We initiate coverage on Perdana Petroleum Berhad (Perdana) with an Outperform call and TP of RM1.31 based on a discounted cash flow (DCF) valuation method. Perdana is poised to tap into the increasing markets for deepwater vessels, with key re-rating catalysts being: i) current operating conditions favour younger vessels, of which Perdana is in an ideal position to capitalise on given its newer and higher capacity fleet, ii) OSV demand to pick up significantly and, iii) optimising offshore services through Dayang Enterprise.

• High end specialised vessels to benefit. As oil companies target deeper waters for their E&P activities, we expect an increased demand for larger and more technologically advanced offshore support vessel. We believe the positive outlook for the OSV sector will provide sufficient reason for ship owners to mark fleet replacement in order to meet new requirements (higher vessel specs for deeper waters).
• Continued demand for OSV. We estimate average charter rates for AHTS is between USD1.90-USD2.30 and PSV rates could reach USD22,000-USD26,000 driven by strengthening demand in favour of mid-sized AHTS vessels which are more limited in supply relative to smaller AHTS.
• Collaborating with Dayang. Perdana has stated its strategic aim is optimising its fleet and increasing its exposure through its biggest shareholder, Dayang Enterprise. We expect to see stronger OSV contracts being signed as both are to complement each other to provide a wide range of offshore services.

Company Background

Perdana Petroleum Berhad (Perdana) is an offshore marine vessel supplier primarily supporting the upstream oil and gas industry. Its story began in 1988 when Petra Resources SB (PRSB) was formed to undertake trading activities for the upstream oil and gas industry, continuing over the years in becoming a licensed vendor to PETRONAS. Perdana‟s business fundamentals and investment prospects are without question, evidenced by the securing of significant contracts from oil majors like ExxonMobil, Talisman Malaysia, Nippon Oil Malaysia, Sarawak Shell, Sabah Shell and PETRONAS Carigali. Recent challenges, from within and without, have thrown the group off-course but we believe the turnaround is at hand!

The company is a market leader within the mid-size 10,000 brake horsepower (bhp) anchor handling tug and supply (AHTS) vessel category. In September this year, it divested its remaining 26.9% interest in Petra Energy Berhad to focus solely on the offshore support vessel (OSV) segment, raising about RM96mn cash in the process, which has subsequently been utilised to pare down debts. As at Oct 25, 2012, Dayang Enterprise Holdings Berhad (Dayang) is the major shareholder of Perdana with a 19.09% equity interest

Growth Drivers

Shift in exploration depths to benefit high-end specialised vessels. The accelerating shift from shallow to deepwater exploration will enable Perdana to capitalise on and benefit from its newer fleet. As oil companies target deeper and more challenging environments for their Exploration & Production (E&P) activities, we expect an increase in demand for vessels with newer technology and higher capacities. Offshore vessels with high engine power (more than 10,000bhp) are now preferred by oil majors. In Malaysia, deepwater definition ranges from depth of 200 to 1200 metres. Beyond 1200 metres is considered as Ultra deepwater. Generally accepted deepwater definition is greater than 300 metres depth up to 1500 meters and Ultra deepwater is greater than 1500 meters depth.

To recap, Perdana had instituted a fleet renewal programme in 2007 to strengthen its competitiveness in the offshore services segment, done in part due to oilproducing companies changing their selection criteria to include vessel age restrictions of “No older than 15 years” in the bidding process. Additionally, it is often advantageous to own vessels when companies participate in the bidding process. Currently, Perdana owns a total of 14 vessels which include 8 units of AHTS (2 units of 5,000 BHP AHTS and 6 units of mid-size AHTS between 10,000 and 12,000 BHP) and 6 units of maintenance & hook-up work vessels (4 work barges and 2 workboats). This renewal programme has seen a vast improvement for Perdana, lowering the average age of its fleet to about 3.5 years old.

Perdana announced in Sep that it has ordered 2 new-build work barges, which will be delivered in 2Q13, in anticipation of increasing oil and gas activities and a view we concur with given its potential tie-up with Dayang.

Pursuing long-term charters. The newly-built fleet is targeting long-term charters of more than 12 months, for obvious reasons. In a typical offshore chartering business, securing longer term contracts mean higher day rates. Perdana‟s recent renewal program is consistent with its strategy to promote younger and higher technology vessels where long-term commitment can be demonstrated. Thus, new vessels with deepwater capability have a distinctive advantage over older ones in which they command higher day rates and higher utilisation rate. We estimate average daily charter rates for AHTS to range between USD2.00 and USD2.40 in the near to medium term, and PSV rates to range between USD23,000 and USD27,000.

Excluding seven vessels which are no longer operational, the fleet‟s utilisation rate climbed to a recent-high of 75% as at 2Q12 compared to an average of 60% in 1Q12. We expect the utilisation rate to continue trending upwards for mid-sized AHTS given PETRONAS‟s aggressive increase in E&P and drilling activities domestically. Our anticipation of the Group‟s vessel utilisation rate reaching 95%, coupled with the longer-term and higher charter rates going forward will provide a boost (and stability) to earnings.

Continued demand for OSVs. Recent data from Malaysia Offshore Support Vessels Owners‟ Association (OSV Malaysia) shows that its 18 member companies own a combined fleet of 200 vessels with an average age of 4.5 years. Demand for new-builds is expected to grow over the next five years given that all of the vessels are fully employed currently. OSV Malaysia also reports that the two countries with the greatest forecast investment in their offshore O&G industry within Southeast Asia (in terms of platforms and subsea expenditure), are Malaysia and Indonesia which are actively developing both their shallow water and deepwater wells.

As new-builds coming into the market are not seen to particularly be supporting recent E&P trends of deeper water activities, we see the OSV market strengthening in favour of mid-sized AHTS vessels which are more limited in supply relative to smaller AHTS. In this instance, Perdana will be a prime beneficiary given its current fleet make-up.

Collaborating with Dayang. Dayang‟s (DEHB MK: Outperform; TP: RM2.88) investment in Perdana reflects a commitment to long-term cooperation and will enable both companies to collectively benefit from new opportunities in integrated brownfield services. We expect Dayang‟s hook-up and commissioning (HUC) division to be its key growth driver going forward, with high possibilities of it winning some RM1.5bn worth of contracts for structural maintenance activities under the PAN Malaysia HUC umbrella project. Given that it has no spare capacity as its own fleet is currently fully utilized, its tie-up with Perdana which has spare capacity is a logical and obvious choice as it provides immediate access to vessels which it can capitalize on. As for Perdana, working closely with Dayang may open prospects for further synergistic collaborations.

Dayang has a strong asset base which comprises 7 marine vessels, including 5 workboats and 2 supply vessels. All of these are owned by the Group and are fully utilised, We have been made to understand that Dayang has no sufficient workbarge capacity for some of its new tenders and as such, we believe Perdana‟s new work barges are most likely in support of Dayang‟s operations, highlighting this win-win partnership well underway.

The PETRONAS factor - Massive E&P Capex. Malaysia needs to address declining production levels from its shallow water fields. Over the last few years, as much as 45% of the government's revenue collection is dependent on PETRONAS' dividend and petroleum taxes. As production of oil declines, and the resulting impact of lower contributions to the Federal Government, tackling this ongoing depletion is paramount to the nation.

Oil price (WTI) has rebounded back to above USD80/bbl since bottoming out in 1Q09 and has hovered within the USD80-100/bbl band for the last twelve months. These levels are sufficiently comfortable for oil companies to be  “liberal” with E&P capital expenditures. Oil price estimates for projects to breakeven are as follows:-

• Shallow water: USD40/bbl
• Shallow water, marginal: USD65/bbl
• Deepwater: USD80/bbl
• Ultra deepwater: USD80-USD100/bbl

In June 2011 PETRONAS revised its capex plans upward from RM250bn to RM300bn over the next five years. Domestic capex continues to dominate total expenditure, thereby supporting local economic activities. With this large increase, most if not all players will benefit, as will Perdana directly or indirectly from its higher utilisation rates and potentially stronger charter rates owing to the lack of capacity in the higher-end segment. With the country‟s Cabotage Policy still in place, Malaysian-owned vessels will enjoy a significant advantage in benefiting from the increased spending.

Risk Factors

Low oil prices could diminish E&P activity. The fortunes of supply vessel operators are dependent upon the E&P activity of O&G companies, who are primarily dependent upon oil prices. When oil prices rise, drilling activity tends to increase as producers chase higher profits. Similarly, softening oil price could force slower exploration activity and some oil companies could even cut back on their E&P efforts. .

Lower utilisation rates. The utilisation rate will depend on whether or not there is an oversupply of vessels, which again is dependent somewhat on oil prices. Nevertheless, Perdana is endeavoring to increase customer value through the provision of long term targeted contracts to their repeat major customers in the region, alleviating this concern to an extent once they are locked-in.

Competition by foreign operators. Competition for jobs is becoming more intense as foreign operators enter the market. Generally, local supply vessel operators only offer small to medium size AHTS and PSV. Although the Cabotage law prioritising local OSV service providers is still in effect, unconditional licenses are also granted to foreign operators if local players cannot meet the demands of complex deepwater developments.

Financial Review

Two years lost. Perdana had tumultuous times over the recent two financial periods and reported massive losses, with 2011‟s results poorer than the year before due to a write down in the value of its old vessels. Management resolved to write off RM39.3m, approximately half the book value of the seven aged vessels, to completely eliminate both operational and carrying costs. This is particularly important in its efforts to restore financial robustness going forward. Without the write down, the Group would have posted a net loss of RM30.1m for FY11 versus a net loss of RM68.1m for FY10. On a slightly brighter note, the Group managed to register a marginal increase in turnover to RM255.9m in FY11 from RM254.9m in FY10. Most of the top line improvement was attributable to a mild recovery in charter rates, particularly towards the end of the FY2011.

Signs of a turnaround. The most recent financial quarter (2Q12) marks its first profitable one after three consecutive quarterly losses, with a modest net profit of RM5m versus a net loss of RM8m in 1Q12. Improved earnings were driven by higher vessel utilisation rates and a marginal improvement in charter rates. The group's 1HFY2012 operating margin of 1.7% appears low compared to historical consolidated margins of 14% to 25%. However, we estimate this to strengthen going forward, in part due to improving operational efficiencies and also from „spillover effects‟ of its partnership with Dayang.

Valuation

We initiate coverage on Perdana with an Outperform call and TP of RM1.31 based on a discounted cash flow (DCF) valuation method. Our target price implies an upside of 43% from the current price. We explicitly model cash flows using a weighted average cost of capital (WACC) of 10.1% until 2032 based upon 20 years life expectancy of the vessel. This model assumes no additional investment for vessel. We expect Perdana will be well positioned supported by Dayang in the growth of their operations. The Group is focusing on assets that can secure longterm charter agreements going forward, which will ensure further enhancing its earnings growth.

Source: PublicInvest Research - 25 Oct 2012