This article first appeared in The Edge Financial Daily, on September 29, 2015.

UMW Oil & Gas Corp Bhd
(Sept 28, RM1.25)
Maintain sell call with an unchanged target price of 77 sen: UMW Oil & Gas (UMW O&G) currently has four rigs (Naga 1,4,5 and 6) operating in the third quarter of 2015 (3Q15), while Naga 2,3 and 7 are off charter.

We expect a weaker second half of 2015 as Naga 5 and 6 will complete their contract by end of 3Q15.

The company took delivery of its Naga 8 in early September. Naga 8 is a premium jack-up rig, capable of operating in water depths of up to 400ft (121m) and drilling to a total depth of 30,000ft. The rig is currently under preparation for mobilisation to a potential client in Southeast Asia.

Given the plunge in crude oil price, daily charter rates for jack-up rigs have fallen from US$150,000 (RM661,290) per day one year ago to US$90,000 to US$100,000 per day currently compared with the floater’s rate which declined from US$500,000 per day to US$275,000 per day.

At the current rate of about US$100,000 per day, earnings before interest, taxes, depreciation and amortisation remain positive but in order to be earnings positive, we estimate utilisation rates need to be as high as 85%.

If you take into account the interest expense and principle repayment, cash flow is likely to be negative at current average charter rates of US$100,000 per day.

According to Seadrill Ltd’s latest company presentation, worldwide new-build order book consists of 130 units or 27% of existing fleet of 480 units.

In order to adjust the oversupply situation, the industry needs a higher level of scrapping activities. About 47% of the global fleet are older than 30 years and these make potential candidates for scrapping. 

Given the current oversupply situation for jack-up rigs market, we expect the challenging outlook to continue through to 2016.

For the second half of financial year ending Dec 31, 2015, results are likely to be weaker given the lower utilisation rate and charter rate. 

We also cautious about the potential impairment on assets due to declining asset value and weakening underlying cash flow. — Hong Leong Investment Bank Research, Sept 28