the remaining Kraken equipment, as production is not at optimum capacity yet. Longer-term positives hinges on the quantum of impairment write-back, which depends on the speed of the rectification works done.

The final acceptance of FPSO Kraken was completed in accordance with the amended agreement 2 (AA2) signed on Aug 27, 2018. This milestone would see Bumi Armada recognising the full bareboat charter (BBC) rate under the finance lease (FL) accounting treatment by end-2018.

However, this rate as we understand has been revised lower in the recently signed AA2, albeit still higher than the current rate Kraken is recognising, which is a positive. FL accounting would generally see a higher earnings and cash flow as a result of the final acceptance.

On the balance sheet side, the Kraken RM1.95 billion debt, which was previously reclassified from long-term to short-term (due to the miss in the previous acceptance timeline), is in the midst of negotiation for reclassification back to long-term.

FPSO Kraken was producing at an average 31,000 barrels per day (bpd) of oil in the first half of 2018 (1H18). The production level has subsequently improved to 33,000bpd in July and 36,000bpd in August. EnQuest has completed the subsea infrastructure installation and will be starting its DC4 campaign in 4QFY18 to further ramp up production, and is on track to achieve 50,000bpd target in 2019.

The nature of the recent impairment was a result of the potential impact of the client continent liability across FPSO Kraken’s contract tenure in the event that Bumi Armada fails to rectify the vessel specification. From our understanding, the rectification will take about one to two years, and no actual cash outflow will take place until the rectification has been completed.

The amount of write-back depends on how quickly Bumi Armada can modify the specification of FPSO Kraken. No capital expenditure guidance for this has been disclosed.

In our previous report dated Aug 30, 2018 we had already cut our FY18 estimate (FY18E) to FY20E earnings by 20% to 25%, taking into account the lower FPSO Kraken BBC rate. Nevertheless our FY18 forecast is still significantly above the street’s as we chose to add back the US$25 million penalty payable to EnQuest that will be incurred in 2018, which we deemed as a one-off.

In our view, the current share price has already factored in the worst-case scenario and fully prices in the impairment charge. We believe the stronger earnings and cash flows will rerate the stock in the coming quarters. Further rerating hinges on the impairment write-back, which ultimately depends on the completion of the rectification work. We maintain our “buy” call with an unchanged sum-of-parts-based TP of 66 sen.

The key risks to our view include termination of existing FPSO contracts, delay in Kraken rectification works, and failure to refinance the few upcoming debt repayments. — Affin Hwang Capital Research, Sept 12