This article first appeared in The Edge Malaysia Weekly on April 10, 2017 - April 16, 2017

AS Sapura Energy Bhd reported its lowest annual turnover in four years on March 31, president and group CEO Tan Sri Shahril Shamsuddin told analysts that the worst is not yet over for the integrated oil and gas group.

But the inflection point could be close. For the financial year ended Jan 31, 2017 (FY2017), the group reported a RM208.32 million net profit compared to a net loss of RM791.56 million a year before — the latter being Sapura Energy’s only full-year loss to date.

The turnaround was despite a 25% year-on-year drop in revenue to RM7.65 billion, as all segments recorded lower turnover. The highlight of the results was core net profit of RM396 million, which was a fifth higher than consensus estimates, TA Securities says in an April 3 note.

The outperformance surprised analysts and underlined what had been the key message from the group — resilience. The share price also responded, gaining 7.44% over three trading days from the closing price of RM1.88 on March 31 to RM2.02 by April 5, though the gains have since moderated.

While the sector is not out of choppy waters yet, it is understood that management is expecting conditions to improve significantly by mid-2019 as oil market rebalancing is tipped to soothe cautiousness among oil majors in terms of new capital expenditure.

So far, Brent crude, the international benchmark for oil prices, has remained around the US$55 a barrel level for most of the year, despite a brief dip towards US$50 in March.

That stability is mainly due to the six-month global output cut led by the Organization of the Petroleum Exporting Countries.

Though the cut will be up for review in May, Brent is expected to average US$57 this year, according to a Wall Street Journal survey of 14 investment banks last month. That is just above Sapura Energy’s estimate of US$55 per barrel.

The improved earnings in FY2017 were mainly from increased contribution from its pipe-laying works for Petrobras, which contributed RM280 million last year. Sapura Energy was also able to trim about RM700 million in costs over the past two years, while analysts say it is pushing for another RM200 million in savings this year.

To a lesser extent, the one-off reimbursement of RM37 million for the Berantai risk-sharing contract (RSC) cessation in 2QFY2017 also helped, analysts say.

Out of 20 analysts tracking the group, six have “buy” calls with one “sell” rating and the rest “hold”. The target prices among the “buy” calls range from RM2.08 to RM2.35.

Improved financial health

Another highlight from Sapura Energy’s FY2017 numbers was its improving financial health. That said, analysts say it is not yet plain sailing for the group in the near future.

Most analysts expect Sapura Energy’s earnings to fall in FY2018 before picking up momentum from FY2019 onwards. Maybank IB Research expects a 23% y-o-y decline in earnings per share from 3.5 sen in FY2017 due to loss of earnings from the Berantai RSC.

Shahril has said in a statement that he expects the challenges to persist in the short term but emphasised Sapura Energy’s resilience to weather the turbulence.

A key support will come from its strengthened balance sheet and strong cash flow. The financial year just ended saw its net gearing improve from 1.34 times to 1.15 times, thanks to a drastic 180% increase in its cash pile to RM3.52 billion as at Jan 31.

It achieved free cash flow of RM2.24 billion in FY2017, according to Bloomberg data. While short-term borrowings increased from RM2.09 billion to RM3.51 billion over the past year, RM1.1 billion was repaid in February 2017, JPMorgan writes in a March 31 note.

The strong cash flow enabled the group to fund its RM390 million capital expenditure in FY2017 internally without drawing down on debt facilities. Moving forward, Sapura Energy has said the trend will continue over the next four years at least, says Maybank IB Research.

This year, Sapura Energy is looking at about RM1 billion in total capex to drill seven infill wells at the SK 310 B15 field off Sarawak.

That said, there are potential hiccups ahead. One worry is whether more of its rigs will be idle in FY2018 compared with a 50% utilisation rate at present, UOB Kay Hian says in an April 3 report.

“By 3QFY2018, rig utilisation may decline further with at least two more rig contracts set to expire. The group is actively securing contracts and guided that 4QFY2018 should see utilisation pick up, but the likelihood of immediate replenishments remains unclear,” the research house says.

However, management has indicated that it expects to be able to maintain a 50% utilisation rate this year and sees a worst-case scenario of only 5 out of 16 rigs working by the end of the current financial year.

In addition, Sapura Energy is still burning through its order book faster than it is replenishing it, cautions TA Securities.

As at FY2017, the group’s total outstanding order book stood at RM16.7 billion, having added RM6.3 billion in new contract wins. About one-third of the order book amount will be recognised in FY2018.

It is understood that the group needs at least RM5 billion in new job wins annually to sustain earnings, and its tender book stands at US$7 billion.

On the other hand, Sapura Energy’s competitiveness globally bodes well for the group. Recall that it added RM6.2 billion to its order book in FY2016, which may indicate its consistency in winning jobs despite the turbulent environment.

Some 76% of the new job wins came from Southeast Asia. That highlights how much its earnings profile has diversified geographically amid the oil price downturn since mid-2014.

According to Bloomberg data, only 39.4% of its turnover in FY2016 came from Malaysia, with another 39.3% coming from elsewhere across Asia. That represents a considerable shift compared with FY2013, when 81% of its revenue came from the domestic oil and gas sector.

Its latest foray was into the European market via the RM510 million Trans Anatolian Natural Gas Pipeline contract won last July.

Notably, Sapura Energy is expecting first gas from its SK310 B15 field by end-2017. While the early days of production may not be significant enough to lift earnings, it represents a new growth area coming from a low base.

The group’s net reserves stand at 243 million barrels of oil equivalents (mmboe), out of which 229 mmboe is for gas. With its more mature oilfields seeing a natural decline, the gas output would replenish its current production rate of about 10,000 barrels of oil per day.

Overall, the bulls peg Sapura Energy as the best proxy for the oil and gas recovery story, partly due to its position as the lowest-cost oil producer in Malaysia.

Some feel it remains undervalued, given its price-to-book value of about 0.8 times. Sapura Energy’s net assets per share is at RM2.19 with the book value of its oil and gas assets pegged at US$45 a barrel.

Should oil prices remain steady at current levels for a more sustained period of time, the stock may regain wider favour among investors — only time will tell when.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.