Bumi Armada Bhd
(Nov 12, RM1.36)
Upgrade from “add” to “buy” with lower target price (TP) of RM1.75 from RM2.22: The recent sell-off in Bumi Armada Bhd (Bumi) shares (a decrease of 43% year-to-date [YTD]) looks overdone.

Hit by declining oil prices this year, and the untimely listing in October of its rights shares, Bumi’s share price has fallen by 43% YTD, underperforming both Malaysia-listed oil and gas big caps and its global FPSO peers (Fig 10).

We believe the sell-off is overdone, as the group’s fundamentals are largely intact given RM18.5 billion in long-term floating production, storage and offloading (FPSO) contracts, transport and installation (T&I) businesses, as well as a strong footing in the Caspian Sea T&I market.

T&I should be anchored by recurring work orders from Petroliam Nasional Bhd (Petronas) and Russia’s Lukoil.

The 43% YTD fall in the share price offers a buying opportunity, and hence we upgrade Bumi shares to “buy” from “add” but lower TP to RM1.75 from RM2.22 on sum-of-the-parts (SOTP) valuation adjustments.

The FPSO segment is Bumi’s top earnings driver, making up 85% of its order book and contributing 60% of its 2015 earnings.

The drop in oil price has had no impact on the group’s existing contracts, as they are long-term in nature, with pre-agreed chartering fees.

We expect the FPSO contracts to provide the group with a stable earnings stream up to 2018, regardless of oil price movements.

Execution is a critical factor in the FPSO business, and Bumi has a strong track record.

While the weak oil price may prompt oil companies to cut spending on exploration drilling and the development of higher-cost or frontier projects, we expect the impact on the FPSO market to be muted, as FPSO is a proven technology for oilfield development.

Bumi is still hopeful it can complete the US$1.2 billion (RM4.02 billion) Madura FPSO contract (letter of intent signed in August 2014, but the parties have yet to enter into a formal contract), and the group is now tendering for six more FPSO contracts in Africa and Brazil.

Backed by a long-term contract with Petronas and repeat work orders from Lukoil, we expect the Armada Installer to continue to anchor earnings for Bumi’s T&I segment.

We understand that the Armada Installer has achieved strong utilisation rate in the second and third quarter of 2014 (2Q-3Q14), and we think the 2015 and 2016 earnings outlook from Caspian Sea will remain resilient.

Unlike the FPSO and T&I businesses, we expect the group’s offshore support vessel (OSV) segment, particularly its anchor handling tug supply (AHTS) fleet, to suffer from lower oil prices.

AHTS day rates have been on a downtrend since late 2013 due to oversupply, and the recent cuts in exploration drillings will likely exacerbate the weakness.

Bumi is looking to dispose of seven vessels and redeploy some vessels to the Brazil and Africa markets, where demand is better.

Since its listing in 2011, Bumi has yet to secure any contracts for its oil field services (OFS) division.

Now that some oil companies are re-evaluating their capital expenditure plans due to lower oil prices, we believe that there will be additional setbacks for Bumi’s OFS segment.

We are raising our 2014 to 2016 net profit forecasts by 1% to 2%, imputing lower net interest expense due to the RM1.9 billion in cash proceeds from the group’s rights issue in August.

The RM50 million in net interest savings should more than offset lower OSV and OFS earnings.

Following the listing of the bonus and rights shares, we raise Bumi’s share base (an increase of 100%) and lower our 2014 and 2016 earnings per share (EPS) forecasts by 37% to 49%.

We like Bumi Armada and view the group as an attractive proxy for the global FPSO and Caspian Sea T&I markets.

We believe that these market segments are relatively insulated from the current oil price weakness, and that good execution of its existing FPSO contracts would provide the group with stable, long-term earnings growth.

We nevertheless trim our SOTP-derived 12-month TP to RM1.75 from RM2.22, imputing a lower price-earnings ratio multiple for the OSV division of 12 times 2015 earnings before interest and tax from 15 times and a higher weighted average cost of capital of 7.5% from 6.5% for the FPSO division. — Affin Hwang Investment Bank Sdn Bhd, Nov 12

This article first appeared in The Edge Financial Daily, on November 13, 2014.