PP 7767/09/2010(025354)

Malaysia Corporate Highlights

RHB Research
Institute Sdn Bhd
A member of the
RHB Banking Group
Company No: 233327 -M

Sector Upda te
21 May 2010
MARKET DATELINE

Oil & Gas Recom : Overweight

(Maintained)
Fabricators To Ride On Stronger Contract Flows In
2H10

Table 1 : Oil And Gas Sector Valuations

Fair EPS EPS growth PER P/NTA P/CF GDY
Price
FYE value (sen) (%) (x) (x) (x) (%) Rec
(RM/s) (RM/s) FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY10 FY10
Wah Seong Dec 2.30 3.09 19.3 20.8 46.1 8.0 11.9 11.0 2.7 4.3 3.3 OP
Dialog Jun 1.04 1.29 6.4 9.3 -3.4 45.4 16.3 11.2 4.1 14.2 3.4 OP
EPIC Dec 1.56 2.69 26.9 27.2 7.9 1.1 5.8 5.7 0.8 4.1 6.0 OP
Kencana July 1.39 1.88 10.2 11.7 42.9 15.0 13.6 11.8 2.7 10.1 0.5 OP
SapuraCrest^ Jan 2.01 2.66 16.6 18.4 40.9 10.3 12.1 11.0 1.7 5.2 2.0 OP
P Gas^ Mar 9.76 10.71 62.6 64.4 31.6 2.9 15.6 15.2 3.0 10.5 6.8 MP
Petra Perdana Dec 1.25 1.00 8.0 17.1 -18.5 +>100 15.6 7.3 0.7 1.4 1.6 UP
KNM Dec 0.52 0.51 3.9 6.9 4.2 75.5 13.1 7.5 10.2 11.3 3.9 UP
Sector Avg 24.5 13.9 14.2 12.5
Sector Avg (excl Pet Gas) 22.2 28.7 12.3 9.6
^ FY10-11 valuations refer to those of FY11-12

♦ Development of deepwater fields to spur demand for maintenance Table 2. Basis For Fair Value Estimates
and fabrication works. The focus on developing deepwater fields over Company Valuation Basis
the next six years, led by various oil majors’ participation in the Dialog Target PER of 16x CY10,
exploration and development activities in Malaysian waters, would mean premium to the sector
benchmark due to good
increasing demand for Malaysian maintenance and fabrication works.
management and robust
According to industry sources, Petronas expects to construct 60 new oil & balance sheet.
gas platforms over the period of 2010-15, driven mainly by new EPIC Target FY10 PER at 10x to
deepwater fields coming onstream. factor in flatter growth and
smaller market cap.
Kencana Target CY10 PER at 16x,
♦ Stronger contract flows from Australia’s LNG projects. We
premium to the sector
understand that there are currently eight greenfield liquefied natural gas benchmark due to improved
(LNG) projects under the five-year development plan in deepwater earnings visibility and above-
Western Australia which collectively cost around US$3.7bn. industry earnings growth.
KNM Target FY10 PER at 13x in
line with sector benchmark.
♦ Moving up the value chain. We are positive on fabricators that move Petra P’dana Target FY10 PER at 13x for
up the value chain, i.e. shifting from fabrication of jackets and topsides to marine, plus share of Petra
drilling rigs and FPSO. Furthermore, given the bulk of fabricators’ Energy’s FV at 11.7x.
business is from EPCC or EPCIC (Engineering, Procurement, Construction, PetGas DCF
SapCrest Target FY01/11 PER at 16x,
Installation and Commissiong) works, which are non-recurring, we favour
premium to the sector
companies that are increasing recurring income from activities such as benchmark due to improved
drilling services and chartering of offshore marine support vessels as well earnings visibility and above-
as maintenance services. industry earnings growth.
Wah Seong Target FY10 PER at 16x,
premium to the sector
♦ Risks. The risks include: 1) Cyclical downturn in crude oil prices; 2) benchmark due to improved
Competition from China; 3) Overseas contracts; and 4) Steel costs. earnings visibility and above-
industry earnings growth.

♦ Investment case. While sizeable contract awards were still minimal in

Source: RHBRI

1Q 2010, we believe contract flows will pick up more substantially in the Wong Chin Wai
2H given the gradual pick up in energy demand as well as increased (603) 92802158
reserve replenishment activities by national oil companies and major E&P wong.chin.wai@rhb.com.my
players. In the longer term, we reiterate our view that the continued
shortage of offshore E&P assets (exacerbated by delays in E&P spending)
will underpin growth for the support services companies. Hence, we Yap Huey Chiang
(603) 92802171
reiterate our Overweight stance on the sector.
yap.huey.chiang@rhb.com.my

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 Outlook

♦ Final decision on developments to pick up in 2H 2010. While delays in final investment decisions on major
projects have persisted in 1H 2010, we believe E&P spending would pick up momentum in 2H 2010 given the
gradual increase in crude oil price as well as stabilisation of project costs. According to industry sources, 2010
global E&P spending is likely to increase 10-15% yoy (vs. -15% yoy in 2009) driven mainly by recovery in US and
Canada spending (i.e. non-conventional projects such as oil sands and shale gas) as well as resilient spending in
Asia, Africa, Russia and Middle East.

♦ Development of deepwater fields to spur demand for maintenance and fabrication works. The focus on
developing deepwater fields over the next six years, led by various oil majors’ participation in the exploration and
development activities in Malaysian waters, would mean increasing demand for Malaysian maintenance and
fabrication works. According to industry sources, Petronas expects to construct 60 new oil & gas platforms over
the period of 2010-15, driven mainly by new deepwater fields coming onstream (see Table 3). Furthermore, we
expect higher demand for offshore maintenance ahead given that 60% of the 225 oil rigs owned by Petronas
(135 platforms) and ExxonMobil (90) are more than 10 years old and should be replaced with new ones or
refurbished to extend their operating life. We highlight that deepwater E&P activities would likely pick up
momentum going forward as declining production in more mature oilfields will have to be offset by resources that
are increasingly located in frontier areas.

Table 3: Deepwater/Ultra Deepwater Discoveries In Malaysia

Field Operator Water Depth Recoverable Onstream Date

(m) (mmboe)

Kikeh Murphy Oil 1,300 536 2007

Gumusut-Kakap Shell 1,100 620 2011

Malikai Shell 480 108 2011

Kebabangan ConocoPhillips 190-295 414 2011

Jangas Murphy Oil >1,000 81 2012

Pisangan Shell >1,000 56 2012

Ubah Crest Shell >1,000 215 2014

Kamunsu Shell >1,000 2701 2016

Source: Various

♦ Stronger contract flows from Australia’s LNG projects. We understand that there are currently eight
greenfield liquefied natural gas (LNG) projects under the five-year development plan in deepwater Western
Australia which collectively cost around US$3.7bn. Going forward, we expect higher capex spending by major E&P
players (i.e. Chevron, Shell, Woodside, ConocoPhillips and Hess) in Western Australia given that the region
accounts for 73% of Australia’s natural gas production and 64% of oil and condensate output. We highlight that
the key beneficiaries to the growing deepwater E&P spending in Western Australia would include Kencana
(fabrication of offshore platforms and structures), Petra Perdana (i.e. charters for larger AHTS with bigger engines
and stronger bollard pull to operate in deepwater locations), KNM (process equipment), SapuraCrest (pipelay)
and Wah Seong (pipe coating). Note that Kencana and Wah Seong have already secured sizeable contracts for
the Gorgon LNG project i.e. fabrication of offshore structures (worth RM166m) and pipe coating (US$163m)
respectively.

Malaysia Fabricators

♦ Still have excess capacity. Post acquisition of Ramunia’s fabrication yard (in Teluk Ramunia), Sime Darby
Engineering is now the largest Petronas-licensed major fabricator (for offshore structures). We believe the total
available capacity of around 283,900 tonnes is more than required for Malaysia jobs and this suggests that
players have to bid for overseas jobs to further boost utilisation rate (see Table 4).

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 21 May 2010

Table 4: Holders Of Petronas Fabrication Licences

Licence Holder Location Capacity (tpa) Land (Acres) Remarks

Sime Darby Pasir Gudang, Johor 52,700 114 Post acquisition of Ramunia’s
Engineering fabrication yard, the company expects
Teluk Ramunia, Johor 55,000 170 to secure a sizeable fabrication contract
from Petronas by 2H2010.

MMHE Pasir Gudang, Johor 69,200 160 Stronger margin ahead given higher
contribution from higher-margin FPSO
conversion projects as well as on-going
yard optimisation project at Pasir
Gudang yard.

Kencana HL Lumut, Perak 48,000 135 With the upgrade in the Lumut yard
(i.e. tonnage handling capability
increased to 30,000 tonnes from
20,000 tonnes previously) nearing
completion, we believe Kencana stands
a good chance of securing higher-
margin deepwater jobs.

Oilfab Pulau Indah, Port Klang 16,000 60

Boustead Penang Pulau Jerejak, Penang 9,000 26

Shipyard

Brooke Dockyard & Sejingkat, Sarawak 5,000 54

Engineering Works

Total 283,900 719

Source: Company

♦ Moving up the value chain. We are positive on fabricators that are moving up the value chain, i.e. shifting from
fabrication of jackets and topsides to drilling rigs and FPSO.

1) Kencana- fabrication of tender rigs. Recall that Kencana recently completed the MKR-1 fabrication and is
expected to perform the 5+5 years PCSB contract worth RM827.2m beginning July 2010. Note that MKR-1 is
the largest shallow water tender rig ever to be built in Malaysia. According to management, fabrication of rigs
has a gross margin of around 18-20% (vs. typical fabrication jobs of 13-15%). Further out, we believe
Kencana would be able to fetch a higher margin plus achieve a shorter turnaround time (vs. 10 months
currently) for its second rig (i.e. MKR-2) given the experience and know-how gained during the construction
of MKR-1. Nevertheless, fabrication work for the second rig has been temporarily suspended pending clearer
visibility of the PSC’s drilling requirement.

2) MMHE – FPSO conversion. MMHE’s current orderbook stands at around RM6.4bn, with 30-40% comprising
higher-margin FPSO (floating production, storage and offloading) conversion projects. We believe that MMHE
would be the key beneficiary to the MISC fleet (i.e. FPSO, FSO and FPS) expansion programme as well as
stronger rebound in the FPSO market. We note that the increase in deepwater E&P activities coupled with the
exponential technological developments in subsea production have encouraged the widespread proliferation
of FPSOs as the development and production scheme of choice for fields without the immediate access to
production infrastructure.

♦ Shifting to higher recurrent income business. Given that the bulk of fabricators’ business is from EPCC or
EPCIC (Engineering, Procurement, Construction, Installation and Commissiong) works, which are non-recurring,
we favour companies that are planning to increase recurring income from activities usch as drilling services and
chartering of offshore marine support vessels as well as maintenance services.

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Table 5: Fabricators’ Recurrent Income Business

Companies Business Remarks

Kencana Drilling services MKR-1 is expected to begin operating under the 5+5 years PCSB
contract worth RM827.2m beginning July 2010. Management guided
that projects would be profitable as long as charter rates stay above
US$100k.

Marine services Recently, Kencana secured a 1 + 1 contract worth RM33m to provide

an offshore support vessel to Petronas Carigali Vietnam. We
understand that its 8k AHTS (KPV Gemia), which Kencana took
delivery two weeks ago, will be deployed for the contract. The
contract sum suggests that an average long-term charter rate of
around US$1.63/HP/day vs. spot charter rates of US$2.1/HP/day.

MMHE Marine repair The company expects FY03/11 margin to improve on the back of
stronger contribution from higher-margin marine repair services
stemming from increased dry-docking activities for MISC tankers.
Note that marine repair services margin is 10-15%-pts higher than
the fabrication business.

BHIC Maintenance services Management expects FY12/10 revenue contribution from

maintenance services to increase by 150% driven mainly by two
major contracts (i.e. Scorpene submarines and six patrol vessels).
While management is guiding for a pre-tax margin of 10%, we note
that this could be conservative given that cost component of
maintenance is mainly labour and does not include spare parts and
raw materials. We believe maintenance margin could easily reach 20-
25% (vs. fabrication margin of around 10%).

Source: RHBRI, various

♦ Venturing into overseas markets. Recently, India launched its auction of 70 exploration blocks for exploration
and development of oil & gas fields to meet rising fuel demand in the country. The latest development bodes well
for oil & gas service providers especially those with a track record in India (i.e. Sime Darby Engineering and
Kencana). We note that more than 70% of Sime Darby Engineering’s current orderbook of RM560m comprises
offshore platform fabrication jobs from India. Furthermore, we understand that Kencana is actively bidding for a
sizeable contract from India, Myanmar and Vietnam. While the domestic market remains important (on the back
of Petronas and PSCs’ sustainable E&P activities), local major fabricators would continue to pursue overseas
contracts to boost its utilisation rate as well as to diversify its earnings base.

♦ Positioning for higher-margin jobs in Malaysia waters. We highlight that the opening of deepwater fields
beginning with Kikeh (in 4Q08) and the ongoing Gumusut Kakap project would drive demand for subsea
equipment. Given the high abandonment cost for deepwater fields (i.e removal of surface infrastructure and
plugging of wells), subsea equipment which are designed for the life of the field have been preferred by oil
producers. We understand margins for these jobs are significantly higher, as subsea equipment (i.e. flowlines,
manifold, jumper and riser) cost is small compared to the overall development costs and any mechanical failures
due to quality issues will result in significant loss to oil producers. We highlight BP’s recent accident at one of its
production platforms in the US Gulf has already wiped out £25bn in market value.

Risks and Mitigating Factors

♦ Cyclical downturn in crude oil price. With investment hurdle rates for deepwater or ultra-deepwater of around
US$40-55/barrel (vs. shallow water of US$25-35), we believe any drop in crude oil prices could potentially lead to
project cancellation or deferment. Nevertheless, with crude oil price hovering around US$70-85/barrel for the
past 26 weeks since 18 Oct 2009, we believe the gradual uptrend in 2010 would be driven by expectations of an
economic recovery and higher oil consumption in the future despite still-weak demand and high inventories
currently.

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 21 May 2010

♦ Competition from China. While Chinese yards today are at where the South Korean yards were 25 years ago in
terms of competency and quality, we believe Chinese players will gradually emerge as strong competitiors for
higher-margin fabrication (such as tender rigs and semisubs) jobs given the experience they gain from building
jack-up rigs for cost-sensitive smaller E&P players. Following the trend led by Aker Solutions and Petrofac, state-
owned Saudi Aramco is looking to set up a jv with fabricators to establish an offshore and supply base in China
given low labour cost and huge yard capacity as well as easy access to sea transport. Nevertheless, we believe
major E&P players’ preference for established yards remains intact over the medium term given their proven
track record, resources and experience to build customised rigs and vessels (i.e. tender rigs and FPSO).

♦ Overseas contracts. While contracts from India and Middle East remain strong, we highlight the risk of potential
margin erosion stemming from intense competition and cost overruns. We believe the still-low E&P spending in
the near term could intensify competition for limited amount of jobs. Furthermore, overseas projects tend to have
higher operation (i.e. disruption in raw material supplies and high overhead cost) and contract risks (project
deferment, change orders, delayed progressive billings, charges due to delays in delivery), which in turn could
result in cost overruns and massive write downs.

♦ Steel costs. In general, rising steel prices pose a threat to fabricators’ margins given that significant amount of
steel is used for fabrication works. We estimate that steel costs account for 25-35% of fabricators’ total cost.
Majority of steel materials are sourced from overseas (i.e. Japan, South Korea, Russia and China) as locally
produced steel materials are not suitable for use in the oil and gas industry (mainly due to higher specification
required i.e. API standard). Furthermore, customers often specify the type and source of steel to be used for their
projects. While major fabricators can easily pass on increases in raw material costs to its customers, we highlight
the risk of losing out to more aggressive smallish competitors.

VALUATIONS AND RECOMMENDATION

♦ Recent underperform. We note that the YTD share price of the O&G stocks has underperformed the FBM KLCI
index by 7.5%. We believe this is mainly due to the uninspiring contract awards from Petronas and its PSCs as
well as a slew of negative news flows (i.e. setback in Wah Seong’s bid for Socotherm pipe coating assets and
termination of Kencana’s jv with Global Offshore). Nevertheless, we highlight that while sizeable contract awards
were still minimal in the Jan-May 2010 period, we believe contracts will likely pick up more substantially in 2H
2010 given the gradual pick up in energy demand as well as increased reserve replenishment activities by
national oil companies and major E&P players.

Table 6 : Share Price Performance

Current Current
Bloom- Current Price Vs Price Vs
berg 6-Mth 6-Mth Share 6-Mth 6-Mth FY10 FY11
No Companies Ticker Date High High Date Low Low Price High Low PER* PER*
(RM) (RM) RM (%) (%) (x) (x)

1 Dialog DLG MK 6-Apr-10 1.17 21-Dec-09 0.90 1.04 -11.2 15.5 17.9 14.1
2 Kencana KEPB MK 20-Jan-10 1.75 22-Dec-09 1.31 1.39 -21.1 5.3 14.2 11.4
3 KNM KNMG Mk 17-Feb-08 0.82 20-May-10 0.51 0.515 -37.8 0.0 9.4 7.4
4 P’Perdana PETR MK 7-Jan-10 1.76 21-Dec-10 1.23 1.25 -30.1 0.0 10.7 6.5
5 P’Dagangan PETD MK 12-May-09 9.12 8-Feb-10 8.55 8.94 -2.3 4.2 11.8 11.2
6 Wah Seong WSC MK 5-Apr-10 2.75 19-Feb-10 2.27 2.30 -16.7 0.8 11.9 11.3
7 S’Crest SCRES MK 29-Dec-09 2.53 19-May-10 1.97 2.01 -17.8 5.6 12.0 11.0
8 Coastal COCO MK 8-Mar-10 2.63 16-Dec-09 1.91 2.33 -11.4 22.0 5.0 4.3
9 EPIC EPIC MK 14-Apr-10 1.68 24-Dec-09 1.44 1.56 0.0 83.0 5.7 5.5
10 Alam AMRB MK 6-Apr-10 1.97 19-May-10 1.62 1.73 -7.1 6.2 7.6 6.8
11 T’Offshore TOFF MK 15-Jan-10 1.25 25-Nov-09 0.95 1.04 -16.0 10.5 7.3 5.7
* Consensus Estimates Extracted From Bloomberg
Source: Bloomberg

♦ SapuraCrest upgraded to Outperform. We believe that the current price weakness is an opportunity for
investors to buy into Sapuracrest for its superior earnings growth stemming from its all-time high orderbook of
RM7.4bn. Based on our unchanged target price of RM2.66, expected total return would be 32.3% vs. FBM KLCI’s
total return of 11.2%. As such, we are upgrading our recommendation to an Outperform (from Market Perform).

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 21 May 2010

♦ Reiterate Overweight. In the longer term, we reiterate our view that the continued shortage of offshore E&P
assets (exacerbated by delays in E&P spending) will underpin growth for the support services companies. Hence,
we maintain our Overweight stance on the sector. Our top picks for the sector are Dialog (FV=RM1.29/share)
and SapuraCrest (RM=RM2.66/share).

Table 7: Oil And Gas Fair Value Calculations

Share Price Fair Value Basis Of Valuation Rec
(RM/share) (RM/share)
Dialog 1.04 1.29 16x CY10 PER plus DCF for Kertih Terminals and TLP tank terminals at OP
WACC of 16.8%
EPIC 1.56 2.69 10x FY10 PER OP
Kencana 1.39 1.88 16x CY10 PER OP
Wah Seong 2.30 3.09 16x FY10 PER OP
SapuraCrest 2.01 2.66 16x FY01/11 PER OP
Petra Perdana 1.25 1.00 13x FY10 PER for operating earnings plus share of Petra Energy fair value UP
at 11.7x
KNM 0.515 0.51 13x FY10 PER UP
Petronas Gas 9.76 10.71 DCF with WACC of 9.6% MP
Source: RHBRI estimates

Chart 1: Dialog Technical View Point

♦ Along its uptrend that kicked off since late Oct
2008, the share price of Dialog had traded at above
the UTL.

♦ In Oct 2009, when the stock consolidated sideways

at just above the RM0.89 level, it headed towards
the UTL again before scaling higher along the line
to the RM1.06 resistance level.

♦ When it finally managed to remove RM1.06 in Mar

2010, it launched a final push to a high of RM1.18
in Apr. But, it subsequently fell to below RM1.15, to
trigger a consolidation move.

♦ As the stock eased towards the RM1.06 critical

level, its 10-day SMA has weakened to below the
40-day SMA in recent trading to highlight a
potential medium-term retracement ahead.

♦ It fell to below RM1.06 yesterday, to confirm a

derailment of the UTL and a bearish “dead cross”
signal on the 10-day and 40-day SMAs.

♦ Chat wise, we expect further correction ahead

towards the RM0.89 support in the near term in its
share price. Immediate resistance is seen at
RM1.06.

IMPORTANT DISCLOSURES

This report has been prepared by RHB Research Institute Sdn Bhd (RHBRI) and is for private circulation only to clients of RHBRI and RHB Investment Bank
(previously known as RHB Sakura Merchant Bankers). It is for distribution only under such circumstances as may be permitted by applicable law. The opinions
and information contained herein are based on generally available data believed to be reliable and are subject to change without notice, and may differ or be
contrary to opinions expressed by other business units within the RHB Group as a result of using different assumptions and criteria. This report is not to be
construed as an offer, invitation or solicitation to buy or sell the securities covered herein. RHBRI does not warrant the accuracy of anything stated herein in any
manner whatsoever and no reliance upon such statement by anyone shall give rise to any claim whatsoever against RHBRI. RHBRI and/or its associated persons
may from time to time have an interest in the securities mentioned by this report.

This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives
of persons who receive it. The securities discussed in this report may not be suitable for all investors. RHBRI recommends that investors independently evaluate
particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or
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investment banking and financial advisory services. In the ordinary course of its trading, brokerage, banking and financing activities, any member of the RHB
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The research analysts, economists or research associates principally responsible for the preparation of this research report have received compensation based
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The recommendation framework for stocks and sectors are as follows : -

Stock Ratings

Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.

Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or
more over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take
on higher risks.

Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months.

Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months.

Industry/Sector Ratings

Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

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