Tuesday, August 6, 2013

MISC : The short end of the stick (CIMB)

Current RM5.29
Target RM4.35
The short end of the stick

 Yesterday, Petronas said that it will directly procure future LNG newbuildings, and will no longer charter additional LNG ships from MISC. This is a major negative surprise that threatens to reduce MISC’s LNG revenue by 20% over the next five years.

We keep our Underperform call in view of this unexpected twist in MISC’s relationship with its erstwhile supportive parent. Our target price remains pegged to a 30% discount to its SOP. De-rating catalysts include continued tough cyclical shipping conditions, and the almost certain decline in its LNG shipping earnings. MISC will announce its 2Q results on 16 August and we keep our forecasts unchanged till then.

What Happened
Petronas appears to have repudiated its traditional charterer relationship with MISC by returning to future ownership of LNG ships. This means that MISC will not be able to sign 20- year contracts for the eight new LNG ships that Petronas is looking to buy.

What We Think
This is very bad news for MISC because LNG tanker earnings have helped underwrite the container, petroleum and chemical shipping losses in the past. Over the next five years from 2014-18, contracts for seven LNG ships will expire. We think that five will be renewed at lower rates, and two will not. The net result is that MISC’s LNG revenue will fall 20% between 2013 and 2019. If MISC had the benefit of eight new LNG shipping contracts, the shortfall would have been plugged and even allow for some growth. But since this is now no longer possible, we expect LNG division revenues and profits to start declining from 2014 onwards. We will reflect this in our model in the future.

What You Should Do
MISC’s share price has done well since the termination of the Petronas general offer, and the stock’s subsequent re-inclusion into the FBM KLCI in July. This stock hit a one-year high of RM5.85 on 23 July, narrowing the gap to its SOP of RM6.20 to only 5.6%. The share price dropped to as low as RM3.94 on 4 December 2012, or a 36% discount to SOP. In the unfortunate new reality of MISC’s diminished relationship with Petronas, we believe that MISC’s share price should once again reflect a large discount to its underlying SOP, in the absence of any cyclical upside catalysts.

Sidelined from future LNG ship participation
A Bernama article dated 1 August quoted a media release from Petronas, which said that Petronas has decided to directly procure newbuilding LNG ships to meet its transportation requirements. The move will ostensibly “allow Petronas to have direct access to LNG shipping capacity at the lowest possible costs”.
Petronas will be engaging MISC to provide project management and technical consultancy services during the construction of the new LNG ships, given the latter's extensive experience and expertise in the LNG shipping sector and familiarity with Petronas's business needs.

Effectively, this means that MISC will no longer be participating in the ownership of future LNG assets that are typically chartered on a long-term basis to Petronas. Instead, MISC’s role will be relegated to that of supervising the construction of the LNG vessels at the relevant shipyard.

LNG is the key contributor to MISC’s earnings
This is very bad news for MISC. MISC has traditionally owned all of the LNG vessels that Petronas uses to ship LNG from East Malaysia to customers in North Asia. These are chartered from MISC on 20-year time charter contracts.

As the time charter contracts enjoy stable rates, the LNG business has been a bulwark of earnings stability for MISC over the past five years since the 2008 Global Financial Crisis (GFC). Profits from LNG shipping time charters have underwritten the post-GFC losses from the container shipping division (this has since been closed down), and the petroleum and chemical shipping businesses. As a result, MISC has never suffered a full-year core net loss.

Without the contribution of LNG earnings, MISC’s weaknesses in the cyclical shipping divisions will be more clearly exposed. For instance, in 1Q13, the LNG division contributed US$105.4m in pre-tax earnings, which constituted a staggering 87% of the group’s earnings despite the LNG arm contributing only 27% of group revenue. The outsized importance of the LNG business is due to the fact that other businesses, like the loss-making petroleum and chemical tanker shipping businesses, are not carrying their own weight. The heavy engineering business under MMHE is also producing weak single-digit pre-tax margins, as opposed to pre-tax margins in excess of 50% for the LNG division.
LNG earnings will decline in the absence of new ships
Over the past few months, the shipping press has been reporting that MISC is working to sign up to eight new LNG shipping contracts with Petronas, involving the building of eight new LNG ships with South Korean shipyards, and their subsequent back-to-back time charter with Petronas. These vessels were expected to be delivered to MISC in the 2015-17 timeframe.

These eight new ships were meant to supply Petronas’s shipping requirements for the additional LNG exports from the new Bintulu Ninth Train (requiring three new vessels), for the evacuation of LNG from the Floating LNG project off Sarawak (requiring two new vessels), and a further requirement for three additional ships for unspecified Petronas projects.

If none of these materialise for MISC, it means that there will be no growth in its LNG fleet in the future.

Impact from contract expiries in the next five years
As the existing LNG contracts expire, MISC could have fewer and fewer LNG ship contracts from which revenue is generated.

MISC currently has 29 LNG ships, of which two have been converted into Floating Storage Units (FSU) and chartered to Petronas Gas until 2032. Of the remaining 27 ships, 23 are on time charter to Petronas, two ships are on charter to Total for the Yemen LNG contract, one ship on short-term charter to BG, and one ship on short-term charter to Woodside.

In 2014, one of the LNG contracts will expire. In 2015, there are two expiries; 2016: one expiry; 2017: two expiries; and 2018: one expiry. Hence, over the next five years, there will be seven LNG contract expiries out of the current 27 LNG contracts (representing 26% of ships).

The first four expiries in 2014-16 will likely be renewed by Petronas, we believe, for redeployment to the Australian Gladstone project, which Petronas has a 27.5% stake. However, the renewal is likely to be at rates below those currently enjoyed by MISC, for two reasons.

First, the ship contracts that are about to expire in the next five years were signed in the mid-1990s and have a lucrative daily TCE of US$100,000/day or higher, against more recent 2006-07 contracts that have a TCE of US$65-70,000/day, which we believe approximates the current rates for long-term time charters that are signed today.

Second, when these four ships are renewed upon their expiry in 2014-16, they will already be 20 years old each, meaning that these vessels are not the most fuel efficient, and Petronas will not renew them at the prevailing long-term time charter rate of US$65-70,000/day that owners of new vessels are asking for.

In short, we think that MISC may have to settle for a renewal time charter rate of some US$50,000/day for the four ships that are reaching the end of their current 20-year charter in 2014-16. This is only half the current rate of US$100,000/day that we think these ships are presently enjoying.

Separately, we are unclear if the three ships in 2017-18, that are also reaching the expiry of their current contracts will be renewed. We think that two will not be renewed, but one will be renewed at half the rate it is currently enjoying now.

The net result of 1) the renewal of contracts for five of the seven ships described above at half the present rates, and 2) the non-renewal for the remaining two ships, is the potential reduction of MISC’s LNG division revenue by 20% between 2013 (one year before the first expiry) and 2019 (one year after the last expiry). These are our own internal estimates, as MISC does not provide much detail.

Therefore, MISC needs to sign the contracts for the eight new LNG ships in order to make up for the difference, and allow for growth in the LNG division earnings. Since this option has now been removed by Petronas, we expect MISC’s LNG division revenues and profits to start declining from 2014 onwards. Our model currently reflects stable LNG earnings until the end of our forecast period in 2015. As this assumption is now not likely to be reasonable, we will reflect the new realities in a future update.

Valuation and recommendation
We retain our Underperform recommendation on MISC, with an unchanged SOP of RM6.20. Our target price of RM4.35 is based on an unchanged 30% discount to the SOP, as we believe that there are few catalysts for the stock, and the petroleum tanker and chemical tanker businesses will continue to incur losses in the medium term – especially when the economic slowdown in China will moderate demand growth for crude oil and chemicals, and as the US continues to ramp up its domestic shale oil output that is replacing the import of sweet crude oil from overseas.

MISC’s share price has done well since the termination of the Petronas general offer, and the stock’s subsequent re-inclusion into the FBM KLCI in July. This stock hit a one-year high of RM5.85 on 23 July, narrowing the gap to its SOP of RM6.20 to only 5.6%. This was driven by investors' expectation that MISC’s earnings in the next 3-5 years will be boosted by the signing of the eight new LNG shipping contracts with Petronas. Since this assumption is no longer valid, and in the absence of any other catalysts, we believe that MISC’s share price should once again reflect a large discount to its underlying SOP. The share price dropped to as low as RM3.94 on 4 December 2012, or a 36% discount to SOP. We expect the stock to trade down in that direction, in view of the very unexpected twist in MISC’s relationship with its erstwhile supportive parent, Petronas.

Source/Extract/Excerpts/来源/转贴/摘录: CIMB-Research,
Publish date: 02/08/13

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