This article first appeared in The Edge Financial Daily, on May 17, 2016.

SapuraKencana Petroleum Bhd
(May 16, RM1.58)
Maintain market perform with a lower target price (TP) of RM1.65: The latest Upstream Weekly reported that Brazilian oil giant, Petróleo Brasileiro SA (Petrobras), is carrying out another round of contract renegotiation with its main suppliers of flexible pipe-laying support vessels (PLSVs), in an effort to streamline its operations. It was also stated that Petrobras has no intention of terminating early any of its charters for Sapura Navegacao’s (the 50:50 joint venture company between SapuraKencana Petroleum Bhd and Seadrill Ltd) new vessels, but negotiations regarding contract terms are always ongoing with all suppliers.

This is not entirely surprising to us as Petrobras is in the midst of restructuring. However, management guided that no further rate adjustment is agreed at this juncture. Furthermore, we gather that its fifth vessel, Sapura Esmeralda, was successfully delivered last month and the last vessel, Sapura Rubi, is on track for delivery in August this year. Note that this is not the first round of rate renegotiation. Earlier of the year, SapuraKencana gave about 3% discount on some of the working PLSVs to Petrobras but earnings impact is expected to be insignificant.

Having said that, we believe the news is negative to SapuraKencana as it implies an increase in earnings risk given its huge exposure to Petrobras, constituting 35% of its order book as of the fourth financial quarter ended Jan 31, 2016. Petrobras currently has 16 PLSVs operating in Brazilian waters and has on order another seven new-build vessels with delivery scheduled until late 2017. However, according to the reported news, industry sources estimate that Petrobras may now only require between 10 and 12 PLSVs to carry out pipe-laying work off Brazil, which may lead to vessel terminations.

No changes to earnings forecast as SapuraKencana is still able to deliver the vessels on time and no signs of slowing down for operating vessels. Note that earnings from these PLSV contracts contributed 18%/23% of our FY17 to FY18 net profit estimates. We maintain “market perform” call with lower TP to RM1.65 from RM1.93, pegged to lower calendar year 2017 price-earnings ratio (PER) of 12 times (from 14 times previously) to factor in high earnings risk in view of prolonged challenging operating environment within the oil-and-gas industry. The valuation is in line with its -1.5 standard deviation to its average PER since 2012. Risks to our call include weaker-than-expected margins, lower-than-expected contract replenishment and contract termination. — Kenanga Research, May 16