SapuraKencana Petroleum Bhd
(March 5, RM2.45)
Downgrade to sell with an unchanged target price (TP) of RM2.20. Our forecast financial year ending January 2016 (FY16F) and FY17F earnings are lowered by 6% to 7% as we value upstream at an 8% discount to our oil price assumption (pending the gas sales agreement [GSA]).

Our sum-of-parts (SoP) is unchanged as we reduce our net debt assumptions attributable to the holding company.

SoP comprises exploration and production (E&P) [91 sen per share discounted cash flow, for Malaysia and Vietnam producing fields], five times enterprise value over earnings before interest, taxes, depreciation and amortisation for offshore construction and subsea services and tender rigs, and eight times price-earnings ratio for fabrication.

On top of SapuraKencana Petroleum’s more than one time high net gearing, we view risks highlighted in our previous reports as heightening.

In the environment now, we fear for its long-term pipelay contracts stability as Petróleo Brasileiro SA has cancelled/renegotiated various service contracts (Brazil: 47% of order book). We are unsure how protected the service contractors are from termination clauses.

About 40% of its 17 operational rigs are also up for renewal (three by FY16, three to four by FY17). Weaker E&P earnings and asset impairment possibilities could arise in the earning quarters.

The latest foreign shareholding fell to 20% (from 23%, ex-Seadrill Ltd) and Tan Sri Mokhzani

Datuk Mokhzani Mahathir’s resignation from the board could provide uncertainty on Kencana Capital’s holdings (over 10%).

Despite our 2015 US$72 (RM263) per barrel (bbl) assumption (2016: US$80 per bbl), we see SapuraKencana facing substantial risks on liquefied natural gas (LNG). The over three trillion cu ft gas reserves for SK408 and SK310 are sizable in total oil and gas future production profile estimates.

While we cannot predict exactly when it will sign a GSA with Petroliam Nasional Bhd, we note that expectations for Asia demand for LNG are now bearish.

Japan’s spot LNG already contracted over 40% year-on-year (y-o-y) to average US$10 per million mmBtu in January and some LNG producers are facing difficulty in locking in long-term GSAs with Asian buyers.

Industry experts think LNG, which tracks oil price on a half-year lagged basis, will fall by another 30% in 2015.

Note that SapuraKencana paid RM2.9 billion for Newfield International Holdings Inc’s assets. While we believe the GSA (to be signed per well) will likely be long-term tenures, another uncertainty is the offtake level negotiated between the signing parties. — RHB Research, March 5

This article first appeared in The Edge Financial Daily, on March 6, 2015.