Highlights

Seadrill recently has ordered 2 high specification jackups drilling rigs at Dalian Shipbuilding Industry in China, bringing total new build order for jack up rigs to 13 units. Seadrill shared its bullish view on the premium jack-up rig segment. The global jack up market is at an inflection point as approximately 60% of the global contracted fleet is built before 1993.

According to RS Platou Research, at end 2013, 50% of global jack-up fleet is expected to be 30 years or older while new rigs which are less than 10 years are expected to make up only 37% of the market (see Figure 1). New build activity has increased in response to the industry’s call for additional demand and more capable units. Currently, global new build orderbook is not adequate to fulfill oil major needs, as approximately 50% of the 115 units are not competitive (mostly low spec). In addition, utilization rates have exceeded 90% while average day rate is on the uptrend. This is inline with our view that offshore drilling with margin of circa 30% are one of the best exposure for alpha detailed in our report titled “Drilling Tsunami”.

Over the last six months, tender activity continues to be robust, especially in Latin America, Middle East and West Africa. Oil majors shifted their focus toward higher specification jack-up rigs due to better efficiency and safety. Locally, jack-up rigs outlook is also robust which is underpinned by: i) massive drilling activities (channel check reveals that 22 operating rigs in 2012 will rise to 38 by end of 2013), ii) shortage of locally owned rig, one out of 3 is local own and expects 7-8 foreign-owned rigs contract to expire next year which will open up opportunity for local owned rig and iv) re-rating catalyst from UMW O&G IPO (likely in Oct 13).

According to Coastal Contract’s CFO, as reported in TheEdge, the drilling industry will soon undergo a replenishing phase as equipment ages. As at 2012, 90% of today’s fleet was at least 26 years old (vs. average useful life of 25 years without major upgrade), given the bulk of it was delivered in the early 1980s.

Main beneficiaries are UMW O&G, Perisai (BUY), Coastal Contract (Non-Rated), SapuraKencana (BUY) and Scomi Energy (HOLD due to recent strong share price rally).

Risks

Global recession.

Rating

OVERWEIGHT

Positives: We believe that the ETP driven RM300bn Capex spending to enhance exploration, EOR and Marginal fields will drive earnings in the sector.

Negatives: execution risk, delay in contract rollout and investors’ perceptions on previous disappointments.

Valuation

Top Picks in order of drilling stock preference:

Perisai (BUY, TP: RM2.00)

SapuraKencana (BUY RM4.74)

Scomi Energy (HOLD RM0.90)

Source: Hong Leong Investment Bank Research - 20 Aug 2013