KENCANA — Marginal marvels

Kencana Petroleum Bhd
(Jan 6, RM2.57)
Initiating coverage with a buy call at RM2.52 and RM3.10 target price: We foresee that Kencana will feature prominently in Petronas’ domestic agenda. Enhanced oil recovery (EOR) and marginal field development under the government’s Economic Transformation Programme (ETP) are areas of growth for Kencana. We see Kencana: (i) expanding its yard space; (ii) growing its offshore units; and (iii) seeking strategic tie-ups to grow its income base while remodelling its business model to capture new opportunities. Evidently, Kencana has the balance sheet and management drive to gain from all this.

Prospects are bright for Kencana to ride on Petronas’ domestic E&P programme. With 25 marginal fields identified and 10 fields ready for development, we expect Kencana to profit from these programmes from 2011 via stronger offshore engineering (E&C) and marine engineering works. Kencana’s order book visibility is strong and sustainable, with opportunities in the shallow, marginal and JDA fields.

With projects picking up, we see Kencana expanding its yard space to capture growing opportunities in the offshore and marine engineering segment.This means Kencana could sustain a high RM2 billion job win per year for FY11/12. In addition, we also see Kencana: (i) seeking tactical tie-ups; (ii) prospecting for strategic assets; and (iii) remodelling its business into a hybrid service provider as it further develops in marginal field areas.

We project a three-year net profit compound annual growth rate of 26%, fuelled by a strong outstanding order book (RM1.9 billion as at December 2010) and tender pipeline visibility. The proposed corporate exercises: (i) a 10% private placement of new shares; and (ii) RM350 million Islamic securities to raise RM700 million to RM800 million denote growth; and position Kencana to capture increasing domestic opportunities in the EOR and marginal fields whilst keeping net gearing level at less than 1 time.

We tactically value Kencana at RM3.10, based on 20 times CY12 earnings per share. Our valuations appear aggressive, being at the higher-end, but are not excessive in a capex-fuelled, order book-driven environment. The sector has hit 26 times in the previous upcycle and we reckon it is just at the beginning of another cycle. — Maybank Investment Bank Bhd Research, Jan 6