Macquarie Equities Research (MQ Research) upgrades oil and gas services provider Sapura Energy (SAPNRG) to Outperform with a price target of RM1.00 in a report released yesterday, reflecting SAPNRG's long-term value in the exploration & production (E&P) and engineering & construction (E&C) segment.

SAPNRG's share price fell 2.3% to RM0.635 yesterday and is down 10.6% year-to-date (ytd).

Outperform With a TP of RM1.00 – Inflection Point

MQ Research upgrades SAPNRG to Outperform (from Underperform) with a new sum-of-parts (SOP) based price target of RM1.00 (from RM1.35), MQ Research’s top pick for the sector. SAPNRG is expected to post a smaller net loss in FY19E, however, MQ Research’s valuation reflects the long-term value in the E&P and E&C segment, underpinned by a production ramp-up in the SK408 gas field development and rebounding offshore capex, respectively. An E&P spin-off could be a major catalyst in the near term, funding SK408 capex and reducing group debt. Bull and bear case scenario valuations are RM0.24 and RM1.93, respectively.

The Good, the Bad, the Ugly

The Good: MQ Research believes the E&P and the E&C segments are headed for an inflection point. Offshore capex is showing strong signs of recovery on stronger oil prices, supporting MQ Research’s base case RM5.5bn orderbook wins for FY19E (RM2.7bn won ytd). SAPNRG plans to triple E&P production to ~12mmboe/yr by FY21, nearly tripling revenues. More importantly, the payoff could be brought forward if SAPNRG manages a spin-off of the E&P assets in the next 12 months.

The Bad: The RM2bn impairment to the Drilling division gave the market a shock in March. MQ Research has significantly lowered their numbers to reflect the subdued outlook for this division, halving segment enterprise value (EV) to RM5bn. Utilisation and charter rates are expected to remain subdued but with minimal additional downside.

The Ugly: The bulk of SAPNRG’s RM15bn debt was used to fund acquisition of assets at the peak of the oil and gas (O&G) cycle. While the assets have been (somewhat) impaired, the debt remains – sponging up RM858m of profit in FY18; 2.2X earnings before interest and tax (EBIT). The group has restructured its debt to push back the bulk of repayments, so short-term liquidity is not a problem. The long-term need to restructure the balance sheet is a strong driver for potential spin-off; FY18 net gearing was 1.6x.

Risks and Catalysts

Key risks include

1. delays/failure to ramp-up production,
2. a miss in orderbook wins,
3. impairments to goodwill (RM7.9bn carrying amount), and
4. failure to deleverage the balance sheet.

Given weak sentiment, negative newsflow may have an outsized impact on the share price.

A key catalyst would be the spin-off of the E&P segment that should

1. unlock value,
2. deleverage SAPNRG’s balance sheet and ease interest costs,
3. ease the capex burden for development of SK408 ~RM600m in FY20.

In the short term, MQ Research expects more positive newsflow on contract wins for E&C as well as potential new discoveries for the E&P segment to improve sentiment.

Source: Macquarie Research - 8 Jun 2018