Malaysia Marine and Heavy Engineeringklse.i3investor.com/files/my/ptres/res11778.pdf · Despite...

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(Member of Alliance Bank group) PP7766/03/2013 (032116)

15 October 2012

Valuations are un-compelling We are initiating coverage on MMHE with a SELL recommendation and a target price of RM4.19. The company is expected to announce several new orders amounting to an estimated RM1.5bn in the coming 6 months. Despite this flow of good news, MMHE does not have long term earnings visibility and strong order books as compared to other oil & gas service providers. Furthermore, forward valuations are more than 28-50% above peers. The company also risks being removed from the FBMKLCI during the December review. Malaysia’s largest fabricator Ø MMHE is Malaysia’s largest oil & gas and marine fabricator by hectarage (280.6 ha) and

tonnage (129.7 ton/pa). It has a 50.8% market share of Malaysia’s annual fabrication tonnage capacity.

Ø Listed in March 2010, the company is majority owned by MISC (66.5%) and also Technip S.A (8.5%). MMHE operates out of 3 yards which are: - (1) MMHE West, (2) MMHE East and (3) Kiyanly in Turkmenistan.

Much needed orderbook replenishment is on its way Ø MMHE’s latest orderbook stands at RM2.79bn, down from RM7.3bn in March 2009 as

order intake was slow during 1Q10 to1H11. The gradual decline in orderbook has been due to lack of capacity at their Pasir Gudang yard (utilisation of 80-90%), and delays in the Gemusut-Kakap project. The lack of yard space is despite the acquisition of MMHE East last year as the yard is occupied with the Kebabangan project. Current orderbook will only last the group until 4QFY13 and new contracts are of paramount importance.

Ø Some capacity will free up in 2QFY13 and we see a pick-up in contract flow over 4QFY12 to 1QFY13. We expect up to RM1.5bn of offshore jobs over the next 6 months and these might include the Malikai TLP (RM800m-RM1bn), Damar wellhead platform (RM200m), Turkmenistan (RM200-300m) and possibly Rotan FLNG (for the marine segment). The group is also competing for jacket fabrication for Browse LNG in Australia but is up against regional competitors. For FY14, we view that another RM3bn of contracts is required to yield flat y-o-y earnings growth of 4.2%.

Decent near term growth, but lacking visibility FY14 onwards Ø With new orders expected over FY13 and FY14, we view that MMHE will be able to clock

in decent near term growth. For FY12, we forecast y-o-y growth of 12.2% and we expect 18.5% growth in FY13 from the completion of current orderbook and new orders. Going into FY14, our growth estimates narrow to 4.2% as the forecasted RM3bn of new jobs would only serve as replenishment but yield no growth.

Overvalued…initiating with a SELL call Ø We initiate coverage on MMHE will a SELL recommendation and a TP of RM4.19. This is

derived from pegging FY13 EPS to a peak cycle peer average P/E of 20x (similar valuation used for SapuraKencana and Bumi Armada).

Ø We view that MMHE is currently overvalued. MMHE is trading at a CY13 P/E of 24x compared to SapuraKencana at only 18.1x and Bumi Armada at 15.1x. We view that the company should not trade at a premium to its peers as its earnings growth is lower and orderbook lacks longevity. Furthermore, the lack of recurring income is another risk to MMHE’s outlook, we believe.

Ø Another near term risk is the potential removal from the FBMKLCI during the December review given recent large cap listings and the fact that MMHE is the second smallest component stock in the FBMKLCI by full market capitalisation.

Ø Upside risk to our call would be if MMHE is able to secure contracts worth RM2-3bn on top of our existing expectations. More so if these are overseas work as MMHE has yet to develop good traction outside Malaysia.

Malaysia Marine and Heavy Engineering Sell Oil & Gas Bloomberg Ticker: MMHE MK | Bursa Code: 5186

Initiating Coverage

Analyst Team Coverage [email protected] +603 2604 3909 12-month upside potential Target price 4.19 Current price (as at 12 Oct) 5.03 Capital upside (%) -16.7 Net dividends (%) 0.4 Total return (%) -16.3 Key stock information Syariah-compliant? Yes Market cap (RM m) 8,048 Issued shares (m) 1,600 Free float (%) 25 52-week high / low (RM) 6.18 / 4.63 3-mth avg volume (‘000) 686 3-mth avg turnover (RM m) 3.4 Share price performance 1M 3M 6M Absolute (%) 8.2 -8.5 -5.3 Relative (%) 5.6 -9.3 -8.5 Share price chart

Major shareholders % MISC 66.5 Technip 8.5

Initiating Coverage | Malaysia Marine and Heavy Engineering | 15 October 2012

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SNAPSHOT OF FINANCIAL AND VALUATION METRICS

Figure 1 : Key financial data

FYE 31 Dec FY11 FY11* FY12F FY13F FY14F Revenue (RM m) 4,435.4 2,137.0 2,935.0 3,446.8 3,600.0 EBITDA (RM m) 423.2 233.0 407.9 462.9 485.6 EBIT (RM m) 399.6 203.0 373.5 424.9 444.0 Pretax profit (RM m) 424.0 250.8 373.5 424.9 444.0 Reported net profit (RM m) 450.7 205.6 282.7 335.1 349.2 Core net profit (RM m) 450.7 205.6 282.7 335.1 349.2 EPS (sen) 28.2 12.9 17.7 20.9 21.8 Core EPS (sen) 28.2 12.9 17.7 20.9 21.8 Alliance / Consensus (%) - - 89.2 87.4 79.4 Core EPS growth (%) 61.4 (54.4) 37.5 18.5 4.2 P/E (x) 17.9 39.1 28.5 24.0 23.0 EV/EBITDA (x) 15.6 25.6 16.9 14.5 13.5 ROE (%) 19.6 8.5 11.1 11.7 11.0 Net gearing (%) Net Cash Net Cash Net Cash Net Cash Net Cash Net DPS (sen) - - 1.8 2.1 2.2 Net dividend yield (%) - - 0.4 0.4 0.4 BV/share (RM) 1.44 1.51 1.60 1.78 1.98 P/B (x) 3.5 3.3 3.2 2.8 2.5

*There was a change in financial year to December from March. FY11* earnings are for 9 months. Source: Alliance Research, Bloomberg

Figure 2 : Forward P/E trend Figure 3 : Forward P/B trend

Source: Alliance Research, Bloomberg Source: Alliance Research, Bloomberg

Figure 4 : Peer comparison

Company Call

Target price (RM)

Share price (RM)

Mkt Cap (RM m)

EPS Growth (%) P/E (x) P/BV (x) ROE (%) Net Dividend

Yield (%) CY12 CY13 CY12 CY13 CY12 CY13 CY12 CY13 CY12 CY13

SapuraKencana Buy 2.71 2.45 12,260.7 4.5 43.0 26.5 18.6 2.1 1.9 7.8 10.1 0.7 1.1 Bumi Armada Buy 4.90 3.69 10,808.2 39.3 42.9 21.6 15.1 2.8 2.3 12.8 15.5 0.7 0.7 MMHE Sell 4.19 5.03 8,048.0 0.3 4.2 24.0 23.0 2.8 2.5 9.9 10.6 0.4 0.4 Deleum Neutral 1.93 1.73 259.5 6.7 7.0 8.4 7.8 1.0 0.9 12.1 12.1 5.7 6.1 Petronas Chemicals N/R N/R 6.43 51,440.0 20.3 6.9 13.4 12.5 2.3 2.1 18.0 17.9 3.9 4.2 Petronas Dagangan N/R N/R 22.10 21,955.3 N/A 10.2 23.1 20.9 4.0 3.7 17.6 18.1 4.0 3.9 Dialog N/R N/R 2.38 5,728.5 -0.1 25.3 30.1 24.0 4.5 4.1 19.3 19.1 1.5 1.7 Average 45.5 14.3 17.6 15.4 2.6 2.4 14.7 15.4 2.8 3.0 Source: Alliance Research, Bloomberg Share price date: 13 October 2012

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23

23

24

24

25

25

26

26

2012

P/E (x) P/E Average P/E +1/-1 SD +2/-2 SD

2.5

2.6

2.7

2.8

2.9

3.0

3.1

2012

P/BV (x)P/BV Average P/BV +1/-1 SD +2 / -2 SD


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COMPANY OVERVIEW Malaysia’s largest fabricator MMHE is Malaysia’s largest oil & gas fabricator by hectarage and tonnage. With the recent purchase of Sime Darby Engineering’s yard in Pasir Gudang (MMHE East), MMHE has a 50.8% market share of Malaysia’s annual fabrication tonnage capacity. Listed in March 2010, the company is majority owned by MISC (66.5%) and also Technip S.A (8.5%). MMHE provides fabrication and marine construction and repairs works from the following 3 yards:- Ø Pasir Gudang (MMHE West) – a 150.6ha complex with a 1.8km seafront and annual

tonnage capacity of 69,700mt. Also has 2 drydocks, skid track of 40k/mt, a shiplift of 50k dwt, 2 land berths and 7 quays.

Ø Pasir Gudang (MMHE East) – 130 acres with 60,000mt annual tonnage capacity. Ø Kiyanly, Turkmenistan – a 43.6ha yard complex with 25,000mt annual tonnage capacity.

Figure 5 : MMHE West Figure 6 : MMHE East

Source: Company Source: Company

Figure 7 : MMHE group structure

Note: 100% owned subsidiaries unless indicated Source: Company

MMHE has 280.6 ha of fabrication space in Malaysia with a capacity

of 129.7mt p.a.


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Business divided into 2 segments MMHE’s business is divided into 2 core segments which are:- (1) Offshore Business Unit and (2) Marine Business Unit Ø Offshore Business Unit (OBU) – Involves a full range of construction and engineering

services for the offshore and onshore oil and gas industry, from detailed engineering design and procurement to construction, installation, hook-up and commissioning (EPCIC). Projects include the construction of production topsides, process modules, turrets, floating production systems, mooring buoy systems and mobile offshore storage units. MMHE West’s yard in Pasir Gudang, Johor, is the only yard in Malaysia that has constructed deepwater structures for the local oil and gas industry.

Ø Marine Business Unit (MBU) – A one-stop centre for converting vessels such as VLCCs (very large crude carriers), Aframax tankers, and offshore oil rigs into floating structures for production of hydrocarbons like FPSOs (floating production storage and offloading vessel), FSOs (floating storage and offloading vessel), MOPUs (mobile offshore production unit) and MODUs (mobile offshore drilling unit). The segment also repairs, refits and refurbishes a wide range of vessels, focussing on energy related vessels like ULCCs (ultra large crude carriers), VLCCs, petroleum tankers, chemical tankers, offshore oil rigs and etc. Via a 70%-owned subsidiary, MMHE also maintains and repairs LNG (liquefied natural gas) carriers for MISC and other LNG carriers.

Deepwater capable and the only topside yard in Turkmenistan MMHE has several notable accolades other than being the largest fabricator in Malaysia which make them unique from other fabricators in Malaysia including:- Ø The only deepwater capable yard due to their large load out capacity of 40k mt and

deepwater frontage. This has allowed the group to fabricate Malaysia’s first 3 deepwater floating production systems (FPS) which is the Kikeh Spar, FPSO Kikeh and Gemusut Kakap FPS. The group is currently bidding for the 4th FPS for the Malikai deepwater field.

Ø Manages and operates the only topside fabrication yard in Turkmenistan. Along with this yard, the group has secured close to RM9bn in contracts from Petronas Carigali’s operations for Turkmenistan Phase 1 since 2004. To note, the management and operation of the Kiyanly yard in Turkmenistan is via a 60%-owned JV company. The remaining 40% is owned by Technip. This came into effect in FY11.

Ø The only Malaysian company with capabilities for LNG carrier repair and FSRU/FSU

(Floating storage regasification unit/Floating storage unit) conversion.

Figure 8 : Selection of major projects from the OBU and MBU segments

Source: Company

MMHE has so far monopolised the deepwater fabrication scent in

Malaysia

And is the only topside fabrication yard in Turkmenistan

They also have extensive marine conversion and LNG repair

experience


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Figure 9 : OBU key customers Figure 10 : MBU key customers


Out of all the customers listed in Figures 9 and 10, we highlight that MMHE’s top customer since listing is PETRONAS and its related companies like Petronas Carigali, Petronas Carigali Turkmenistan and also the group’s immediate parent company, MISC. Going forward though, as the group’s orderbook with PETRONAS has run low, Exxon Mobil and KPOC (Kebabangan Petroleum Operating Company) will become the largest customers because of the Tapis EOR contract (RM1.4bn) and Kebabangan topside contract (RM1.15bn) which was novated to the group by Sime Darby Engineering. That said, KPOC is also PETRONAS related as it is a consortium comprising of PETRONAS (40%), Shell (30%) and ConocoPhillips (30%).

OUTLOOK Yard running close to full capacity… MMHE’s latest orderbook stands at RM2.79bn and the group’s orderbook has been on a consistent decline since March 2009. As can be seen from Figure 12 below, order intake was very slow during 1Q10 to1H11. This was largely because the group was running close to full capacity at their yard, with the Gemusut-Kakap FPS (GK FPS) taking longer than expected to be completed. Furthermore, the group did not replenish any work in Turkmenistan post March 2011, thus leading to a further drop off in orders. The GK FPS project has been delayed by more than 12 months so far. Had it been completed earlier and loaded out, it would have freed up valuable space at MMHE West. Yard utilisation of MMHE West continues to stand at roughly 80% with the current orderbook. Further to this, MMHE East is also fully occupied with the novated Kebabangan project and this will only be completed at end-FY13. MMHE’s current orderbook will last them only into end FY13 when the group is slated to deliver the Kebabangan Northern Hub project and Tapis EOR project.

Figure 11 : Order backlog Figure 12 : Order intake


MMHE’s top customer is PETRONAS and its related companies

Contract replenishment has been weak

As both yards are running at about 80% of capacity


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Figure 13 : On-going projects

Source: Company, Alliance Research …But some space available starting 1QFY13 MMHE is currently tendering for several major projects inside and outside of Malaysia with a combined value of RM4-5bn. Some of these jobs will need to be awarded by year end or 1QFY13 in order to achieve our FY13 growth target of 18.5% and contract replenishment assumption of RM1.5bn. Going into FY14, to meet our earnings growth target of 4.2%, MMHE would require another RM3.0bn of new orders to be recognised during the year. On the MBU (marine business) side, we expect some RM600m of new marine jobs per annum for FY13 and FY14. The group would have freed up some yard space by 2QFY13 from the completion of the massive Gemusut-Kakap FPS, FPSO Cendor, F14/F29 topsides and Telok Gas contracts. As such, we view that contract awards over the period of 4QFY12-1QFY13 are a possibility. To note, once a contract is awarded, construction does not commence immediately as procurement exercise need to be completed first. Actual construction typically commences 2 to 4 months after award. We list down below several contracts that could potentially make up the contract flow for the group over the coming 2 financial years:- Ø 23,000MT Malikai Tension Leg Platform (TLP), RM800m-1bn estimated contract value.

Shell called for a re-tender for the TLP in Dec 2011, after scrapping their initial tender in Jun 2011 citing that bids submitted were above budget. So far, bids have been submitted by MMHE-Technip, Floatec (McDermott-Keppel FELS), Intec sea-China Offshore and Modec. News on Upstream Online indicates that MMHE is set to secure the job and we expect an award of the project by year end or 1QFY13.

Current orderbook will be depleted by end FY13, hence replenishment

by 1QFY13 next year is crucial

We expect some RM1.5bn in contracts to flow through over the

next 6 months

As some yard space will be freed up starting 2Q13

The Malikai TLP project is expected to be awarded soon


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Ø 4,000mt Damar wellhead platform, RM200m – MMHE is lined up to clinch a wellhead

platform contract from ExxonMobil for the Damar gas field off Peninsula Malaysia. The contract is a small one at an estimated RM200m and could be awarded by 4QFY12.

Ø Central Diyabekir wellhead platform – MMHE is expected to secure a new contract in

Turkmenistan for a 6,000mt well head platform. Details have not yet been finalised but given MMHE’s strong traction in Turkmenistan, we view the group’s chances are good. That said, this will be a small contract likely worth RM200-300m. News on this contract emerged in May 2012 and we continue to wait on the outcome of the tender.

Ø Browse LNG – MMHE is reportedly bidding for jacket construction for the Browse LNG

central processing facility and also living quarters. The group is in the race with McDermott Indonesia, China’s Offshore Oil Engineering Corporation, and PengLai Jutal Offshore Engineering. Award for this contract is expected in 1QFY13 and both jackets could be worth RM500m to RM1bn given the large size of the jackets at 28,000mt for the central processing facility and 25,000mt for the living quarters.

Ø Rotan Floating LNG (FLNG) vessel conversion – MMHE is expected to be one of the

fabricators of choice for the vessel conversion work and we view that this could be a sizeable conversion worth up to RM1bn. Conversion of an FLNG will be a milestone for the group as this is the first vessel of this kind in South East Asia. However, Korean players are also in the fray for the project and may have an upper hand in terms of pricing and track record.

Ø NC3 and NC8 Gas development – PETRONAS is reportedly looking to tender out both

FEED (front end engineering design) and EPCIC contracts in a package for a 10,000mt central processing platform and well head platform. MMHE together with Technip are strong contenders but this bid could be opened up to regional players. Results likely to be known for this RM500m-RM1bn contract by year end or 1QFY13 if this project is fast tracked. To note, these gas fields lie off Sarawak and its production are meant to be fed into the 9th train of PETRONAS’s LNG complex in Bintulu.

And on-going yard optimisation could allow the group to take on more orders eventually MMHE took a breather on their Yard Optimisation (YO) programme during the time when they were acquiring MMHE East from Sime Engineering. As such, spending in their YO programme shrank to below RM200m during the 1HFY11-1HFY12 period. That said, going forward, the group is getting back on track to optimising their East PG and West PG yard over the next 5 years. Their new budget for the 5-year programme is roughly RM3.1bn. This will be funded by existing IPO proceeds as well as internal cash flows. MMHE is in a net cash position of RM1.27bn as at 2QFY12. The plans are as follows:- Ø West PG. Phase 1 involves installing goliath cranes, movable shelters, equipment and

machineries. Phase 2 involves a floating crane, structural and piping workshop installations.

Ø East PG. Phase 1 involves installing a 25k mt wharf and skid track so that the yard can accommodate construction of larger structures. Phase 2 involves inclusion of a tubular production workshop.

And also some replenishment of orders in Turkmenistan

Award of the Browse LNG jacket contract could be a game changer

for MMHE

The Yard Optimisation Programme is back on track with a RM3.1bn

budget for 5 years

Many facilities will be upgraded and expanded


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When the YO plan is completed, MMHE hopes to have expanded their capacity to close to 180k mt per annum from the current 129.7k mt per annum. MMHE West will continue to focus on deepwater jobs and marine contracts while MMHE East will be used for smaller shallow water topside and jacket projects. We view that this programme is essential for MMHE to realise the potential of their huge yard space post acquisition of MMHE East. MMHE has noted that many areas of MMHE East are not in a suitable condition to carry out fabrication works. With the YO programme slated for completion in 2017, we do not expect major growth in orderbook in the interim period. We view that the additional capacity will only be available from 2014 onwards.

Figure 14 : Historical capex spend on the Yard Optimisation programme

Source: Company

Figure 15 : Current yard capacity Figure 16 : Future yard capacity


Contract flow to pick up, but no exceptional growth is expected Despite our expectation that the group will add some RM1.5bn in contracts over the coming 6 months, we do not view this to be a major catalyst for MMHE as this RM1.5bn will only serve as orderbook replenishment rather than orderbook growth. In order to grow its orderbook, and bring earnings back to levels seen in FY09 and FY10, the group would have to secure several very sizeable (>RM2bn) and major deepwater type contracts which are typically high in value. Job flow turnover would also have to be improved in order to take on more projects. The RM3.6bn of new jobs we expect in FY14 will also be just for replenishment, and not growth.

And post the YO in 2017, the yards could have an additional capacity

of up to 50k mt/pa

All in all, we expect more orders in the coming months but view that

the group needs more than RM4.5bn over the next 2 years to

sustain earnings growth


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From our tracking of new jobs in the market, we have also noted that there aren’t many sizeable jobs like the GK FPS (>RM5bn) and Turkmenistan (RM8.2bn) available for the group to capitalise on. Also, if there are projects of that magnitude, most of them are outside Malaysia and MMHE does not have significant traction overseas yet. Healthy industry will help the group with replenishment The current climate of the O&G industry is conducive for service providers like MMHE. Crude oil prices appear to be sustained at high levels and production companies are actively spending to increase and/or sustain hydrocarbon output. In Malaysia itself, offshore spending is rife with PETRONAS’s RM300bn capex plan, ExxonMobil (RM37bn) and Shell’s (RM3.5bn) investments into enhanced oil recovery (EOR) and also new developments like the North Malay Basin (RM15bn). Based on our quarterly compilation, contract awards have been flowing in consistently this year and is expected to peak in 4Q12. We expect similar patterns going into 2013 and possibly 2014 given the development plans put forth by production companies in Malaysia. Given the 4Q peak in contract awards, we expect MMHE to secure jobs during this time.

Figure 17 : Contracts awarded to Malaysian O&G service providers

Source: Bursa Malaysia, Alliance Research

FINANCIAL HIGHLIGHTS Some growth to be seen over FY12 and FY13 For FY12, we expect the group to clock in earnings growth of 37.5%. Growth is strong because FY11 earnings are only for a 9-month period. Recall that starting April last year, MMHE has changed their financial year end from March to December. Should we compare based on a 12-month y-o-y basis, growth will narrow down to 12.2% y-o-y. Key drivers for the growth would be projects like the on-going Tapis EOR project, Telok Gas project, Cendor FPSO and also Gemusut-Kakap FPS. For FY13, new orders amounting to RM1.5bn (Malikai TLP, Damar, and other local shallow water fabrication) are expected to flow through to the company. Also, we expect the marine business unit to have roughly RM600m worth of work for the year from repairs and conversions. These new orders along with existing contracts to be completed in FY13 will bring earnings higher by 18.5%. We have not factored in any earnings from additional work in Turkmenistan for FY13.

Times are good in the industry, and this should help the group in their

replenishment

We expect annualised growth of 12.2% in FY12

And 18.5% growth in FY13 from completion of major jobs and

addition of new jobs


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But conservative estimates for FY14 For FY14, we have taken a conservative view, expecting earnings growth of only 4.2%. This will stem from new orders amounting to roughly RM3bn and work in the marine segment of to RM600m in value. We choose to be conservative as we do not have good visibility on MMHE ability to win sizeable contracts outside Malaysia and also in Turkmenistan. Should the group be able to gain traction overseas over FY13, we would impute larger contract flow for FY14 onwards. For the three financial years of our forecast, we have imputed gross margins for fabrication in a range of 12.5-13% while marine segment margins are pegged at 11.5%. While margins of the group have a tendency to fluctuate from quarter to quarter, these levels of margins have been sustained over the past two financial years. That said, should the group take on very complex jobs, we might adjust our expectations lower to account for some risk for delays or cost overruns. 1H12 results have been slow In 1H12, MMHE recorded results which were about 38% of consensus estimates. Revenues over 2Q12 were strong but margins were very thin during the quarter, thus bringing results below on a y-o-y (-31%) and q-o-q (-29%) basis. As mentioned earlier, MMHE is prone to fluctuating results from q-o-q and margins were low in 2Q because of low value work (typically procurement) carried out during the quarter. Going into 2H12, we expect slightly stronger earnings of RM149m as the group would start construction for the F14/F29 job and also gain further traction in construction work for the Tapis and Kebabangan projects.

Figure 18 : Results review

2QFY12 2QFY11 % y-o-y change

% q-o-q change 6MFY12 6MFY11

% y-o-y change Comments

Key financial highlights Revenue (RM m) 965.7 463.1 108.5 45.2 1,631.0 1,881.1 (13.3) 6M12 revenues are lower as work from

Turkmenistan was completed in FY11. Operating profit (RM m) 53.6 84.9 (36.8) (37.4) 139.4 157.5 (11.5) Pretax profit (RM m) 60.5 100.4 (39.7) (30.3) 147.3 210.5 (30.0) Net profit (RM m) 55.6 80.2 (30.7) (29.0) 133.6 207.9 (35.8) Lower because of lower thinner margins for

work completed during the 2Q12 period Core net profit (RM m) 55.6 80.2 (30.7) (29.0) 133.6 207.9 (35.8) Also lower because of smaller volume of

orderbook with Turkmenistan jobs completed.

Per share data EPS (sen) 3.5 5.0 (30.7) (29.0) 8.3 13.0 (36.1) Core EPS (sen) 3.5 5.0 (30.7) (29.0) 8.3 13.0 (36.1) Net DPS (sen) - - - - BV/share (RM) 1.60 1.51 1.60 1.51 Margins Pretax (%) 6.3 21.7 (15.4) (6.8) 9.0 11.2 (2.2) Net profit (%) 5.8 17.3 (11.6) (6.0) 8.2 11.1 (2.9) Margins lower as work in Turkmenistan has

completed. This was recognized as profit from JV and associates.

Source: Company, Alliance Research

For FY14, we have flattish expectations, with only 4.2%

growth expected

1H12 results have not been encouraging, but 2H12 should be

better


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KEY RISKS Decline in crude oil prices If crude oil prices decline to a low level (below USD50/bbl) for a prolonged period, many major projects will likely be taken off the table. This would especially be the case for deepwater and redevelopment projects, which require higher levels of crude oil prices to be commercially viable. It is speculated that some deepwater projects require prices to be consistently above USD70/bbl to breakeven while some redevelopment projects require crude oil price to stay above USD50/bbl. A sharp drop off in contract flow and earnings can be expected of MMHE should this scenario materialise. Furthermore, the group has little buffer against a major down turn as their orderbook is relatively short term in nature and they have no other major recurring income. Lumpy earnings due to lack of consistent orderbook flow For most O&G service providers which are project-based, lumpy earning is a perennial problem unless jobs secured have long tenure or construction period (3-5 years). In the event that MMHE is unable to replenish their orderbook by end 1H13, there would be a significant drop off in earnings over 2H13 and potentially FY14. In fact, with all of their current contracts due to be completed by end FY13, lack of major contract wins would see a very bleak outlook for FY14 estimates. To note, lack of orderbook replenishment may not be the group’s fault entirely as production companies often do not stick to award timeline schedules. Besides that, re-tendering is also a common occurrence and this may result in contracts being awarded later than expected or lost altogether because of the retender. Competition While MMHE is a dominant fabricator in Malaysia because of their relationship with PETRONAS and also their track record for deepwater projects, there is still competition risk, particularly from foreign competitors. All this while, MMHE’s projects have been very Malaysian centric but as the group starts to bid for work outside Malaysia, competition definitely becomes a factor to consider. PETRONAS of late has also been opening several of their tenders to regional players. This started with the Malikai tender which they opened up to regional competitors last year. For oncoming new projects like gas developments off Sarawak, there has been talk of inclusion of regional fabricators as well. Key competitors in the region other than SapuraKencana include McDermott, Nippon Steel, Chinese yards COOEC (China Offshore Oil Engineering) and PengLai Jutal, and also Korean yards like Samsung Heavy Industries, Daewoo Shipbuilding and Hyundai Heavy Engineering.

VALUATION AND RECOMMENDATION Initiating coverage with a SELL call We initiate coverage on MMHE will a SELL recommendation. At last closing price of RM5.03, we view that MMHE is currently overvalued especially when compared to their closest peer SapuraKencana Petroleum. Based on our one year forward estimates, MMHE is trading at a one year forward P/E of 24x compared to SapuraKencana at only 18.1x and Bumi Armada at 15.1x. We view that the company should not trade at a premium to its peers as its earnings growth is lower and orderbook lacks longevity. Furthermore, the lack of recurring income is another risk to MMHE’s outlook, we believe. Companies like SapuraKencana and Bumi Armada on the other hand, have up to 50% recurring income from their assets like rigs, pipelay vessels and FPSO. Orderbooks are also larger and longer term in nature (SAKP at RM14.0bn and Bumi Armada at RM10.6bn), compared to MMHE. Similar to our valuation for SAKP and Bumi Armada, we value MMHE using a 20x P/E which is a long term average peak cycle P/E for the large cap O&G players. Pegging FY13 EPS to a 20x P/E derives our TP of RM4.19 for MMHE citing a downside of 16.7%

Decline in crude oil prices will induce a cut in offshore spending

MHE has little buffer as their orderbook is fairly short term

Untimely orderbook replenishment could lead to lumpy earnings

As PETRONAS opens up tenders regionally and MMHE bids outside

Malaysia, they will face stiff competition

MMHE trades significantly above their peers and we view this is an

underserving premium

MMHE order books are smaller, growth is lower and they lack

recurring income

We have a TP of RM4.19, citing downside of 16.7%


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Figure 19 : CY13 P/E vs EPS growth

Source: Alliance Research Potential for FBMKLCI exclusion Another potentially negative catalyst for the company is that they might be removed from the FBMKLCI during the December review given recent large cap listings and the fact that MMHE is the second smallest component stock in the FBMKLCI by full market capitalisation. In December, we expect heavy weights like Felda Global Ventures, and SapuraKencana to be included, thus increasing the possibility of MMHE’s exclusion. We view that this may result in selling pressure on the stock because of portfolio rebalancing.

We view that potential removal from the FBMKLCI may trigger

some selling on MMHE


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APPENDIX I : MANAGEMENT TEAM

Figure 20 : Management Committee

Name Position Background Dominique de Soras MD and CEO Appointed to the Board of MHB on 1 February 2011. Prior to joining the Company, Mr

de Soras was the President, Subsea Division of Technip (2007 – 2010), Executive Vice President, Oil and Gas Division of Technip (2006 – 2007) and Vice President, Offshore Resources Profit Unit of Technip Offshore UK Limited (2001 – 2006). He was also a member of Technip’s Executive Committee.

Frederic Dabe Acting Senior General Manager, Offshore Business Unit

Mr Frederic Dabe joined MMHE on 12 September 2011. He has worked in various companies with almost 20 years of experience in marine and offshore industries including conversions and various phases of EPCIC projects with renowned international organisations.

Ahmad Zaki Abd Malik Senior General Manager, Marine Business Unit

Encik Ahmad Zaki Abd Malik joined as the Senior General Manager, Operations of MMHE on 1 April 2010. Following the recent organisation re-structuring as part of the Group’s integration and transformation exercise, he is now appointed as the Senior General Manager, Marine Repair Business Unit. He joined MISC Berhad in December 2000 and held various positions with his last position as General Manager, Maintenance of Fleet Management Services.

Wan Mashitah Wan Abdullah Sani

Chief Financial Officer Cik Wan Mashitah Wan Abdullah Sani was appointed as the Chief Financial Officer (CFO) of MHB on 30 June 2010. She was the CFO of MMHE Sdn Bhd since May 2010. She joined MISC Berhad in 2002 and held various positions with her last position being the General Manager, Finance before being seconded to MMHE.

Manoel Francisco Avelino Gomez

Business Development and Special Projects

Mr Manoel Francisco Avelino Gomes was appointed the General Manager, Business Development and Special Project since June 2010. He began his career with Jurong Engineering Pte Ltd, Singapore in 1976 before joining MMHE Sdn Bhd in 1981 as Head of Projects, Shipbuilding and rose to Senior Manager and later Director of Shipbuilding & Conversion and Director of Engineering & Construction Division.

Ausmal Kardin General Manager, Legal Appointed to the Legal division since March 2010. En Ausmal started his career with MISC Berhad in 1994 where he held various positions within the Legal & Corporate Secretarial Affairs Division. His last position in MISC Berhad was as Senior Manager, Maritime Legal Services before joining Bumi Armada Berhad as Vice President, Legal & Secretarial in 2005.

Captain Selval Kumar Chief Transformation Officer Captain Selva Kumar joined MMHE on the 1 May 2012 as the Chief Transformation Officer. He joined the MISC Group in 1980 and has years of experience in the LNG, Petroleum and Chemical tanker transportation sector. He has vast international experience in the same sectors, having worked in Holland, Nigeria and the UK on commercial assignments. Prior to this appointment with MMHE, Captain Selva was the General Manager of Ship Management Audit, MISC.

Hasinah Kamrudin Supply Chain Management Puan Hasinah was appointed in October 2011. She has worked in various companies namely, Sapura Crest Petroleum Berhad, Total E&P Malaysia, PETRONAS Holding Company and PETRONAS Carigali Sdn Bhd where she strategically oversaw all contracts and procurement matters.

Rooyahaiti Yakub Human Resources Puan Rooyahaiti Yakub joined Malaysia Marine and Heavy Engineering Sdn Bhd in July 2010 as the General Manager, Human Resource. She has worked in various industries namely, manufacturing, telecommunication, engineering and construction holding positions within the human resource management and development.

Source: Company


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APPENDIX II : GLOSSARY

Figure 21 : Glossary

Aframax tankers Class of crude oil carriers, with a loading capacity between 80,000dwt and 120,000dwt

Bbl Barrel, a unit of measure for oil and petroleum products equivalent to 42 US Gallons, 35 Imperial Gallons and 159 litres.

Bulkhead A reinforced retaining wall at the seafront used to offload heave structures from the yard onto transporting vessels

Buoy An unmanned floating structure used for mooring units offshore

Deepwater Water depths equal to/or more than 300metres

Dry-Dock Narrow basin that can be flooded to allow a vessel to be floated in, then drained to allow the vessel to rest on a dry platform.

Dwt Dead weight tonnes, the measure used to measure ship capacity.

E&P Exploration & Production

EPC Engineering, procurement and construction

EPCIC Engineering, procurement, construction, installation and commission.

FEED Front end engineering and design. Includes the process of defining a project’s basic systems, the detailed evaluation of these conceptual schemes in preparation for execution and the basic engineering conducted before project approval

FPS Floating production System. A collective term for all types of floating production units, including FPSO’s, semi-submersibles, TLP’s, SPARs and FSOs. Semi-submersibles, TLPs and SPARs are normally deployed in locations with pipeline infrastructure, since they do not have storage facilities.

FPSO Floating production storage and offloading system. An offshore vessel with installations of oil or gas production facilities.

Jacket Structure under a platform fixed to the seabed using piles.

Living Quarters Modules designed to provide living space for personnel working on an offshore platform.

LNG Liquefied natural gas

Land Berth Onshore berth for vessel docking and repair

Modules Modular sets of equipment designed to perform one or more functions and be installed on an offshore platform.

MOPU Mobile offshore production unit

Platform An offshore structure that is permanently fixed to the seabed.

Semi-Submersible A floating offshore system with pontoons and columns of which drilling and production facilities can be mounted.

Skid track A track system for rolling or sliding objects

Shiplift Structural platform that is connected to a number of winches and hoist systems to dock and un-dock vessels.

SPAR A vertical, cylindrical structure with the majority of the hull underwater. The deep hull of the spar lowers its centre of gravity, making the structure more stable.

TLP Tension leg platform. A floating platform with a deck on a pontoon column structure moored to the seabed with steel tendons.

Topside Oil production facility above the water, usually on a platform or production unit for drilling, production, accommodation or a mixture of these purposes.

VLCC Very large Crude Carriers. Loading capacity of 200,000-300,000dwt

ULCC Ultra large Crude Carriers. Loading capacity of 300,000dwt or more.

Source: MMHE, Various


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*There was a change in financial year to December from March. FY11* earnings are for a period of 9 months.

Malaysian Marine & Heavy Engineering Financial Summary

Balance Sheet Income StatementFY 31 Dec (RM m) 2011A 2011A* 2012F 2013F 2014F FY 31 Dec (RM m) 2011A 2011A* 2012F 2013F 2014F

PPE 1,097.4 1,156.2 1,463.0 1,625.0 1,783.3 Revenue 4,435.4 2,137.0 2,935.0 3,446.8 3,600.0Investment properties - - - - - EBITDA 423.2 233.0 407.9 462.9 485.6Property development - - - - - Depreciation & amortisati (23.6) (30.0) (34.4) (38.0) (41.6)Inventories 30.6 25.6 64.3 75.5 78.9 Net interest income (0.8) 1.1 (0.0) - -Receivables 2,304.0 1,131.3 1,367.0 1,605.3 1,676.7 Share of associates 25.2 46.8 - - -Other assets 47.2 63.8 47.2 47.2 47.2 Pretax profit 424.0 250.8 373.5 424.9 444.0Deposit, bank and cash 1,448.1 2,085.6 1,176.7 1,338.0 1,504.9 Taxation 26.5 (44.9) (85.9) (85.0) (88.8)Total Assets 4,927.3 4,462.5 4,118.2 4,691.0 5,091.0 Minority interest 0.3 (0.3) (4.9) (4.9) (6.0)

Net profit 450.7 205.6 282.7 335.1 349.2LT borrowings 0.0 - - - - Adj net profit 450.7 205.6 282.7 335.1 349.2ST borrowings - - - - - Payables 2,596.3 1,990.5 1,527.8 1,794.2 1,874.0 Key Statistics & RatiosOther l iabil ities 29.3 47.8 29.3 29.3 29.3 FY 31 Dec (RM m) 2011A 2011A* 2012F 2013F 2014FLiabilities 2,625.6 2,038.3 1,557.1 1,823.5 1,903.3

GrowthShare capital 800.0 800.0 800.0 800.0 800.0 Revenue -27.8% -51.8% 37.3% 17.4% 4.4%Reserves 1,498.4 1,620.6 1,752.9 2,054.4 2,368.8 EBITDA 4.3% -44.9% 75.1% 13.5% 4.9%Shareholders' equity 2,298.4 2,420.6 2,552.9 2,854.4 3,168.8 Pretax profit 12.4% -40.8% 48.9% 13.7% 4.5%Minority interest 3.3 3.6 8.2 13.1 19.0 Net profit 61.4% -54.4% 37.5% 18.5% 4.2%Total Equity 2,301.7 2,424.2 2,561.1 2,867.5 3,187.8 Adj EPS 61.4% -54.4% 37.5% 18.5% 4.2%

Total Equity and Liabilities 4,927.3 4,462.5 4,118.2 4,691.0 5,091.0 ProfitabilityEBITDA margin 9.5% 10.9% 13.9% 13.4% 13.5%Net profit margin 10.2% 9.6% 9.6% 9.7% 9.7%

Cash Flow Statement Effective tax rate -6.6% 22.0% 23.0% 20.0% 20.0%FY 31 Dec (RM m) 2011A 2011A* 2012F 2013F 2014F Return on assets 9.1% 4.6% 6.9% 7.1% 6.9%

Return on equity 19.6% 8.5% 11.1% 11.7% 11.0%Pretax profit 424.0 250.8 373.5 424.9 444.0 Depreciation & amortisatio 37.3 36.6 34.4 38.0 41.6 LeverageChange in working capital (440.0) 554.7 (165.2) 16.8 5.0 Total debt / total assets (x 0.00 - - - -Net interest received / (pai (3.5) - (0.0) - - Total debt / equity (x) 0.00 - - - -Tax paid (28.5) (16.1) (85.9) (85.0) (88.8) Net debt / equity (x) (0.63) (0.86) (0.46) (0.47) (0.47)Others (38.7) (84.2) 0.0 - - Operating Cash Flow (49.3) 741.8 156.9 394.7 401.9 Key Drivers

FY 31 Dec (RM m) 2011A 2011A* 2012F 2013F 2014FCapex (143.2) (95.4) (400.0) (200.0) (200.0) Others 28.4 74.0 - - - New orders Offshore 191.0 2,083.0 898.0 1,500.0 3,000.0Investing Cash Flow (114.8) (21.4) (400.0) (200.0) (200.0) New orders Marine - 850.0 534.0 594.8 600.0

Issuance of shares 949.3 - - - - ValuationChanges in borrowings 197.1 - (0.0) - - FY 31 Dec (RM m) 2011A 2011A* 2012F 2013F 2014FDividend paid (300.0) (80.0) (28.3) (33.5) (34.9) Others - (3.0) - - - EPS (sen) 28.2 12.9 17.7 20.9 21.8Financing Cash Flow 846.4 (83.0) (28.3) (33.5) (34.9) Adj EPS (Sen) 28.2 12.9 17.7 20.9 21.8

P/E (x) 17.9 39.1 28.5 24.0 23.0Net cash flow 682.2 637.5 (271.5) 161.2 166.9 EV/EBITDA (x) 15.6 25.6 16.9 14.5 13.5Forex - - - - - Beginning cash 765.9 1,448.2 1,448.2 1,176.7 1,337.9 Net DPS (sen) - - 1.8 2.1 2.2Ending cash 1,448.2 2,085.6 1,176.7 1,337.9 1,504.9 Net dividend yield 0.0% 0.0% 0.4% 0.4% 0.4%

BV per share (RM) 1.44 1.51 1.60 1.78 1.98P/BV(x) 3.5 3.3 3.2 2.8 2.5

Price Date: 12 October 2012


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DISCLOSURE Stock rating definitions Strong buy - High conviction buy with expected 12-month total return (including dividends) of 30% or more Buy - Expected 12-month total return of 15% or more Neutral - Expected 12-month total return between -15% and 15% Sell - Expected 12-month total return of -15% or less Trading buy - Expected 3-month total return of 15% or more arising from positive newsflow. However, upside may not be sustainable Sector rating definitions Overweight - Industry expected to outperform the market over the next 12 months Neutral - Industry expected to perform in-line with the market over the next 12 months Underweight - Industry expected to underperform the market over the next 12 months Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date


17

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