Malaysia Marine and Heavy Engineering Holdings Bhd
(Dec 19, RM1.60)
Maintain “sell” with a target price of RM1.15: MHB, a pure domestic fabricator with single business focus, has been hit by a double whammy of higher competition (entrance of South Korean yard and SapuraKencana Petroleum Bhd’s dominance in the local market) and weaker domestic oil and gas capital expenditure (capex).

The oil and gas industry website Upstream reported last Friday that Hyundai Heavy Industries is close to securing a US$1 billion (RM3.49 billion) engineering, procurement and fabrication contract for the central processing platform for the Baram Delta Gas Gathering Project 2 (Bardegg 2) and Baronia enhanced oil recovery project off Malaysia. This contract, if awarded to Hyundai, will mark the South Korean’s second major Malaysia contract win this year. In June 2014, the group secured a turnkey contract from Hess Corp to build a large central processing platform under the North Malay basin gas and condensate development.

SapuraKencana, another major upstream engineering, procurement, construction and commissioning (EPCC) player, fared reasonably well in the domestic fabrication space this year.

In June this year, this group secured US$415 million engineering, procurement, construction, installation and commissioning (EPCIC) contracts for the construction and installation of three remote wellhead platforms for North Malay Basin and four wellhead platforms for JDA Block B-17 and B17-01 field development. In addition, in December 2014 the group secured an RM480 million EPCC contract for the Baronia and Tukau wellhead platforms and RM140 million EPCC contract for the Angsi compression module.

Meanwhile, MHB is losing out to its competitors. The group has secured a mere RM323 million worth of contracts year-to-date (YTD), significantly lower than its RM1.7 billion to RM2.9 billion contract wins in 2011 to 2013. The contract awards to the South Korean yards signal that Petroliam Nasional Bhd (Petronas) is now highly focused on cost control while SapuraKencana’s strong performance this year could be due to its integrated operation and strong management team. While we expect MHB to secure some RM1.2 billion to RM1.5 billion worth of contracts per year in 2015/16, we opine that its bids will need to be highly competitive, hence its profit margins may come under pressure.

In the first half of this year, MHB undertook a mutual separation scheme involving 100 employees. We understand that Technip Malaysia, MHB’s strategic technical and project partner, is also undertaking a rightsizing exercise, signalling that the industry downturn and its impact on the joint venture may be more pronounced than we expected.

Our economist has recently lowered our 2015E Brent crude price forecast to US$75 per barrel from US$85 per barrel on the large global oil production surplus and the Organisation of the Oil Producing Countries’ decision not to intervene in the oil market. The lower oil price has pressured Petronas to cut its 2015 capex by 15% to 20%. MHB, a domestic oil and gas company with single business focus, is vulnerable to lower domestic upstream capex.

In view of the increasingly competitive domestic fabrication landscape and possible project delays due to uncertain oil price outlook, we have lowered our 2015/16E earnings per share forecast by 5% to 10%, imputing a lower new contract wins assumption of RM350 million for 2014E from RM500 million previously, and RM1.2 billion for 2015E from RM1.5 billion.

We maintain our “sell” rating with a lower target price of RM1.15 from RM1.50, pegging the stock at 12 times 2015 price-earnings ratio ([PER] from 15 times). Our target PER of 12 times is comparable to -1 standard deviation PER of 11.5 times. We opine that the potential entrance of a South Korean yard will permanently change the local fabrication landscape, pressuring margins and reducing the appeal of MHB. Also, MHB’s weak YTD contract wins, low order book backlog and the weak oil price will further weigh down its share price. — Affin Hwang Capital Research, Dec 18

This article first appeared in The Edge Financial Daily, on December 22, 2014.