Regional Industry Focus Offshore & Marine Regional Industry Focus Offshore & Marine Page 3 INVESTMENT SUMMARY Structural issues make forecasting a more difficult affair this time around.

www.dbsvickers.com

ed: JS /TH / sa: TW

Bracing for a new wave of M&A Base forecast for Brent crude price : US$55-65/bbl in

2015 and US$65-75/bbl in 2016

Downside risks priced in; watch for inflexion points

Theme #1: Survival of the fittest – Ezion

Theme #2: M&A plays – Ezion, Ezra, Triyard, Dyna-Mac, BakerTech, SapuraKencana and Dayang

Watch for 2H recovery. Our new base case forecast for Brent crude price for 2015/2016 are US$55-65/bbl and US$65-75/bbl respectively. Volatility will prevail in the near term, though we expect some rebound in prices in 2H as production cut filters through.

Downside risks priced in; watch for inflexion points. Most of the bad news is known already - capex cuts, declining rig counts, falling charter rates and utilisation, contract terminations /renegotiations, and earnings disappointments. The spiralling effect is likely to continue in the next few months, but these may be largely been priced in. The key inflexion point is production cuts expected from 2H15. Empirically, the supply side of the equation has a bigger bearing on oil price recovery following the steep slide.

Investment theme #1 Survival of the fittest: We devised a scorecard to determine the long term winners among smaller cap OSV providers who would be able to better withstand the current climate, in conjunction with current valuation levels (details inside). We prefer players with exposure to the resilient shallow water segment and production phase, and have a sound strategy, favourable asset mix, proven track record, and healthy balance sheets. Our top pick is Ezion. Quality OSV operators like POSH and Pacific Radiance should be among the first to benefit in an oil price rebound scenario but near term earnings are expected to remain weak, thus limiting share price upside potential.

Investment theme #2 M&A plays: The plunge in oil prices is set to fuel another wave of mergers and acquisitions, as major players shed non-core assets and smaller companies merge in an attempt to scale up and survive. We identify some potential takeover targets to be Ezion, Dyna-Mac and Ezra Group companies like Triyards and EMAS Offshore. In Malaysia, SapuraKencana and Dayang are on acquisition trails. Companies with high cash hoards such as Baker Tech are good privatisation candidates. We do not rule out M&A possibilities among Singapore shipyards to boost competitiveness amidst rising competition from Korea and China.

For an in-depth sector discussion, please click here Analyst Janice CHUA +65 6682 3692 Suvro SARKAR +65 6682 3720 [email protected] [email protected]

HO Pei Hwa +65 6682 3714 Arhnue TAN +603 2604 3909 [email protected] [email protected]

STOCKS

Prices as of 17 April 2015

Source: DBS Bank, DBS Vickers, AllianceDBS

DBS Group Research . Equity 20 Apr 2015

Regional Industry Focus

Offshore & Marine

Refer to important disclosures at the end of this report

Price Mkt Cap Target Price Performance (%)

S$ US$m S$ 3 mth 12 mth Rating

Singapore Sembcorp Marine 3.08 4,779 2.89 4.8 (24.7) HOLD Yangzijiang 1.41 4,014 1.62 11.9 29.4 BUY Cosco Corporation 0.58 957 0.49 8.5 (19.6) FV Ezion Holdings 1.24 1,448 1.58 6.9 (32.0) BUY PACC Offshore 0.52 696 0.50 (1.0) N.A HOLD Pacific Radiance 0.74 396 0.78 0.0 (31.3) HOLD Nam Cheong Ltd 0.34 522 0.36 4.7 (5.6) HOLD Vard Holdings Ltd 0.58 508 0.51 12.6 (44.8) FV Mermaid Maritime 0.28 289 0.27 (5.2) (45.5) HOLD Indonesia Wintermar Offshore 510 160 730 (25.6) (41.0) HOLD Logindo 2,140 107 2,460 (2.5) (39.7) HOLD Malaysia Coastal Contracts 3.03 443 3.35 13.9 (38.8) BUY Deleum Bhd 1.76 194 1.60 2.3 (30.4) HOLD Pantech Group 0.77 126 0.95 2.7 (23.5) BUY Sapura Kencana 2.72 4,485 2.55 8.8 (36.3) HOLD Bumi Armada 1.16 1,873 1.15 (3.3) (52.5) HOLD Dialog Group Bhd 1.66 2,308 1.65 5.1 (6.5) HOLD Malaysia Marine & Heavy Eng

1.28 564 0.90 (3.8) (66.5) FV

Dayang Enterprise Holdings

2.57 620 2.85 (5.2) (30.5) HOLD

UMW Oil & Gas 2.40 1,428 2.15 (7.7) (38.0) FV


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Analysts Janice CHUA +65 6682 3692

[email protected]

Suvro SARKAR +65 6682 3720

[email protected]

HO Pei Hwa +65 6682 3714 [email protected]

Arhnue TAN +603 2604 3909

[email protected]

Table of ContentsInvestment Summary 3 Is it time to revisit O&G stocks? 4 Is there more downside to earnings? 7 Investment Themes #1: Survival of the fittest 8 #2: M&A plays 11 Rigbuilders struggling at the deep end 14 Stock profiles 17 Oil Price Forecasts 28 Base case scenario forecast for oil prices The demand supply game What has happened and what does history tell us? Critical issues that will affect the oil price scenario What Does History Tell Us? 34 The Critical Issues Now 35 Conclusion 55

Appendices 58 I - What is Regression? II – Regression of Rigbuilders’ PE III - Scorecard Details IV – Qualitative Analysis


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INVESTMENT SUMMARY Structural issues make forecasting a more difficult affair this time around. We believe that over the last few years, global oil markets have been changing and becoming harder to forecast. We highlight some of these issues in more detail inside.

1. Response of OPEC – what to expect and why? 2. How will the inventory buildup in the US and OECD

countries affect prices? 3. Is shale oil production in the US more resilient than

we think? 4. Structural changes in the global economy – less oil

intensity and demand elasticity to oil prices? 5. China – how much of an impact will it continue to

have on global oil demand? 6. The rally in the US dollar – further negative impact

on oil prices? 7. Geopolitical issues – any unplanned outages or

supply resumptions on the horizon? 8. Will global O&G capex reductions affect the long

term picture? Oil price volatility will prevail near term, though we can expect some rebound in the medium to long term. Unfavourable trends on both the supply and demand fronts in the near term, as well as the strong US$ will prevent oil prices from breaking out before 2H15. As storage capacities in OECD countries near peak levels, there could be high price volatility in the market from spillover fears, until we see production cuts. While we are tempted to call a market bottom for oil prices at US$45/bbl as seen in January 2015, we are not ruling out the odd wobble here and there over the course of the next few months. Base case forecast of US$55-65/bbl in 2015 and US$65-75/bbl in 2016. At this point, we are reasonably confident that oil prices will not tank and stay at lower levels for long, as we do not expect OPEC to maintain production levels for an indefinite time at prices below US$40-50/bbl. This would be asking too much from some of the weaker member nations. From 2H15 onwards, we expect some production cuts to kick in and support oil prices. But, in the absence of a strong demand push, the recovery in prices could be a tepid affair at best.

Thus, our base case forecast for oil prices for the rest of 2015 is US$55-65/bbl. For 2016, we project oil prices to recover to US$65-75/bbl. How quickly and how much can oil prices recover? On average, oil prices have empirically been slow to recover to pre-crisis levels, hovering at 50-80% of pre-crisis levels for the 12 months following an oil price bottom. The only outlier was the 1997-98 crisis, when a coordinated response by the OPEC producers to cut production had a strong impact on oil prices. Hence, it seems a recovery in demand does help to an extent but the supply side of the equation has a bigger bearing on oil price recovery following a steep slide. In the current scenario, the uncertainty regarding OPEC’s response does not bode well for a sharp oil price recovery. Time to bottom-fish oil and gas stocks? Value is emerging as the market is pricing in the negatives that is currently plaguing the sector. While we anticipate that negative industry-wide newsflow will continue to flow ranging from contract terminations, falling utilization and charter rates to earnings disappointments that would dampen sentiment further in next few months, investors may look to bargain hunt companies with strong fundamentals or M&A potential. Theme #1: Survival of the fittest. Against the backdrop of relatively weak oil prices in the next two years, uncompetitive O&G players may go bust. We devised a scorecard to determine the long term winners among smaller cap OSV providers, in conjunction with current valuation levels (details inside). Our top pick is Ezion (BUY; TP S$1.58). SapuraKencana (HOLD; RM2.55) would be the stock to watch for an upgrade in the event of crude oil price recovery given its upstream exposure. Avoid rigbuilders. Theme #2: M&As back in play. The plunge in oil prices is set to fuel a new wave of mergers and acquisitions in the 2H15, as majors shed fringe assets and smaller companies merge in an attempt to survive. We identified potential takeover targets to be Ezion, Ezra, Dyna-Mac and Triyard. SapuraKencana and Dayang are set on acquisition trails. Companies with high cash hoards such as Baker Tech are good privatisation candidates.


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IS IT TIME TO REVISIT O&G STOCKS? Downside risks are diminishing... Barring a complete collapse of the global economy, we believe downside catalysts for the oil and gas sector are fading. Most of the bad news is already out there:

1) Surging non-OPEC supply especially from the U.S.; 2) OPEC's refusal to cut production; 3) Slower-than-expected global economic growth (and

hence energy demand); 4) Greater energy efficiency; 5) Strengthening USD; 6) Iran’s potential lifting of sanctions

… and largely priced in. Investors are no longer viewing the sector with rose-coloured glasses, but are prepared for volatile and relatively low oil prices for the next 12-24 months. The new lower norm of oil prices has brought about capex and opex cuts by oil majors, translating to a plunge in rig count, and therefore terminations and renegotiations of rig charter contracts, thereon to declining charter rates and utilisation for both rigs and support vessels, and phasing out of less competitive players eventually. No doubt such news will continue to flow in the coming months, but we believe these are largely reflected in the stock prices. O&G stocks have lost 40-50% of their market cap. On average, market cap of oil & gas names have halved over the past 6 months. For Singapore companies, we note that stocks had lost almost 70% of their values during the GFC crisis. However, we do not think that stocks will test GFC levels this time around, given that operating conditions are better in terms of overall macro and oil demand outlook as well as access to funding as compared to the global recession during the GFC. Hence, it is also probably fair to look at relative stock price performances to the various indices instead of absolute price performance. On that front, underperformance of O&G names is greater this time round compared to during the GFC.

O&G stocks tumbled c.40-50% from Sept’14 to Mar’15;

signs of price recovery since Mar’15

Source: Bloomberg Finance L.P. Finance L.P, DBS Bank Regression analysis supports our argument. We have run a linear regression to examine our hypothesis that O&G stocks should not test GFC levels despite similar oil price levels. We regress rigbuilders’ PEs to oil price and STI PE given that oil price is the key leading indicator of rigbuilding activities and STI’s valuation would reflect overall market and macro conditions. According to our analysis, Rigbuilders’ PE = -8.1492 + 0.052*Oil Price + 1.0968*STI PE

Thus, at current oil price level, Singapore rigbuilders look fairly priced at c.10x PE.

Please refer to Appendix I and II for more details on our regression analysis.

Share price performance GFC Sept'14 - Mar'15

Mar'15 - Current

STI -44% 1% 4% EZRA -83% -63% 19% Pacific Radiance na -58% 21% VARD na -58% 43% Ezion -67% -49% 31% POSH na -49% 12% Mermaid -80% -43% 25% Cosco Corp -78% -34% 22% Nam Cheong -56% -34% 16% ASL Marine -64% -29% 0% Sembcorp Marine -71% -24% 5% Yangzijiang -63% 5% 11% Average -70% -40% 29% Relative performance to STI -26% -41% 24%

JCI -46% 5% 4% Logindo na -57% 5% Wintermar na -52% 6% Average na -54% 6% Relative performance to JCI na -59% 2%

KLCI -26% -3% 2% MMHE na -65% 11% SapuraKencana na -47% 19% Bumi Armada na -45% 15% UMW O&G na -45% 11% Coastal Contract -53% -44% 6% Dayang Enterprise -38% -35% 13% Deleum -41% -32% 12% Pantech Group -32% -29% 4% Dialog Group -50% -11% 6% Average -43% -39% 10% Relative performance to KLCI -17% -36% 8%


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Rigbuilders are trading close to 10x FY15F PE while SMC O&G names are trading at 5-10x PE after earnings downgrade

post oil price collapse Name Crncy Price DBS DBS Mkt

Cap PE EV/EBITDA Net Debt to

Ebitda EBITDA Margin

P/B ROE Net Pft

CAGR 17

Apr Target Price

Rec (US$m)

CY 15F

CY 16F

CY 15F

CY 16F

CY 15F

CY 16F

CY 15F

CY 156F

CY 15F

CY 15F

14-16

Singapore SMM SGD 3.13 2.89 Hold 4843 10.9 10.2 8.1 7.6 0.8 0.9 14.6 15.0 2.0 19.2 7.1 SCI SGD 4.78 4.80 Buy 6317 10.4 10.3 7.4 7.2 1.2 1.1 14.7 14.7 1.4 13.9 1.6 Yangzijiang SGD 1.41 1.62 Buy 4003 7.7 7.1 4.1 3.3 -1.3 -1.8 27.8 28.5 1.1 16.5 0.1 COSCO SGD 0.58 0.49 FV 962 33.8 26.1 15.3 14.7 9.2 9.2 9.9 11.6 0.9 2.8 54.3 Ezion SGD 1.225 1.582 Buy 1,433 5.5 4.5 6.6 5.1 2.9 2.1 82.9 80.1 1.1 21.3 34.3 Ezra SGD 0.485 0.510 Hold 364 34.6 10.9 10.6 9.3 7.5 6.6 11.9 13.1 0.3 6.4 57.3 Mermaid SGD 0.260 0.271 Hold 272 10.2 10.4 4.0 7.7 0.4 4.5 25.7 26.4 0.5 4.7 -28.2 Nam Cheong

SGD 0.345 0.357 Hold 536 6.7 6.6 8.6 7.9 2.7 2.2 14.5 14.8 1.4 21.9 -0.9

PACRA SGD 0.740 0.780 Hold 398 7.9 6.1 7.5 5.4 3.0 2.0 41.9 45.5 0.9 11.2 -2.6 POSH SGD 0.515 0.500 Hold 694 7.8 5.9 8.0 6.3 3.6 2.8 47.1 49.7 0.5 7.1 48.4 Vard SGD 0.600 0.505 FV 525 11.6 14.1 23.2 13.8 14.4 7.8 3.7 6.0 0.9 8.1 -9.2 Average 8.7 8.4 8.6 7.1 1.1 13.8 Malaysia Bumi Armada

MYR 1.17 1.15 Hold 1,889 16.4 11.9 8.2 7.1 3.0 2.8 59.2 66.6 1.0 6.2 62.3

Coastal Contracts

MYR 2.98 3.35 Buy 436 7.7 7.3 8.1 7.1 1.4 0.9 25.4 26.8 1.0 13.4 6.1

Dayang MYR 2.59 2.85 Hold 625 11.9 10.6 7.5 6.5 -0.5 -0.8 26.8 27.3 2.5 22.5 9.6 Dialog MYR 1.67 1.65 Hold 2,323 33.8 31.0 22.4 21.0 0.8 1.1 17.7 18.4 5.0 15.5 13.1 MMHE MYR 1.31 0.90 FV 577 23.2 24.8 11.4 11.1 -1.4 -1.6 9.2 9.4 0.8 3.4 -19.3 Perisai MYR 0.58 0.35 Sell 190 17.5 8.5 12.3 8.5 7.6 5.9 80.8 73.8 0.6 3.6 120.5 Sapura Kencana

MYR 2.68 2.55 Hold 4,421 14.3 13.4 11.9 11.4 5.8 5.6 26.9 28.7 1.2 9.0 -8.6

Average 15.6 13.4 10.2 9.1 1.5 10.5 Indonesia Logindo IDR 2,040 2,460 Hold 102 8.2 6.9 6.3 5.4 3.6 3.1 51.6 57.7 0.7 9.3 -13.5 Wintermar IDR 484 730 Hold 152 8.4 6.6 5.4 4.7 2.1 1.7 36.8 35.7 0.6 8.0 3.1 Average 8.3 6.7 5.8 5.1 0.7 8.6 Europe Bourbon EUR 18.23 NA NR 1,234 23.9 20.4 6.1 6.8 3.0 2.8 26.4 25.5 0.9 3.9 -6.8 Farstad NOK 38.00 NA NR 192 12.4 na na 8.1 7.1 7.9 32.2 30.0 0.2 1.1 269.4 Prosafe SE NOK 26.50 NA NR 789 3.6 4.3 4.8 4.5 3.4 4.2 54.6 50.5 0.9 24.7 -4.1 Siem NOK 2.69 NA NR 131 na na 6.1 7.6 7.2 8.4 34.6 33.4 0.2 1.7 na Solstad Offshore

NOK 49.50 NA NR 247 3.7 4.8 7.6 8.9 6.6 7.9 39.8 38.6 0.3 8.1 23.9

Average 10.9 9.9 6.1 7.2 0.5 7.9 US Tidewater USD 28.76 NA NR 1,286 8.1 15.2 15.8 7.8 3.5 4.5 27.0 24.8 0.6 6.0 -22.1 Hornbeck USD 24.73 NA NR 841 19.6 18.4 6.1 6.8 3.9 3.3 40.9 41.0 0.6 2.5 -29.7 SEACOR USD 77.65 NA NR 1,403 27.7 21.9 6.4 7.2 1.3 0.7 18.5 19.6 0.9 na -8.5 Gulfmark USD 17.38 NA NR 402 533.7 na 4.9 8.9 4.6 4.5 26.0 26.8 0.4 0.6 na Average 147.3 18.5 8.3 7.7 0.6 3.0

Source: Companies, Bloomberg Finance L.P., DBS Bank


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Peak of negative newsflows = bottom of cycle. In fact, we are approaching the peak of negative newsflows, which often marks the bottom of the downturn and stock prices. While there may be little reason to rush in the rocking boat as 1H15 is widely

expected to remain highly volatile, it is time to put O&G stocks on the radar and bottom-fish when opportunities arise.

Oil price is the leading indicator of energy stock performance; Energy stocks tend to underperform for 12 months post

oil price plunge in the demand-led case. Reason Decline

start date Px before fall

Lowest price

% fall

Oil Price after 12M

% price rise

% of original

S&P 500 performance in next 12M

Energy index performance in next 12M

Energy index relative performance

1991 Reaction to 1991 Gulf War, reversal of oil price spike

16/01/91 30.20 16.50 -45% 17.60 7% 58% 10% -6% -16%

1992-94 OECD

recessionary stretch

24/06/92 21.57 12.92 -40% 16.92 31% 78% 3% 1% -2%

1996-98 Asian financial

crisis, OPEC excess production

08/01/97 24.80 9.64 -61% 24.46 154% 99% 22% 14% -7%

2001 Recession in EU

and US 12/10/00 34.59 17.68 -49% 23.35 32% 68% -20% -7% 13%

2008 Global financial

crisis 03/07/08 146.08 36.61 -75% 76.31 108% 52% 30% 20% -9%

Average -54% 66% 71% 9% 4% -4%

2014-15 Supply glut 19/06/14 115.06 46.59 -60% ??? ??? ??? ??? ??? ???

Source: DBS, Bloomberg Finance L.P. Prefer offshore service providers over rigbuilders. Singapore rigbuilders seem fairly valued at 1.5-2.0x PB and 10x PE in view of the rig supply glut, sector headwinds and Brazil saga. While rigbuilders' share prices have traditionally been highly correlated to oil prices, with a coefficient of 0.8-0.9x, sector structural issues may be a drag on fundamental catalysts – order wins in the next two years. The smaller O&G names are worse hit with their PEs having fallen to 5-10x on new revised forecasts and an average of 0.7x PB in anticipation of further earnings downside and asset deflation. Unlike the large cap rigbuilders which have relatively stronger balance sheets, O&G SMC is deemed more susceptible to insolvency risks, given the smaller cap and geared balance sheet. As such, we have devised a scorecard to identify the long-term winners who are likely to better weather the low oil price environment these two years.


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IS THERE MORE DOWNSIDE TO EARNINGS? Earnings forecasts have been downgraded. The market has fine-tuned its expectations and downgraded earnings for O&G stocks over the past six months. We have lowered our rigbuilders’ order win assumption from S$10bn to S$7bn; charter rates and utilisation for OSVs by 10-20% and 10-15% respectively. Slashed rigbuilders’ order win further. In line with the lower oil price forecast, we have trimmed our FY15 order win assumption for Singapore rigbuilders by a further S$2bn to S$5bn, but have kept our FY16 order win expectation of S$7bn intact. This is close to the post-GFC levels of S$2.9bn/S$6.2bn in 2009/2010. The impact to earnings would be more significant from 2H16 onwards. Hence, our FY16 PATMI forecasts for SMM are cut by 6.8%. Maintain HOLD.

OSVs: No further revision for now but wary of earnings disappointments. Earnings projects for OSV players are tricky due to the lack of market datapoints and short contract tenure. Our sense is that earnings would remain vulnerable to downward pressure in the next two quarters in the light of the low oil prices and continued falling rig count. Service rigs: Impute in 5% fall in charter rates. Ezion’s liftboat/service rig business has demonstrated resiliency over the past few months relative to OSVs. Nonetheless, it would not be logical for Ezion to be completely immune. We take the initiative to prudently lower charter rates, broad-brush, by 5% from 2H15 onwards. Accordingly, our EPS is cut by 4%/9%., while TP is reduced to S$1.55.

Revisions in assumptions

Sub-sector Revision in assumptions since Oct-14 New changes Downside risks Singapore rigbuilders We have lowered FY15 order win

assumption from S$10bn to S$7bn in Dec-15.

Trimmed FY15 order wins further to S$5bn on the back of lower oil price expectations.

YTD order flow has been slow, making up only 5% of our assumption. We may have to revisit order win expectations by mid-2015.

Offshore support vessels

Trimmed charter rates by 10-20% na Downside risk prevails in the next two quarters in view of the falling rig count. Cut utilisation rates from 85% to 70-

75%

Service rigs Reduced new contract assumption

from 10 to 6. Trimmed charter rates by 5-10%. This applies across the entire fleet, assuming renegotiation and re-contract at lower rates.

Less so on charter rates which we believe our assumptions are rather conservative but rescheduling of delivery due to yard delays.

Source: Companies, DBS Bank

Revisions in earnings and TP; No changes to recommendations New PATMI % Chg TP FY15 FY16 FY15 FY16 S$

Sembcorp Marine 591.4 598.8 Unchanged -6.8% 2.89 (unchanged)

Ezion 261.1 322.3 -4.2% -8.5% 1.55

(Prev: 1.58) Source: Companies, DBS Bank


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Theme #1: SURVIVAL OF THE FITTEST Scorecard The oil price collapse has taken a toll on oil and gas-related stocks, with share prices tumbling by an average of 40-50% since Sept’14. While the low oil price is affecting businesses across the supply chain, not everyone will be hit in the same manner and magnitude. The listed companies in Singapore, Malaysia and Indonesia are exposed to different parts of the value chain and have different business models – be it shipbuilding, owning vessels, or providing services. We propose a scorecard to better identify the long-term winners. Scorecard to identify long-term winners. Some O&M players will have relatively better financial strength, earnings visibility, and offer favourable risk/reward investment opportunities, for exposure to the sector over the cycles. How the scorecard works. Our final selection is based on a bottom-up approach, after examining the fundamentals of each company with respect to: 1) Business model, 2) Asset quality, 3) Earnings visibility, 4) Operational efficiency, and 5) Balance sheet strength. We grade the companies under our

coverage on 15 criteria under the broad headings above on a scale of 1 (lowest) to 4 (highest) based on defined thresholds. We then calculate the weighted average score (out of 4) with the average scores in each broad bucket weighted as follows: business model (20%), asset quality (15%), earnings visibility (15%), operating efficiencies (20%), balance sheet strength (25%). An additional 5% weight bonus is accorded for trading liquidity score. How the scores stack up. Ezion and Dayang are the clear leaders among the stocks under our coverage in the region, followed closely by Deleum and Dialog, mainly because of their niche positioning. SapuraKencana and Pantech also scored highly, given their exposure to protected markets. They are followed by Vard Holdings, Bumi Armada, UMWOG, Coastal Contracts, POSH, Pacific Radiance, Nam Cheong and Mermaid Maritime. Ranking low on our scale are Ezra Holdings and Vard. Please refer to Appendix III for more details on individual companies’ scores for each category and Appendix IV for qualitative analysis on each company

Scorecard (Highest score = 4)


3.34 3.30 3.13 3.08

2.69 2.69 2.65 2.56 2.50 2.49 2.46 2.40 2.40 2.23 2.21

1.98 1.74

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00


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Top picks – balancing scorecard against valuations Scores for Singapore stocks pegged against valuations


Scores for Malaysia stocks pegged against valuations


Ezion

PACRAPOSH

Mermaid

Nam Cheong

Vard

2

4

6

8

10

12

14

1.50 2.00 2.50 3.00 3.50

PE (x

)

Scores (max = 4)

SapuraKencana

UMW OG

Bumi Armada

Dayang

Coastal

Deleum

Pantech

6

8

10

12

14

16

18

2.00 2.50 3.00 3.50

PE (x

)

Scores (max = 4)

SapuraKencana

UMW OG

Bumi Armada

Dayang

Coastal

Deleum

Pantech

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5

2.00 2.50 3.00 3.50

PB (x

)

Scores (max = 4)

Ezion

PACRA

POSH

Ezra

Mermaid

Nam Cheong

Vard

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.50 2.00 2.50 3.00 3.50PB

(x)

Scores (max = 4)


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Key financials

Net gearing (x)

Net debt/ EBITDA EBITDA Interest Cover

Gross CCE (US$m)

Short-term borrowings (US$m)

Current ratio

Cash conversion

cycle

Operating margin

ROE

FY14 FY14 FY15F FY14 FY14 FY14 FY14 (x) FY14 (Days) FY15 (%) FY15 (%)

Singapore Ezion 0.86 3.8 2.9 12.8 332.9 303.9 1.55 (148) 47.7% 17.4% Ezra 1.39 10.3 8.8 2.6 241.0 696.6 1.12 105 5.0% 7.1% Nam Cheong 0.42 1.6 1.9 20.5 216.2 150.3 2.10 281 13.5% 21.9% Pacific Radiance 0.53 3.9 3.6 6.4 101.4 51.8 1.74 46 14.2% 11.2% POSH 0.45 7.5 3.9 5.5 12.2 260.5 0.61 (61) 25.9% 7.1% Mermaid Maritime

0.04 0.4 0.6 13.6 89.4 8.9 3.66 66 4.4% 4.7%

Vard 1.76 17.6 13.4 21.7 250.3 1,008.6 1.11 284 2.3% 8.1% Swissco 0.82 75.04 N/A -0.62 29.2 54.4 0.69 (41) N/A 22.2% Ausgroup 0.40 N/A N/A 5.67 51.2 3.1 2.35 141 0.03 3.8% Marco Polo 0.77 5.11 N/A 6.91 13.8 60.7 0.64 130 0.17 9.4% Swiber 1.50 N/A 16.92 -1.20 166.3 349.4 1.59 234 N/A 0.5% Vallianz 2.17 9.49 NA 2.27 20.8 118.7 0.88 37 NA NA Otto Marine 2.05 14.05 N/A 1.75 3.4 163.7 1.08 87 N/A N/A ASL Marine 0.48 6.21 N/A 2.35 51.5 215.6 1.26 250 N/A N/A Triyard 0.48 1.99 N/A 6.84 34.7 117.4 1.32 198 0.13 8.9%

Malaysia SapuraKencana^ 1.31 10.25 9.20 7.70 349.1 305.2 1.28 39 31% 13% Bumi Armada 0.96 6.51 7.04 11.00 593.8 391.7 1.91 156 30% 6% UMWOG 0.34 2.60 2.00 16.00 327.5 345.6 1.13 108 31% 8% Dialog 0.20 N/A 1.07 26.40 193.7 79.1 1.84 17 11% 16% MMHE Net Cash nm nm 16.90 163.7 73.6 1.35 43 6% 3% Dayang 0.04 0.54 nm 37.50 25.9 30.0 1.55 86 23% 25% Coastal Net Cash nm 2.30 N/A 130.5 26.5 3.20 552 22% 16% Deleum 0.26 0.68 nm 27.22 21.0 14.1 1.51 66 13% 21% Pantech 0.33 1.30 0.90 9.68 22.4 45.0 2.36 215 15% 14% ^ Because SAKP has a Jan year end, we have used FY15A, FY16F and FY17F instead

Indonesia Wintermar 0.65 2.0 2.2 6.0 29.8 38.0 1.23 15 20.1% 8.0% Logindo 0.91 3.0 3.6 6.2 6.0 30.7 0.62 48 27.6% 9.3%



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Theme #2: MERGER & ACQUISITION PLAYS Shell kickstarts mega M&A. In a recent breaking news,, global O&G supermajor Shell swooped in to buy UK-based BG Group for Eur47bn (US$70bn) in the industry's first mega-deal since the oil price collapse. The deal will be funded by cash and new shares in Shell, and is expected to conclude by early 2016. This begs the question - who’s next? Could the Shell-BG deal spell the beginning of a new wave of mega-mergers in the sector? Exxon-Mobil is probably the only other supermajor that has the flexibility to do big-ticket deals, while BP could find itself the target of a takeover. Likewise, the M&A trend could gain traction in regional offshore marine space. The OSV sector, especially in the Asia Pacific region, is quite fragmented with a number of players offering similar services and vessel types. Hence, consolidation makes sense in order to gain better access to capital and move up the value chain. We expect the depressed valuations in the sector to lead to consolidation in the market, with companies having stronger balance sheets taking the opportunity to enhance their market shares while some players exit the market.

Sector's M&A and privatisation activities in the region have been heating up since 2014, as can be seen in the table below. The current spate of M&A activities, we noticed, is either triggered by substantial shareholders, mostly out of considerations to streamline ownership structures or to acquire related businesses to enhance long-term value for these shareholders. Strategic rationale aside, we believe feasible valuations and favourable financing costs have also played a role in facilitating deal flows.

We have also seen private equity activity in the space, with buyouts of SGX-listed subsea services player Kreuz Holdings and ASX-listed OSV player Miclyn Express offshore. Press reports have also indicated in the past that some parties had expressed interest in Ezra’s deepwater subsea division, EMAS AMC, but that is in the past. With oil prices falling steeply, interest from PE funds could fluctuate but consolidation should continue. We believe FY15/16 could herald more M&A activities in this sector. Favourable interest rate environment for M&A activities. We see positive interest rate environment as one of the factors supporting buyouts. Interest rates in Singapore have remained relatively favourable and capable of supporting leveraged buyout deals.

Recent regional M&A activities in the offshore marine space

Date Target Acquirer Seller Total Value (US$m)

Type TV/ EBITDA

Dec-14 CH Offshore Falcon Energy 125 Cash 8.01 Nov-14 Newcruz Vallianz Swiber Holdings 34 Stock & Debt

Oct-14 Strategic Marine Triyards Henderson Marine Base Pty Ltd 20 Cash

Feb-14 Jaya Holdings (assets)

Mermaid Marine Asia Jaya Holdings 625 Cash

Nov-13 Kreuz Holdings Ltd SEA9 Pte Ltd Swiber Holdings Ltd 206 Cash 4.98

Oct-12 Neptune Marine Services Ltd MTQ Corp Ltd 42 Cash 8.13

Jan-11 Intan Offshore Perisai Petroleum Ezra Holdings Ltd 15 Stock Apr-10 PPL Holdings Yangzijiang Baker Technology Ltd 155 Cash Mar-10 Kreuz Subsea SEA9 Swiber 206 Cash

Jan-10 Aker Marine Contractors Ezra Akastor ASA 250

Cash, Stock & Debt

Source: Bloomberg Finance L.P.


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Potential M&A candidates and deal rationale We attempt to identify potential M&A /privatisation candidates with specific criteria. We believe the M&A/privatisation and other corporate activities will continue in the low oil price environment amidst depressed valuations. Successful M&A deals could provide many benefits including possible expansion into related businesses, entry into new markets, acquisitions of new capabilities or just taking advantage of favourably priced targets to enhance positions in existing businesses, To pick out candidates that could potentially jump on the M&A/privatisation bandwagon, we think some of these criteria could be important: 1) High key investor shareholding with solvency issues; or 3) PE fund ownership; or 4) High cash, profitable, but illiquid counters; and/or 5) Senior founders/owners without apparent successors Scouting regionally among O&G-related names, we identify the potential takeover targets to be Ezion, Dyna-Mac and Ezra Group companies like Triyards and EMAS Offshore. Ezra Holdings itself could be subject to corporate restructuring in the near future, likely involving asset sales. Over in Malaysia, we believe SapuraKencana and Dayang are set on acquisition trails. We also identify companies with high cash hoards, such as Baker Tech, as good privatisation candidates. Takeover targets: Ezion offers immediate access into new market segment. Ezion is a good takeover candidate in our view, as it has a first-mover advantage in Asia and a sizeable fleet of 37 service rigs. Valuation is compelling at <7x FY15F PE. While net gearing may appear high at US$1.1bn or 0.9x, this is backed by 3-5 years' long-term charter contracts worth over US$2bn, providing 3.7x revenue coverage. Potential buyers could be existing international liftboat players, or asset owners in offshore support vessel space that would like to gain fast access to the service rig business in Asia that complements their geographical reach or product offerings. Dyna-Mac a proven specialist in topside modules. Founder, Mr. Desmond Lim Tze Jong remains the key personnel as Executive Chairman and CEO of the Group. He is also the controlling shareholder, holding a 42.06% stake in Dyna-Mac. If Mr. Lim decides to retire and divest his stake in the Group, we believe the second largest shareholder - Keppel Corp, which owns a 24.43% stake, could be one of the potential strategic acquirers to fortify its capabilities in floating production topsides. Dyna-Mac has a solid track record in the FPSO topside module market going back to 1999, counting the world’s largest FPSO operators, SBM and Modec, as its key recurring customers. Assuming a 20% premium to market price, total consideration works out to be around S$310m, well within KeppelCorp's means.

Ezra Holdings – susceptible to corporate activity, asset sales/divestments in Group companies possible. Ezra Holdings, which comprises a 100% interest in its subsea business plus about 75% stake in recently listed OSV owner/operator EMAS Offshore plus about 67% stake in fabrication outfit Triyards Holdings, would be struggling to refinance its short-term borrowings in 2015, according to our estimates. The Group will need to refinance S$225m worth of notes by September 2015, as well as try to call back S$150m worth of perpetual securities, failing which the interest rate on the perpetual will rise by more than 300bps. Given that its balance sheet is already stretched and banks may be unwilling to refinance these liabilities on favourable terms, Ezra may need to consider a sale of assets as well as issue equity instruments to meet its requirements. Thus, we believe the Group’s listed but tightly held subsidiary companies, Triyards Holdings and EMAS Offshore (both NOT RATED) could be open to offers in the market. Triyards has a good track record in building OSVs, construction vessels as well as self-propelling units (SEUs or liftboats) and demand for the latter still remains robust. It is currently sitting on an orderbook of close to US$400m, and could be attractive opportunity for other yards in the region looking to access the liftboat building market. The Group’s OSV subsidiary EMAS Offshore is currently trading at distressed valuations of less than 0.3x P/BV and could also be an attractive takeover target for other OSV owners in the region looking to scale up. Cash-rich counters are attractive takeover bets as well. Cash-rich CH Offshore has been in the news since last year as the subject of a takeover offer from fellow SGX listco Falcon Energy. Likewise, we believe there are a few counters in the O&M space in Singapore, which are cash rich, have positive free cash flows and are relatively illiquid. Baker Tech is a good example of this, and we think it could be taken out/privatised in the near future. SGX-listed companies in O&M sector with net cash positions

Company Mkt Cap

(S$m)

Avg. daily

traded value (S$m)

Free Cash Flow

Net Cash (S$m)

Net cash/ mkt cap

Baker Technology 209 0.15 Positive 206 99% Yangzijiang Ship 4,867 9.43 Positive 148 3% CH Offshore Ltd 321 0.52 Positive 111 35% Kim Heng Offshore 88 0.07 Positive 41 46% Penguin International 132 0.29 Negative 37 28% SBI Offshore Ltd 60 0.26 Negative 4 7%



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Potential consolidators in Malaysian market: Dayang looking to grow their fleet. Dayang has recently been raising its associate stake in Perdana Petroleum with a view to eventually launch a takeover of the company. The move will grow Dayang’s fleet of workboats and workbarges, allowing it to take on more hook-up and commissioning as well as topside maintenance work. However, we are concerned that the purchase of Perdana will alter Dayang’s typically clean balance sheet and lower overall group ROE which is usually healthy at >25%. Perdana’s net gearing is 0.9x and its ROE is 13%. For now though, timelines of the takeover are still uncertain. SapuraKencana pushing for more acreage. SapuraKencana is not resting on its laurels post the Newfield acquisition in 2014. The group has recently announced its intention to purchase new acreage in Vietnam as well as an unexplored onshore block in Sabah. The Vietnam acquisition will help to address declining output at Malaysian fields, keeping group production at 20-25k barrels a day in the next 2-3 years before new gas production comes on stream. The Sabah block could yield very significant results, and comes at a low cost of only USD40m, and blocks in Vietnam cost USD400m. Together, the purchases will leave group gearing of 1.2x largely unchanged but offer potential significant cash flow in the future, depending on exploration activity. The shipyard consolidation theory: A case study on China's shipbuilding industry. During the shipping industry's superboom in 2007-2008, China had more than 3,000 big and small yards spread across the country. Post-GFC, China's shipbuilding industry has undergone drastic consolidation as orders have dried out. Uncompetitive small yards were phased out while the bigger yards have been merged or acquired. Thus, there are now a little more than 100 shipyards with active day-to-day operations in China, a figure that has dwindled from about 400 during mid-2014. China will eventually be left with only 20 to 30 shipbuilding companies with active operations when the severe, ongoing consolidation period of the industry is completed over the next few years, according to Ren Yuanlin, Executive Chairman of Yangzijiang Shipbuilding. Rumours on the merger of the two largest private Chinese shipyards – Yangzijiang and Rongsheng. According to an upstream article in Mar'15, Yangzijiang is in advanced talks to take as much as a 20% stake in troubled HK-listed shipbuilder –

RongSheng. Earlier last year, the local government in Jiangsu was trying to rope in CSSC’s subsidiary - Shanghai Waigaoqiao Shipbuilding (SWS) to take over the Rongsheng yard but was unsuccessful. The latest development focuses on four investors, with Yangzijiang said to be set to take 20%, a number of Chinese banks including China Minsheng Bank, China Everbright Bank and China Development Bank to take up to 40%, major shareholders of China Rongsheng (including Zhang Zhirong) to hold 20%, and the rest to be held by other small investors. Yangzijiang has clarified that it is evaluating the opportunity and has yet to firm up its decision. If the offer price is attractive and the restructuring plan is clearly mapped out, it may not be a bad idea to consolidate and eliminate the potential threat that RongSheng poses, considering its strategic location within Yangzijiang’s close proximity. In addition, RongSheng has one of the largest and most advanced shipyards in China, which would allow Yangzijiang to expand its capacity in the construction of sophisticated vessels. Consolidation in Chinese rigbuilding space? In China, there are probably around 10 rigbuilders with orders on hand. Since Chinese yards started jumping on the offshore bandwagon in 2005, we observed that there are only a handful of pioneering yards, namely Dalian Shipbuilding, Cosco Corp, CIMC Raffles Yantai, Shanghai Waigaoqiao and China Merchant Industry Holdings, which have survived and retained focus on rigbuilding. Many smaller yards have kind of “tried-and-given-up”, realising that offshore projects were more complex than they initially thought, and making profits was almost impossible without economies of scale. Possible restructuring of Singapore shipyard groups? In the previous downcycle, Singapore shipyards went through a major consolidation during the late 1990s, where various mergers resulted in two giant Singapore government owned shipyard groups today. In 2001, the two Singapore shipyard groups embarked in preliminary talks to rationalise their shipyard operations but the deal fell through as they failed to agree on certain terms. This time round, Singapore shipyards are bracing for tough times ahead – absence of new rigbuilding orders, dwindling order book, low book to bill ratio, project cancellations, project deferments, high fixed cost and the need to keep shipyards at high utilization – will force the yards to look for ways to restructure. We do not rule out restructuring, mergers and acquisitions possibilities, as any cost rationalization exercises will boost competitiveness of Singapore yards, amidst rising competition from Korea and China, and the added burden of operating shipyards in Brazil .


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RIGBUILDERS STRUGGLING AT THE DEEP END Depressed oil price adds fuel to fire. Even if oil price rebounds to US$70/bbl, order win momentum is unlikely to see an immediate upswing, in view of the rig order backlog and keen competition, in our view. Lacklustre order momentum Oil price correlation may break. Singapore rigbuilders' stock prices traditionally have a strong correlation with oil prices, with a coefficient of 0.8-0.9x. This is because oil price is a leading indicator of order momentum, which is the key catalyst for rigbuilders’ stock performance. However, the correlation may break down this time round. Rigbuilders could lag oil price recovery, given that order flow might remain slow as the market needs time to digest the massive supply coming on stream where the bulk of the rigs are deployed.

Huge order backlog... There are 209 drilling rigs under construction, largely to be delivered in 2015-2018, representing book-to-bill of 23%. In particular, orderbook-to-fleet ratio is high for drillship at 50% due to a low base and long-term shift towards ultradeepwater and jackup at 23%, in anticipation of replacement demand as half of the fleet is >30 years' old. Meanwhile, semi-submersibles are more benign at 13% partly because of preference towards drillships. … but weaker demand outlook. Near-term demand for rigs took a turn for the worse since the oil price collapse as oil majors push back capex and rig count heads south. Global E&P spending is expected to fall around 17% this year with a greater cut in exploration activities

, Mobile rig deliveries, 1969 – 2018+

Source: Clarkson, DBS Bank

US rig count fell c.50% to 988 as of 10 Apr, close to GFC trough

Source: Baker Hughes, DBS Bank

0

20

40

60

80

100

120

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

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1989

1990

1991

1992

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1996

1997

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2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

1120

1220

1320

1420

1520

1620

1720

18

No.

of d

elive

rs

Jackup Semisubmersibles Drillships

0

500

1000

1500

2000

2500

3000

3500

4000

4500

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Worldwide rigcount

U.S. Canada Total Intl.

International rig count saw a mere 6% y-o-y decline as of Mar-2015 while US and Canada rig counts plunged 40-50% y-o-y


Offshore & Marine

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Downtrend in new orders since the big bang in 2012. There are zero rig orders YTD. New order trends for Singapore rigbuilders hit a peak of S$21bn, boosted by the Petrobras orders, and have been trending down since. This trend will be exacerbated by the current headwinds, led by the sizeable global rig orderbook and lower long-term oil prices. Lowering Singapore rigbuilders’ order win assumptions by 29% to S$5bn for 2015. We have trimmed our FY15 order win assumption for Singapore rigbuilders by a further S$2bn to S$5bn, but keep our FY16 order win expectation of S$7bn intact. This is lower than the 10-year average of S$9bn secured by Singapore rigbuilders, and close to the post-GFC levels of S$2.9bn/S$6.2bn in 2009/2010. Slower contract wins will lead to a declining orderbook in the next two years and affect earnings from 2H16 onwards. We expect new contracts to come from production platforms such as FPSOs, FLNG vessels, specialised vessels (for instance, pipelay vessels, semi-submersible accommodation vessels and semi-submersible crane vessels).

New orders heading south

Source: Companies, DBS Bank Estimates

Orderbook of Singapore rigbuilders set on downtrend

Singapore rigbuilders S$ m Orderbook 23,900 Orderbook – Petrobras* 11,662 Orderbook - Other Rigbd & conversion* 12,238 Revenue (Rigbdg + Conversion) 12,877 Revenue – Petrobras* 3,337 Revenue - Others Rigbg & conversion* 9,540 Book to bill * 1.9x Book to bill (Excl Petrobras)* 1.3x

Source: Companies, *DBS Bank Estimates Asset prices going downhill Softening utilisation rates and charter rates. The average utilisation for drilling rigs have declined to <80% in Apr-2015, from >90% a year ago. Semi-submersibles suffered the least, with only a 6-ppt drop and still hovers above 90%, probably due to lesser supply pressure. Meanwhile, drillships and jackups saw greater declines of 10ppt/14ppt to 80%/75%. The average charter rates can be misleading because of the additions of newer and more advanced rigs to the fleet. We observe that charter rates for jackups and drillships of similar specs have fallen around 20-30%. Asset prices to follow suit. While there hasn’t been newbuild orders for drilling rigs YTD, our channel checks suggest that the secondhand market for newbuild rigs under construction has

dropped some 10-15%. However, we believe there is more to go. Market players are monitoring for opportunities to bargain hunt assets on fire sale from shipyards that are desperate to recoup construction costs for owner-initiated cancellations or asset liquidations by creditors of rig-owners that go belly up. Petrobras scandal a can of worms… Petrobras corruption scandal is dragging the Brazilian O&G sector, deferring exploration and well development (thus delaying rig delivery and award of FPSO orders), resulting in funding issue of Sete Brasil, and closure of Brazilian O&G players. The Singapore rigbuilders were implicated as the agent/consultant appointed in Brazil were said to be involved in bribery, but both have refuted

Orderbook set to decline on the back of lower order intakes 0

5,000

10,000

15,000

20,000

25,000

30,000

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

F

S $ m Outstanding orderbook of Singapore Rigbuilders

Boosted by S$14.2bn Petrobras orders in 2012

Ideal book-to-bill ratio would be 1.5-2.0x.

4.4 5.1

10.7 10.4 12.8 11.5

2.9 6.3

13.6

21.0

11.1 9.2

5.0 7.0

0

20

40

60

80

100

120

0

5

10

15

20

25

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015F2016F

US$/bblS$ bn Annual order wins

Singapore Rigbuilders' order wins (LHS) Oil price (RHS)


Offshore & Marine

Page 16

the allegations. The corruption investigations are ongoing in Brazil and may take awhile. This would create an overhang to Singapore rigbuilders, given that Petrobras-related projects account for almost half of their current order backlogs. So, what’s the impact? The rigbuilders were supposed to receive monthly milestone payments but these have been halted since Nov-2014 pending Sete Brasil’s project funding. We believe deliveries of the 13 rigs awarded to Singapore rigbuilders could be pushed back. In the worst case scenario, if Petrobras decides to cancel the rig contracts, then rigbuilders could suffer significant financial losses as those rigs fetch a price tag of over US$800m each which is 30-40% higher than the market now, adjusting for higher cost local content requirement. However, we believe this is unlikely to happen as Petrobras has already terminated the remaining 16 rig contracts with Brazilian yards, partly due to the yards’ incapability to deliver the rigs on time or meet their working capital requirements with delayed payments. What could drive rigbuilding recovery? Catalyst #1: Retirement of old rigs. After a rigbuilding boom in 1980s, the sector went through a 20-year gloom till 2005 when we entered a new era of high oil prices. Hence, half of the rig fleet at current is >30 years' old and should gradually be retired. We believe the reality of lower oil prices will accelerate the replacement cycle. Rig owners are retiring older rigs and making plans to cold stack others in an effort to reduce costs in the current market climate. In general, most future rig attrition can be identified from the existing fleet of cold-stacked rigs, although in some instances a rig owner may opt to retire a rig immediately after contract completion. In the past few months, Hercules Offshore, Diamond Offshore, Noble Corporation and ENSCO have cold stacked a combined total of eight jackups and four semisubs. On the retirement front, since 4Q14, Transocean (11) and Diamond Offshore (6) have scrapped 17 floating rigs. Most recently, Noble Corp. (3) and Atwood Oceanics (1) announced the retirement of four floating rigs. All were older, shallow and mid-water units that were either

not likely to work for some time or they were going to require substantial capital expenditures to remain competitive. The pace of old rig attribution plays a critical role in restoring supply/demand equilibrium as the recent rigbuilding boom in 2012-2014 was fuelled by replacement demand. Catalyst #2: Cancellations at Chinese yards. Chinese yards benefitted most from the latest rigbuilding boom, raising their market share to a third of global orderbook of drilling rigs, from <10% previously. However, the bulk of the orders came from new players or speculators who were lured by the attractive payment terms of 1:99 or 5:95 and easy financing. This makes the Chinese yards particularly vulnerable to contract cancellations in the current climate. The opportunistic and cash-rich players are monitoring the secondhand market for opportunities to acquire distressed assets. Buyer and sellers are in a price impasse. Based on our channel checks, the speculators who have yet to secure charter contracts for vessels delivering in 2015 have dropped prices by 10% or so, leaving themselves some margins to be made. From the buyers’ standpoint, they have the upper hand given the supply glut, and are expecting more downside. If speculators fail to flip the rig, they could forego the 1-5% downpayment and eventually walk away from the contract. But, before that, we believe there will be massive rescheduling at Chinese yards and eventually some cancellations. This will help to mitigate the supply pressure in the near term. The best scenarios will be cancellations of projects that have yet to start, which will “remove” the supply completely. Catalyst #3: Sharp recovery in oil prices. A sharp rebound in oil price and plateau at high levels will incentivise investments into deepwater and ultra deepwater spaces and re-activate some of the higher-cost projects. As a result, it might raise demand for newbuild rigs especially drillships and harsh-environment jackups, and benefit Korean and Singapore rigbuilders. However, we don’t think order win momentum could reprise the 2012-2013 levels.


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STOCK PROFILES Sembcorp Marine (Share price: S$3.13; HOLD; TP S$2.89)

PE charts

PB charts

Rationale & Catalysts A pure O&M play and proxy to tap the potential rebound in oil

prices. Earnings have been patchy due to conservative margin

recognition in initial construction phases and release of contingency margins closer to completion for projects of new vessel types, and for Sete Brasil

Less rosy outlook for newbuild rigs amid supply glut due to substantial order backlog, and declining rig demand in low oil price environment

Downside risks Prolonged low oil price environment could dampen rig demand

in the near term, triggering delivery deferments/cancellations and asset deflation.

Almost half of if its orderbook is exposed to Brazilian projects which pose relatively higher execution risks.

Rising competition from Korean and Chinese offshore players might lead to further margin compression.

Source: DBS Bank

Cosco Corp (Share price:S$0.58; FULLY VALUED; TP S$0.49)

PE charts PB charts

Rationale & Catalysts One of the pioneer offshore yards in China with an established

track record and strong R&D team. Diversified product mix is a double-edged sword, reduces

economies of scale and efficiency. Aggressive pricing strategy in our view, to fill yard capacity adds

to the woes.

Downside risks Vulnerable to rescheduling and cancellation risks amid

challenging shipping and offshore O&G markets. Spike in steel cost and interest rate will adversely impact

earnings. Rising competition, prolonged low oil price could lead to asset

deflation and further margin compression.

Source: DBS Bank

2.0

6.0

10.0

14.0

18.0

22.0

26.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

SMM - PE(x)

-2sd: 4.4x

Avg: 14x

+1sd: 18.8x

-1sd: 9.2x

+2sd: 23.6x

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

SMM - PB(x)

-2sd: 1.4x

Avg: 3.7x

+1sd: 4.9x

-1sd: 2.6x

+2sd: 6x

0

20

40

60

80

100

120

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Cosco - PE(x)

-1sd: 17.6x

Avg: 44.1x

+1sd: 70.6x

+2sd: 97.1x

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

Cosco - PB(x)

-1sd: 0.1x

Avg: 3.4x

+1sd: 6.8x

+2sd: 10.1x


Offshore & Marine

Page 18

Yangzijiang (Share price: S$1.41; BUY; TP S$1.62)

PE charts PB charts

Rationale & Catalysts Among the best Chinese shipbuilders to ride the shipping and

shipbuilding recovery; set to outperform peers with 5- to 10-ppt higher margins, through better newbuild prices, payment terms, efficiency and active cash management.

Relatively stable profits and DPS of 5.5 Scts, backed by healthy order backlog of US$4.6bn or 1.9x revenue coverage.

To benefit from industry consolidation; undemanding valuation at 6x FY15F PE and 1x PB despite attractive ROE of 16% and yield of 4%.

Downside risks Prolonged shipping downturn from slow economic recovery and/or

shipowners’ lack of discipline in newbuild programme. Execution of new vessel types such as LNG carriers and potentially

larger containership. Spike in steel cost and Rmb appreciation.

Source: DBS Bank

Ezion (Share price: S$1.225; BUY; TP S$1.55)

PE charts PB charts

Rationale & Catalysts One of our top picks in O&G sector; most resilient to near term oil

price weakness, backed by long term charter contracts of 3-5 years. Strong order backlog of US$2bn underpins 3-year earnings visibility.

Favourable industry prospects with liftboats gaining popularity in the Asia Pacific region. We see the emergence of new entrants as positive signs of rising acceptance and demand of liftboats, and Ezion will be the prime beneficiary, riding on its first mover advantage

Against this backdrop, Ezion could be a takeover candidate by international liftboat players or OSV players in the region.

Downside risks Sustained low oil prices of below US$50/bbl for a prolonged

period could dampen demand for liftboats. Loss of revenue contribution due to delivery delays from shipyard. Interest rate hike. Ezion has swapped 70% of loans under floating

rates to fixed.

Source: DBS Bank

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2008 2009 2010 2011 2012 2013 2014 2015

Yangzijiang - PE(x)

+2sd: 10.3x

+1sd: 8.4x

Avg: 6.4x

-1sd: 4.5x

-2sd: 2.6x

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2008 2009 2010 2011 2012 2013 2014 2015

Yangzijiang - PB(x)

+2sd: 6.6x

+1sd: 4.5x

Avg: 2.5x

-1sd: 0.4x

-2sd: -1.6x

0.0

3.0

6.0

9.0

12.0

15.0

18.0

2009 2010 2011 2012 2013 2014 2015

Ezion - PE(x)

Avg: 9x

+1sd: 12.1x

+2sd: 15.1x

-1sd: 6x

-2sd: 3x

0.0

0.6

1.2

1.8

2.4

3.0

3.6

4.2

2009 2010 2011 2012 2013 2014 2015

Ezion - PB(x)

Avg: 2.2x

+1sd: 3x

+2sd: 3.7x

-1sd: 1.5x

-2sd: 0.8x


Offshore & Marine

Page 19

PACC Offshore (Share price: S$0.515; HOLD; TP S$0.50)

PE charts PB charts

Rationale & Catalysts Weak fleet utilisation trends amid deteriorating industry

fundamentals, especially in the OSV and shallow water T&I segments.

Mexican vessels will continue to be a drag on profitability in the near term.

Expect deferments in newbuild vessel pipeline. Relatively healthy balance sheet and support from parent Kuok

Group are key positives in riding out current downcycle.

Downside risks The two SSAVs account for close to half of projected profits in

FY15, hence delays in commencement of charters could hurt earnings significantly.

POSH has about five idle vessels in Mexico; these were previously chartered out to Pemex through Oceanografia

POSH is trying to reflag some of the vessels and charter them in international waters, but it could be a while before the processes required to get these vessels back on hire are completed. Hence, losses could drag for at least two more quarters.

Source: DBS Bank

Pacific Radiance (Share price: S$0.74; HOLD; TP S$0.78)

PE charts PB Chart

Rationale & Catalysts Effective control of the supply chain through access to third party

Chinese shipyards keeps shipbuilding costs low without compromising quality, and enhances returns on capital in OSV business.

However, knee-jerk reaction of oil majors to the oil price slump has led to deferral of demand for inspection, repair, maintenance of subsea equipment, and hence, utilisation of the Group’s subsea vessels are expected to remain weak in the near term, dragging down Group earnings.

Balance sheet improved in FY14, with net gearing declining to 0.53x. Free cash flows expected to remain positive, hence dividends can be sustained.

Downside risks Pacific Radiance is operating in the shallow water offshore space,

where barriers to entry are lower and management needs to be continually on top of the game to identify trends first or risk losing market share.

On our estimates, every 25bps increase in floating interest rates would impact net profit by about 1%.

Source: DBS Bank

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

Oct-13 Jan-14 Mar-14 Jun-14 Aug-14 Nov-14 Jan-15 Apr-15

PACRA - PE(x)

Avg: 11.1x

+1sd: 14.8x

+2sd: 18.5x

-1sd: 7.4x

-2sd: 3.6x

0.0

0.4

0.8

1.2

1.6

2.0

2.4

2.8

Oct-13 Jan-14 Mar-14 Jun-14 Aug-14 Nov-14 Jan-15 Apr-15

PACRA - PB(x)

Avg: 1.4x

+1sd: 1.7x

+2sd: 2.1x

-1sd: 1x

-2sd: 0.6x

2

4

6

8

10

12

14

16

18

Apr-14 Jun-14 Aug-14 Sep-14 Nov-14 Dec-14 Feb-15 Mar-15

POSH - PE(x)(x)

Avg: 10.7x

+1sd: 14.1x

+2sd: 17.6x

-1sd: 7.2x

-2sd: 3.8x

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Apr-14 Jun-14 Jul-14 Sep-14 Oct-14 Dec-14 Jan-15 Mar-15

POSH - PB(x)(x)

Avg: 1x

+1sd: 1.3x

+2sd: 1.6x

-1sd: 0.7x

-2sd: 0.4x


Offshore & Marine

Page 20

Ezra Holdings (Share price: S$0.485; HOLD; TP S$0.51)

PE charts PB charts

Rationale & Catalysts Execution woes persist; operating performance at both subsea and

OSV divisions continue to underwhelm New order intake for subsea division could be lower than

expected, as development projects in the North Sea and Gulf of Mexico face delays and deferments following the oil price collapse.

While the stock looks cheap at first glance on a P/B basis (0.4x P/B), we need to take into account the sub-par ROE of 2-3% it is expected to generate in FY15/16.

Downside risks There could be downside risks from higher interest cost or equity

cash calls as Ezra needs to refinance S$225m of notes and call back S$150m of perpetual securities in September 2015.

The addition of flagship vessel Emas Constellation in 2015 raises Ezra's profile but also means sufficient amount of work needs to be secured to ensure adequate utilisation.

Deepwater projects are highly sensitive to oil price changes and regulatory clearance, and hence, volatility can be expected.

Source: DBS Bank

Mermaid Maritime (Share price: S$0.26; HOLD; TP S$0.27)

PE charts PB charts

Rationale & Catalysts Subsea IRM industry prospects expected be one of the brightest in

the offshore oil & gas services space once oil prices recover. While two of the flagship DSVs, Commander and Asiana, are

booked for a fair number of days in FY15/16, the same cannot be said for the other two – Endurer and newly chartered-in DSV Windermere.

Both of Mermaid’s tender rigs MTR-1 and MTR-2 are currently off hire. We believe the age of these vessels could be a major obstacle in securing future charters.

Downside risks Subsea engineering operations sensitive to delays in the award of

offshore projects. Slide in oil prices have led to oil majors’ delaying IRM works in the near term.

Associate contributions from AOD – three drilling rigs chartered out to customer Saudi Aramco – accounted for about 65% of Group PBT in FY14. Given that the three rigs are enjoying premium day rates of US$180,000 each, these may come under scrutiny soon and rates may be renegotiated downwards.

Source: DBS Bank

0.0

20.0

40.0

60.0

80.0

100.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

Ezra - PE(x)

Avg: 35.9x

+1sd: 67x

+2sd: 98.1x

-1sd: 4.8x

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

Ezra - PB(x)

Avg: 1.4x

+1sd: 2.4x

+2sd: 3.4x

-1sd: 0.4x

-2sd: -0.6x

(x)

Avg: 1.4x

+1sd: 2.4x

+2sd: 3.4x

-1sd: 0.4x

-2sd: -0.6x

0

10

20

30

40

50

60

70

80

90

2011 2012 2013 2014 2015

Mermaid - PE

+2sd: 64.6x

+1sd: 43.2x

Avg: 21.8x

(x)

-1sd: 0.4

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2010 2011 2012 2013 2014 2015

Mermaid - PB

+2sd: 1.1x

+1sd: 0.9x

Avg: 0.7x

-1sd: 0.5x

-2sd: 0.3x

(x)


Offshore & Marine

Page 21

Nam Cheong (Share price: S$0.345; HOLD; TP S$0.36)

PE charts 0.0

2011 2012 2013 2013 2014 2015

PB charts

Rationale & Catalysts Nam Cheong derives about 50% of its vessel sales from the

Malaysian market, where PETRONAS has announced that it will cut 2015 capex by 15-20% following the decline in crude oil prices.

While demand for shallow water OSVs – especially built-to-stock vessels, where the customer doesn’t have to take the upfront risk – isn’t likely to fall off the cliff, we expect there would be some pressure on pricing of vessels. The PSV market is more vulnerable, since there is a bigger supply overhang in the market.

We do not expect Nam Cheong to repeat its record FY14 performance in FY15/16 as lower oil prices depress industry fundamentals. Given the asset-light structure though, Nam Cheong should still be able to generate healthy ROEs of more than 20% in FY15/16, better than peer average. Dividend yield of close to 5% provides further support to share price.

Downside risks Failure to read the market correctly will result in unsold inventory.

High working capital requirements of its business model can stress balance sheet, if not managed well.

Chinese yards have spare capacity and are moving up the value chain into more sophisticated OSVs. The key barrier to entry is branding and industry contacts, which an established yard like Nam Cheong has.

Source: DBS Bank

Vard Holdings (S$0.60; FULLY VALUED; TP S$0.51)

PE charts PB charts

Rationale & Catalysts Earnings outlook muted in FY15/16 as order wins slow. Our new

order win assumptions for Vard in FY15/16 stand at NOK5bn and NOK7bn, respectively, compared to NOK9.5bn order wins in FY14.

Uncertainty on margin recovery trend will persist in the near term. While further improvements in EBITDA margins are expected in FY15, we are only forecasting 4% EBITDA margin for FY15, as we expect cost overruns in Brazil to continue.

While Vard retains a solid reputation as a high-end OSV shipbuilder, and its current orderbook of NOK17bn underpins revenue visibility in FY15, near-term uncertainties are compounded by low oil price environment and execution issues at its Brazilian shipyards, where losses continue to mount. Valuations are also affected by the weak Norwegian Kroner.

Downside risks While VARD operates mostly in niche sophisticated vessel space, it

does face more competition from Asian yards on some of the lower spec vessels.

Vard ended FY14 with a stretched balance sheet, on account of the very high workload at most of its yards, without the commensurate number of deliveries, hence locking up working capital.

Source: DBS Bank

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

2011 2012 2013 2013 2014 2015

Nam Cheong - PE(x)

Avg: 5.6x

+1sd: 6.9x

+2sd: 8.2x

-1sd: 4.3x

-2sd: 3x

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2011 2012 2013 2013 2014 2015

Nam Cheong - PB(x

Avg: 1.6x

+1sd: 1.8x

+2sd: 2x

-1sd: 1.3x

-2sd: 1.1x

2.0

8.0

14.0

20.0

26.0

32.0

2011 2012 2013 2014 2015

Vard - PE(x)

+2sd: 26.5x

+1sd: 20.9x

Avg: 15.4x

-1sd: 9.9x

-2sd: 4.3x

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2011 2012 2013 2014 2015

Vard - PB(x)

+2sd: 3x

+1sd: 2.4x

Avg: 1.8x

-1sd: 1.2x

-2sd: 0.6x


Offshore & Marine

Page 22

Wintermar Offshore (Share price:Rp484; HOLD; TP Rp730)

PE charts

PB charts

Rationale & Catalysts Indonesia has to increase oil and gas production in the country as

a priority due to the sharply declining profile of most of the country’s older oilfields. Higher activity expected from 2016 onwards, especially from development projects in eastern seas.

However, we expect 2015 to be a slow year in the Indonesian O&G space, especially as the impact of new policies and new administrators will not be felt so soon.

Wintermar will need to market its vessels outside Indonesia as well to ensure better fleet utilisation, thus depressing margins.

Downside risks Regulatory and political factors could lead to delays in the award

of mega E&P projects, which in turn could affect demand for offshore support vessels.

While the new government has instituted a new setup at regulator SKK Migas and has been pursuing investment-friendly policies, it may be a while before any impact is felt on the ground.

Excess supply of vessels in the Indonesian market through newbuilding or re-flagging may result in lower charter rates in the near term.

Source: DBS Bank

PT Logindo (Share price: Rp2040; HOLD; TP Rp2,460)

PE charts PB charts

Rationale & Catalysts Utilisation of high end vessels has been falling over the last couple

of quarters, resulting in weaker margins. Fleet expansion plans affected, only two new vessels added in

FY14; vessel additions likely to be muted in FY15 as well. After strong growth in FY13/14, we expect earnings to fall off to

in FY15/16 due to the oil price slide affecting capex plans of global oil and gas majors.

Downside risks Close to 50% of revenues come from one major customer and

one field – Total Indonesia’s Mahakam gas block. Total will hand over ownership of this block to state-owned Pertamina at end-2017 and hence, there could be issues cropping up in the interim period.

2015 to likely be a slow year in the Indonesian O&G space, especially as the impact of new policies and new administrators will not be felt so soon

Source: DBS Bank

0

5

10

15

20

25

30

Jan-11 Sep-11 Jun-12 Feb-13 Nov-13 Jul-14 Apr-15

Wintermar - PE(x)(x)

Avg: 10.3x

+1sd: 16x

+2sd: 21.7x

-1sd: 4.6x

0.0

0.5

1.0

1.5

2.0

2.5

Jan-11 Sep-11 Jun-12 Feb-13 Nov-13 Jul-14 Apr-15

Wintermar - PB(x)(x)

Avg: 1.2x

+1sd: 1.5x

+2sd: 1.8x

-1sd: 0.8x

-2sd: 0.5x

0

5

10

15

20

25

30

Dec-13 Mar-14 May-14 Aug-14 Nov-14 Jan-15 Apr-15

Logindo - PE(x)(x)

Avg: 14.8x

+1sd: 20x

+2sd: 25.2x

-1sd: 9.6x

-2sd: 4.4x

0.0

0.5

1.0

1.5

2.0

2.5

Dec-13 Mar-14 May-14 Aug-14 Nov-14 Jan-15 Apr-15

Logindo - PB(x)(x)

Avg: 1.5x

+1sd: 1.9x

+2sd: 2.4x

-1sd: 1x

-2sd: 0.6x


Offshore & Marine

Page 23

Coastal Contracts (Share price: RM2.98; Buy; TP RM3.35)

PE charts PB charts

Rationale & Catalysts Coastal has secured a record OSV orderbook of RM1.2bn as at

end FY14. This should see it comfortably through FY15 The group also has a 8 year charter of a gas compression unit

to Pemex, which will commence in mid-2015, worth RM1.35bn

However, given the challenging jack-up rig market, Coastal is now seeking a sale of their maiden jack-up and may not be able to secure a timely charter for their 2nd rig.

Downside risks Delay in securing a charter for the jack-up drilling rig is possible

due to current weak market conditions Potential for order cancellations for OSVs or delivery slippage

Source: AllianceDBS Research

UMW Oil & Gas (Share price: RM2.45; HOLD; TP RM2.70)

PE charts

PB charts

Rationale & Catalysts Fleet of 7 rigs with 5 jack-ups on short term charter ending in

2Q15-3Q15. The remainder are secured by long term charters. Average rates within the group are currently high at USD165k/day

However, increased competition in the drilling market is likely to result in lower charter rates and slower chartering activity going forward

UMWOG has strong traction in SEA especially with Petrovietnam, PTTEP and PETRONAS and may surprise by securing charters despite the challenging market

Downside risks Earnings risk from 2H15 onwards due to stiff competition with

new rigs entering the market. UMWOG may see some need to warm stack its rigs if unable to secure contracts


0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2010 2011 2012 2013 2014 2015

COCO - PE(x)

Avg: 8.9x

+1sd: 11.7x

+2sd: 14.4x

-1sd: 6.2x

-2sd: 3.5x

0.0

0.5

1.0

1.5

2.0

2.5

2010 2011 2012 2013 2014 2015

COCO - PB(x)

-2sd: 0.7x

Avg: 1.4x

+1sd: 1.7x

-1sd: 1x

+2sd: 2.1x

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Nov-13 Mar-14 Jul-14 Nov-14 Mar-15

UMWOG - PE(x)

Avg: 24x

+1sd: 29.5x

+2sd: 35.1x

-1sd: 18.5x

-2sd: 13x

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Nov-13 Mar-14 Jul-14 Nov-14 Mar-15

UMWOG - PB(x)

-2sd: 1.3x

-1sd: 1.8x

Avg: 2.4x

+1sd: 2.9x

+2sd: 3.5x


Offshore & Marine

Page 24

Dayang Enterprises (Share price: RM2.59; Hold; TP RM2.85)

PE charts PB charts

Rationale & Catalysts Strong orderbook of c. RM3.8bn which consist of 3-5 year

contracts for hook-up and commissioning and topside maintenance

Solid execution track record and operational efficiency as seen by consistent and healthy margins of >18% which is ahead of peers

Market leader in Malaysia for supply of HUC and TMS services

Downside risks Contracts for the next few years have largely been secured,

therefore, newsflow on the stock could be quiet PETRONAS’ opex cut and review of operations is likely to

result in slower work orders over FY15 before normalising in FY16


MMHE (Share price: RM1.31; Fully Valued; TP RM0.90)

PE charts PB charts

Rationale & Catalysts Latest orderbook of RM1.6bn is <1x book-to-bill and

requires immediate replenishment to improve earnings visibility for FY15 and FY16. Most of the jobs on hand will run down by mid FY16.

With PETRONAS cutting capex and opex, there will be fewer projects for bidding, especially in FY15. Many projects have also been delayed.

Stiff competition in the industry is leading to margin compression.

Downside risks MMHE could potentially dip into losses if new contract

replenishment is not timely Lack of price competitiveness could result in losing jobs to

foreigners


-1.0

2.0

5.0

8.0

11.0

14.0

17.0

20.0

2008 2009 2010 2011 2012 2013 2014 2015

DEHB - PE(x)

Avg: 9.3x

+1sd: 14.1x

+2sd: 18.9x

-1sd: 4.5x

-2sd: -0.3x

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2008 2009 2010 2010 2011 2012 2013 2014 2015

DEHB - PB(x)

-2sd: -0.8x

Avg: 1.9x

+1sd: 3.2x

-1sd: 0.5x

+2sd: 4.6x

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2011 2012 2013 2014 2015

MMHE - PB(x)

-2sd: 0.7x

-1sd: 1.8x

Avg: 2.8x

+1sd: 3.9x

+2sd: 5x

20.0

30.0

40.0

50.0

60.0

70.0

80.0

2010 2011 2012 2013 2014

MMHE - PE(x)

Avg: 44.2x

+1sd: 56x

+2sd: 67.8x

-1sd: 32.4x

-2sd: 20.5x


Offshore & Marine

Page 25

SapuraKencana (Share price: RM2.68; HOLD; TP RM2.55)

PE charts PB charts

Rationale & Catalysts Strong orderbook of RM25bn offers long term earnings

visibility Malaysian market leader for tender rigs and heavy lift and

deepwater installations Immediate earnings accretion on recovery of crude oil

prices with growing upstream exposure at 16% of operating profit. Further upside in the future from significant natural gas reserves which were recently discovered

Caution on oncoming results, we view that consensus has not fully priced in lower earnings of the upstream business.

Downside risks Sustained low oil price below US$50/bbl for prolonged

period could dampen demand for deepwater installations and also result in low return from oil production assets.

Recent acquisitions have driven up the group’s net gearing which currently stands at 1.2x. That said, debt service is still healthy given strong cashflows from key assets like tender rigs.

PETRONAS’ opex cut could result in slower installation and hook-up and commissioning activities under Pan Malaysian contracts


Bumi Armada (Share price: RM1.17; Hold; TP RM1.15)

PE charts PB charts

Rationale & Catalysts 9 firm FPSO contracts provide long term earnings visibility

and underpins orderbook of RM21.8bn and RM11.8bn worth of optional extensions

Potential M&A or privatisation may materialise at valuations higher than current

However, FY15-FY16F earnings could be dragged down by weak OSV and Transport & Installation segments.

Downside risks PETRONAS’ capex and opex cut dampens prospects for

immediate recovery in the OSV segment, of which 50% of the group’s vessels are Malaysian based

Delays in FPSO conversion work could result in penalties and damage its track record

New FPSO projects not likely to materialise until FY16 onwards due to weak crude oil prices currently.


0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

2013 2014 2015

BAB - PE(x)

Avg: 24.4x

+1sd: 33.4x

+2sd: 42.3x

-1sd: 15.5x

-2sd: 6.6x

0.8

1.2

1.6

2.0

2.4

2.8

2011 2012 2013 2014 2015

BAB - PB(x)

-2sd: 1x

-1sd: 1.4x

Avg: 1.7x

+1sd: 2x

+2sd: 2.4x

4.0

7.0

10.0

13.0

16.0

19.0

22.0

25.0

2012 2013 2014 2015

SAKP - PE(x)

Avg: 16.8x

+1sd: 20.8x

+2sd: 24.8x

-1sd: 12.8x

-2sd: 8.8x

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2012 2013 2014 2015

SAKP - PB(x)

-2sd: 1.2x

-1sd: 1.6x

Avg: 2x

+1sd: 2.4x

+2sd: 2.8x


Offshore & Marine

Page 26

Pantech Group (Share price: RM0.755; Buy; TP RM0.95)

PE charts 0.0

2008 2009 2010 2011 2012 2013 2014 2015

PB charts

Rationale & Catalysts We expect strong 3-year earnings CAGR of 17% over FY15-

FY17, driven by demand for pipes, valves and fittings (PVF) at Pengerang Integrated Petrochemical Complex (PIPC) starting 2HFY16

Pantech is the market leader for PVF in Malaysia and its one-stop trading business has strong EBIT margins of 15-20%

Attractive dividend yield of 6% going forward

Downside risks A delay in the PIPC would result in slower earnings for Pantech Changes in import export regulations could affect its stainless

and carbon steel export business


Dialog Group (Share price: RM1.67; Hold; TP RM1.65)

PE charts PB charts

Rationale & Catalysts Dialog has a fairly consistent and steadily growing earnings

profile due to recurring income from its tank terminal concessions and EPCC works at Pengerang

Major earnings catalyst for the group are still a long way ahead in 2019, when the Pengerang Independent Deepwater terminals will be fully commissioned

Meanwhile, the stock appears to be trading at historical average multiples, which is fair given weak industry prospects

Downside risks There could be slower demand for sales of drilling fluids going

forward. This makes up c. 20% of group revenue Delays at Pengerang could result in a delay in start-up of Phase

2 of its tank terminal Upstream enhanced oil recovery and redevelopment business

maybe slow moving due to low crude oil prices


0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2008 2009 2010 2011 2012 2013 2014 2015

PGHB - PE(x)

Avg: 7.5x

+1sd: 10.2x

+2sd: 12.8x

-1sd: 4.8x

-2sd: 2.2x

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2008 2009 2010 2011 2012 2013 2014 2015

PGHB - PB(x)

-2sd: 0.5x

-1sd: 0.8x

Avg: 1x

+1sd: 1.2x

+2sd: 1.5x

-2.0

8.0

18.0

28.0

38.0

48.0

2009 2010 2011 2012 2013 2014 2015

DLG - PE(x)

Avg: 21.5x

+1sd: 33x

+2sd: 44.5x

-1sd: 10x

-2sd: -1.4x

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2009 2010 2011 2012 2013 2014 2015

DLG - PB(x)

-2sd: 0.7x

Avg: 3.7x

+1sd: 5.2x

-1sd: 2.2x

+2sd: 6.6x


Offshore & Marine

Page 27

Deleum Berhad (Share price: RM1.76; Hold; TP RM1.60)

PE charts PB Chart

Rationale & Catalysts Deleum has a solid order book of RM3.8bn which will keep the

group busy until 2023. Contracts on hand are brownfield services for supply and maintenance of gas turbines, slickline services and also corrosion control.

Growth to be muted in FY15 as PETRONAS’ opex cut is likely to result in slower gas turbine demand and also slickline activity. Expecting only 6.5% growth compared to >20% in FY14.

Steady dividend payout of 50% offers a yield of 5% going forward. Healthy balance sheet with 0.1x gearing.

Downside risks Impact from PETRONAS opex cut could be more severe than

expected


-3.0

0.0

3.0

6.0

9.0

12.0

15.0

18.0

2008 2009 2010 2011 2012 2013 2014 2015

DLUM - PE(x)

Avg: 5.3x

+1sd: 9.4x

+2sd: 13.4x

-1sd: 1.3x

-2sd: -2.8x

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2008 2009 2010 2010 2011 2012 2013 2014 2015

DEHB - PB(x)

-2sd: -0.8x

Avg: 1.9x

+1sd: 3.2x

-1sd: 0.5x

+2sd: 4.6x


Offshore & Marine

Page 28

OIL PRICE OUTLOOK Where Will We Go From Here? If only we could forecast oil prices with a simple demand-supply equation. Alas, it is far more complicated nowadays. While we believe that gradually improving demand-supply fundamentals will lead to some recovery in oil prices, it is extremely difficult to determine how fast or how far that recovery will be. There are many economic structural issues to consider as well as a maze of global geopolitical shifts, conspiracy theories, and potential acts of one-upmanship. That said, if history is any indicator, it seems unlikely that oil prices will reach pre-crash levels, at least in the near term. Structural Issues Make Forecasting More Difficult During the last few years, global oil markets have been changing, making them harder to forecast. In this report we will highlight some of the big issues, including OPEC’s refusal to cut production, the resiliency of US shale oil production, China’s slowing demand, and the geopolitical risks ahead. We also look at others factors such as a massive inventory buildup around the world, the strong US dollar, structural changes in the global economy, and how oil companies are responding. Volatility will prevail in the near term … We believe volatility will prevail in the near term, though there could be some eventual rebound in the medium to long term. Unfavourable trends on both the supply and demand fronts in the near term, as well as the strong US dollar will keep oil prices from breaking out at least before the second half of 2015. There could be high volatility in the market from spillover fears as the storage capacity in the US and OECD

countries nears peak levels and until we see production cuts. We are tempted to call a market bottom for oil prices at US$45 per barrel (/bbl) that we saw in January 2015, but we are also not ruling out the odd wobble here and there over the course of the next few months. We are reasonably confident at this point that oil prices will not tank and sustain at lower levels for long. This is because we do not expect OPEC to maintain production levels consistently at prices below US$40-50/bbl. That would be asking too much from some of the weaker OPEC member nations. From the second half of 2015 onwards, we expect some production cuts to kick in and support oil prices. But, in the absence of a strong demand push, the recovery in prices could be tepid at best. Thus, our base case scenario forecast for oil prices for the rest of 2015 is around US$55-65/bbl. For 2016, we project oil prices could be in the range of US$65-75/bbl. A “blue skies” scenario … However, there is always the possibility that oil prices might recover to near pre-crash levels under a “blue skies” scenario. But that would have to mean global oil demand picking up significantly over the next two years – driven by stronger economic growth in non-OECD countries spurred by low oil prices. It would also require OPEC as well as non-OPEC states (like the US and Russia) ironing out their differences on output levels. At this point, however, we are reserving our bets on this happening.

Oil price forecast scenario

Source: Bloomberg Finance L.P., DBS Bank forecasts

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Blue skies scenario

DBS Base case scenario


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The Demand-Supply Game

Global crude oil prices have fallen almost 50% since last June. Of course, they fell more than 60% at one point during January 2015, and recovered modestly by March before flattening out. The major factors have been a surge in production in non-OPEC countries during the past year or so, especially the US. There has also been an unwillingness by OPEC countries, led by Saudi Arabia, to cut their existing production levels. This has been compounded by slower-than-expected growth in global demand, thanks to falling demand

in many of the developed economies, including the Eurozone and Japan. How big of an impact each of these factors have had individually on the oil price slide is hard to measure. But suffice to say, the gap between demand and supply needs to be bridged before we can see a meaningful recovery in oil prices. The gap between demand and supply needs to be bridged before we can see a meaningful recovery.

Magnitude of oil price decline this time around

Source: Bloomberg Finance L.P. How big is the gap between demand and supply? In 2014, the US Energy Information Administration (EIA) estimated that oil production grew by about 2.2 million barrels per day (mmbpd), whereas oil demand growth was just around 0.9 mmbpd, much below initial projections. Almost all of the growth in supply came from non-OPEC sources, led by the US, as OPEC

production remained flat at about 30 mmbpd. Thus, the gap in demand-supply was around 1.3 mmbpd on average in 2014, widening in the second half of 2014. This is less than 2% of global oil consumption of about 92.2 mmbpd in 2014, hence the magnitude of decline in oil prices has been a bit surprising for market watchers in general.

Global oil production and consumption – trends and forecasts (EIA)

Source: US EIA

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OPEC maintains production despite calls to cut. OPEC’s production of 30.1 mmbpd in 2014 was largely unchanged from a year before, as increases in Libya, Angola, Algeria and Kuwait offset declines in Iraq and Iran. Despite the fall in oil price since June 2014 and pressure from some members to cut production targets, OPEC, in its last meeting on November 27, 2014, maintained its production target at 30 mmbpd. This

was a slight departure from its usual stance of trying to balance global supply to maintain a reasonable level for oil prices. Saudi Arabia, the key OPEC member nation, has actually been raising supplies in recent months, as has Iraq, the second largest producer in OPEC. Only Libya has seen declines, largely owing to political instability, but that has not affected overall OPEC output.

OPEC Crude Output (‘000 bpd) since June 2014

Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15

Saudi Arabia 9800 9820 9600 9650 9750 9650 9500 9720 9850

Libya 300 400 500 780 850 580 450 300 220

Iraq 3100 3000 3100 3150 3300 3370 3700 3400 3450

Iran 2840 2830 2800 2780 2780 2780 2770 2780 2780

Kuwait 2800 2880 2890 2900 2850 2790 2790 2850 2850

UAE 2800 2800 2800 2850 2850 2800 2700 2700 2800

Qatar 725 725 727 690 690 650 680 680 675

Algeria 1125 1125 1125 1100 1100 1100 1100 1100 1100

Angola 1660 1610 1750 1870 1700 1640 1620 1810 1830

Nigeria 2150 1920 2200 2130 2090 1970 2080 2040 1990

Ecuador 556 557 559 550 555 561 564 557 554

Venezuela 2470 2475 2471 2471 2469 2470 2468 2468 2469

Total 30326 30142 30522 30921 30984 30361 30422 30405 30568

Source: Bloomberg Finance L.P. Supply Glut Mainly Driven by US Shale Oil Revolution. Whereas OPEC production remains steady, non-OPEC production has been growing relatively fast, thanks to the US. US production grew by 1.6 thousand barrels per day (mbpd) in 2014, frequently outpacing earlier production growth estimates owing to the shale oil revolution, characterised by

technological advances and short lead times to production. This has made the US the leading contributor of non-OPEC crude oil production growth in 2014, as can be seen below. Canada and Brazil are the next biggest contributors to supply growth.

Non-OPEC crude oil production trends

Source: EIA


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Non-OPEC production growth by country (2014)

Source: EIA

The boom in US production has been mainly due to growing output of shale oil or ‘tight oil’, which represented close to one-third of total crude production in the US in 2014 (20% of total

petroleum supply including imports). Production of shale oil has grown at a compound annual growth rate (CAGR) of almost 50% over the past four years.

Increase in tight oil (shale oil) production in the US

Source: EIA

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US petroleum supply by source

Source: US EIA, Annual Energy Outlook 2014

Demand decline largely led by OECD nations. Consumption outside the OECD region grew by around 1.2 mmbpd in 2014, but this was offset by 0.3 mmbpd decline in consumption in OECD countries, driven by slow economic growth as well as

efficiency gains. Japan and Europe led the decline among OECD countries, and we can expect the declines to continue, though maybe at a slower pace, in the near future.

Demand growth in key OECD nations

Country/ region Consumption (mbpd) % chg y-o-y

9M-2013 average 9M-2014 average

Canada 2,434 2,408 -1.1%

France 1,787 1,714 -4.0%

Germany 2,415 2,381 -1.4%

Italy 1,312 1,231 -6.2%

Japan 4,472 4,258 -4.8%

Korea, South 2,301 2,338 1.6%

United Kingdom 1,518 1,501 -1.1%

United States 18,858 18,895 0.2%

Source: EIA Demand-Supply Can be Bridged With Time and Effort… …who will drive additional demand? As mentioned earlier, divergence between supply and demand is not that big in an overall context. However, the key question is who will drive additional demand? China will still be growing, and so will the rest of Asia, which will still be a significant source of oil demand for the next two years. But the rate of growth could be slower than it has been in the recent past, owing to changes in China’s economic policies. Asia’s demand for crude

oil will probably grow by around 0.7 mmbpd per year, and total global demand by around 1.0 mmbpd, subject to risks. On the other hand, the growth in production, especially from the US, will likely slow down over the next two years, after peak growth in 2014, as low oil prices bite to an extent. Thus, there should be a gradual convergence in oil demand and supply trends, especially if some of the higher-cost producers are squeezed out of the market over time. How long that will take and whether oil price recovers to previous highs is difficult to predict at this point.


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Asia has been the key driver for oil demand in the last decade – 10 year CAGR of 4.2% compared to global oil demand CAGR of just 1.3% over the same period

Source: EIA Annual change in Asia ex-Japan oil consumption – Asia continued to grow even during 2008-09, when oil consumption in rest of the world declined

Source: EIA US production growth expected to slow down – will growing demand from Asia be able to offset this growth and reverse oil price trend over time?

Source: EIA

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What Does History Tell Us?

We think that the actual base case scenario for oil price trend is not as simple as a demand-supply equation. We reckon forecasting oil prices here on presents a more challenging problem than in previous cases owing to the slightly unique nature of this oil price crash of 2014-15. First, we examine the current oil price crisis relative to previous crises over the last two-and-a-half decades and see if there is a lesson to be learnt, or not. Secondly, we take a look at the structural issues which may lead to more uncertainty and volatility in oil prices than a straightforward outright recovery. This oil price crash is unlike most we have seen in the past, which have been largely demand driven. A look at the chart above and we find oil price declines of similar or higher magnitude recurring every few years since 1990 – hallmark of a cyclical asset – but there are no real cases of a big supply glut causing oil prices to crash in recent history. Except for 1991 (reaction to Gulf War supply outages and restoration)

and 2008-09 (global financial crisis), most of the declines have been pretty long drawn out as well, and not as sharp in terms of duration, as demand rarely falls off very rapidly. In cases where changes in demand is the key driver for oil price drops, the situation has tended to reverse quite quickly as lower oil prices stimulates consumption and GDP growth, thus restoring the demand-supply equilibrium. In 1998, there was a case where OPEC responded reasonably swiftly to a drop off in demand, which had been triggered by the Asian financial crisis which happened to coincide with increased production by the bloc. OPEC agreed to coordinated production cuts to restore prices to comfortable levels. Unlike then, this time we have not yet seen a similar response by OPEC, or even concerns from key OPEC members regarding the current scenario. This makes the direction of oil prices in the current situation quite difficult to call.

Oil price crashes since 1990


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supply driven


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Comparison of current oil price crash with previous cases since 1990

Timeframe Reason for oil price crash Decline start date

Decline stop date

Price before fall Lowest price % fall No of days

1991

Reaction to 1991 Gulf War, reversal of oil price spike 16/01/91 17/06/91 30.20 17.34 -43% 152

1992-94 OECD recessionary stretch 05/06/92 16/02/94 21.56 12.72 -41% 621

1997-98 Asian financial crisis, OPEC excess production 08/01/97 10/12/98 25.00 9.00 -64% 701

2001 Recession in EU and US 07/09/00 15/11/01 37.73 16.62 -56% 434

2008 Global financial crisis 03/07/08 24/12/08 145.66 34.04 -77% 174

Average -56% 416

2014-15 Supply glut combined with slow demand 19/06/14 26/01/15 115.00 45.25 -61% 221

Source: Bloomberg Finance L.P., DBS Bank estimates

How quickly and how much did prices recover in the past? On average, oil prices have been slow to recover to original levels after a crisis, hovering between 50-80% of the original price in the next 12 months following an oil price bottom. The only outlier is the 1997-98 crisis, when a coordinated response by OPEC producers to cut production had a strong impact on oil

prices. Hence, it seems recovery in demand does help to an extent but the supply side of the equation has a bigger bearing on oil price recovery following a steep slide. In the current scenario, the uncertainty regarding OPEC’s response does not bode well for a sharp oil price recovery.

Speed and extent of oil price recovery in past crises

Timeframe Reason for oil price crash Decline start date

Decline stop date

Price after 12 mths % price rise % of original

1991

Reaction to 1991 Gulf War, reversal of oil price spike 16/01/91 17/06/91 21.22 22% 70%

1992-94 OECD recessionary stretch 05/06/92 16/02/94 17.15 35% 80%

1997-98 Asian financial crisis, OPEC excess production 08/01/97 10/12/98 25.31 181% 101%

2001 Recession in EU and US 07/09/00 15/11/01 23.13 39% 61%

2008 Global financial crisis 03/07/08 24/12/08 75.37 121% 52%

Average 80% 73%

2014-15 Supply glut 23/03/11 26/01/15 ??? ??? ???

Source: Bloomberg Finance L.P., DBS Bank estimates


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The Critical Issues Now

Structural issues make forecasting a more difficult affair this time around. We believe that over the last few years, global oil markets have been changing structurally. This has made them much harder to predict. Technological advances in shale oil drilling, the role of financial markets, and the probability that lower oil prices may not stoke demand as much as before, are some examples. In the following pages, we explore some factors, which we believe will affect oil prices in the near, medium and long terms and will have a direct bearing on our base case oil price scenario.

1. What to expect from OPEC and why.

2. How will the inventory buildup in the US and OECD countries affect prices?

3. How resilient is US shale oil production?

4. Structural changes: Is the global economy less oil-intensive and is demand less elastic to oil prices?

5. What is China’s impact on global oil prices?

6. Will the stronger US dollar weigh negatively on oil prices?

7. What are the geopolitical risks ahead?

8. How will the response of international oil companies affect the long term?

1. What to Expect from OPEC and Why

OPEC has maintained production slightly over 30 mmbpd over the last 8 months since oil price slide started


The surprise from Saudi so far. Historically, Saudi Arabia, as the leading producer in OPEC, has adjusted its production during periods of instability in the oil markets to restore some balance. However, this time around, there has been a sharp departure from its usual policy. Despite oil prices sliding for almost six months, it decided not to cut output during the last

scheduled OPEC meeting on November 27, 2014. The main logic reverberating across decision makers in Saudi seems to be that cutting output will only help its non-OPEC competitors gain more market share, and hence, without reciprocity, OPEC will not take an unilateral stance of cutting production.

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Highlights of OPEC’s last meeting on Nov 27, 2014

OPEC effectively embraces market force mantra, abandoning its long-held role as global swing producer

Led by Saudi Arabia, OPEC chooses to maintain its 30 mmbpd production quota, prioritising longer term market share

objectives over shorter term price stability

Effectively handed control over supply and price cuts to the market, thus forcing high-cost producers to take a call on reducing supply rather than OPEC

What is Saudi trying to achieve? Trying to battle its higher-cost competitors like the US, Russia and Brazil, who have all turned up their taps in recent years Betting that a period of low oil prices will force some of the high-cost producers in non-OPEC countries to blink Maintaining market share in a scenario which has seen non-OPEC output grow by 6 mmbpd since 2008 whereas OPEC

output has been capped at 30 mmbpd Saudi believes that if OPEC cuts production targets, it will have to cut again and again as non-OPEC supply will increase

and the overall supply situation will not ease

Some other OPEC countries may be hard pressed. According to Bloomberg Finance L.P., ten out of the 12 OPEC members will run a budget deficit this year, including an expected US$38.6 billion deficit in Saudi Arabia. But Saudi Arabia has around US$750 billion in foreign currency reserves to ease the blow, so it's willing to take a long view on oil. Smaller OPEC countries do not have the same luxury. Nigeria could have a budget shortfall of as much as 5% of GDP, which could be a funding gap of $21 billion over the next four years. That is one reason it is pushing hard for a cut in OPEC production. Venezuela's budget deficit may reach a whopping 19% of GDP in 2014, and it owes US$23 billion to partners like oil drillers and airlines, according to Ecoanalitica. With the country's currency spiralling out of control, low oil prices only make Venezuela's calls for an emergency OPEC meeting more urgent.

Oil price hawks in OPEC: Algeria, Iran, Iraq, Venezuela, Nigeria, Angola, Ecuador, Libya Oil price doves in OPEC: Saudi Arabia, Kuwait, United Arab Emirates, Qatar But almost all have enough foreign reserves to tide through a period of low oil prices. Many OPEC countries will likely run into budget deficit problems from a low oil price scenario, especially given OPEC countries focus on running social spending programmes to curb civil unrest. But it should not bother them too much as they have built up significant reserves of foreign currency. This will help them weather a short period of low oil prices. Of course, Saudi Arabia leads the pack here with more than US$700 billion in reserves, but many other countries boast significant reserves as well. Only Ecuador, Nigeria and Venezuela will be under pressure to ensure oil prices move up quickly as their reserves run out.


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Key figures related to OPEC countries Country Crude oil production

(mmbpd) Oil price needed to

balance 2015 budget (US$/bbl)

Oil export earnings as % of GDP (2013

figures)

Foreign exchange reserves (as of last

available date)

Algeria 1.4 130.5 30% 192.5

Angola 1.7 98.0 57% 37.9

Ecuador 0.5 79.7 28% 2.6

Iran 2.7 130.7 27% 68.1

Iraq 2.9 100.6 39% 71.2

Kuwait 2.9 54.0 63% 34.4

Libya 0.9 184.1 56% 120.9

Nigeria 1.8 122.7 18% 32.4

Qatar 0.7 60.0 68% 41.1

Saudi Arabia 9.6 106.0 51% 732.4

UAE 2.8 77.3 96% 58.0

Venezuela 2.8 117.5 24% 21.2

Source: Wall Street Journal, OPEC, IMF, Central banks We expect no change when OPEC members meet in mid June to discuss output policies and whether to curb the production output. Between now to the meeting date, we may see volatility in prices due to continuing strong output from OPEC members. A strong message to US shale oil producers … OPEC’s decision to keep producing oil has sent a strong message to US shale oil producers in as much as they are willing to

absorb low prices to keep US producers at bay. They are unlikely to revise this decision now as investments in new projects in the US are being revised and costs are being squeezed. While production levels in the US may not be affected much in 2015, owing to extensive hedging, a pullback in drilling should lead to lower shale oil production in the US, especially from 2016 onwards, which is the long term scenario that the OPEC is trying to achieve.

Some recent voices from OPEC participants imply no change in next meeting

Date Country Who Comments

10 March

2015

Kuwait Nawal Al-Fuzaia,

OPEC Governor

OPEC is likely to maintain its production policy at a meeting in June.

10 March

2015

Qatar Former energy

minster

OPEC won’t change policy at its next meeting in June unless non-OPEC

producers join in a collective cut.

9 March

2015

Abdalla El-Badri ,

OPEC Secretary

General

The global crude-oil market will return to balance in the second half of this year

from an oversupply of 2 million barrels a day.

4 March

2015

Saudi

Arabia

Ali Al Naimi,

Oil Minister

Refutes any plans of OPEC emergency meeting.

Saudi Arabia will not be cutting down supply as long as customers are there and

Saudi will always have customers since it is the most reliable supplier.

It is not the role of Saudi Arabia, or certain other OPEC nations, to subsidize

higher-cost producers by ceding market share.

23 Feb 2015 Nigerai Diezani Alison-

Madueke, Oil

Minister

May convene emergency OPEC meeting before scheduled meeting in June.

Source: Press reports


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OPEC’s surplus capacity is expected to rise in 2015 and 2016, hence production cuts are unlikely. Excluding 2009-2011 when EU and US economies fell into recession, OPEC’s surplus capacity in the near future is estimated to be at the higher end of its usual band seen over the last decade.

The EIA estimates OPEC surplus capacity to remain high at 2.3 mmbpd in 2015 and 2.7 mmbpd in 2016. Although surplus capacity has always been in the market, it can translate into production within weeks.

OPEC crude oil surplus capacity

Source: US EIA

2. How Will Inventory Buildup in US and OECD Affect Prices?

US crude oil supplies are at their highest level in more than 80 years. US crude oil supplies are at their highest level in more than 80 years while spare storage capacity is dwindling around the globe. This has led to fears that crude prices could fall further in the near term. The crude oil inventory in the US reached 449 million barrels (mmbbl) as of the first week of March, equal to almost 70% of US storage capacity. If this continues, according

to the US EIA forecasts, the US storage hub in Cushing is expected to hit maximum capacity this spring. On the other hand, data shows that more storage tanks are being built across the US, and some large tanker ships are being leased to store the oil. But the new tankers will take time to be built and will not be able to serve the growing supplies in the market. Thus, crude oil prices will continue to be under pressure.

Crude oil inventory in the US Source: Bloomberg Finance L.P. Finance L.P


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US inventory levels represent a good barometer of excess oil in the system, given the regular data flow and the fact that it consumes about 20% of the world’s oil annually. But on top of this, inventory levels in other developed countries have also been rising. Media reports indicate that inventories in countries like South Korea and Japan could be at 80% capacity levels as well. So there is some market concern over where all this excess oil can be stored and, if there is spillover

at some stage, how it will affect oil prices. The EIA estimates that OECD commercial oil inventories totalled 2.75 billion barrels at the end of 2014. That is the highest end-of-year level on record and is equivalent to roughly 60 days of consumption. OECD oil inventories are projected to rise to 2.90 billion barrels at the end of 2015 and to 2.92 billion barrels by the end of 2016.

OECD commercial oil stocks – days of supply Source: EIA

Inventory buildup expected to intensify in 1H15. Global oil inventory builds are projected to average 1.3 mmbpd through the first half of 2015, with the builds moderating during the second half of the year as demand rises and non-OPEC supply growth slows, particularly in the US, because of lower oil prices. The expected inventory builds in 2015 are on top of an estimated average 0.9 mmbpd increase in 2014. Making it difficult for a sharp recovery in oil prices. This inventory buildup seems to indicate that demand-supply parity could be restored within the next six to 12 months and could lead to a stabilisation of prices. However, bringing oil prices back to where they were in June 2014 – around US$115/bbl – may be some way off. The excess inventory is also likely to

lead to more volatility in the system as these oil stocks can be released rapidly, if held for trading purposes. Absorbing the excess inventory in the system would require cuts in capital expenditure by oil and gas majors that would result in lower supply in the coming years. It would also require steady demand growth from Asia and a more gradual restoration of the balance in the market that had been seen from 2012 to mid-2014. Thus, our base case scenario of oil prices averaging around US$60/bbl in 2015 and US$70/bbl in 2016 may be more realistic, with true balance in the system probably being restored gradually beyond 2016.

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3. How Resilient is US Shale Oil Production?

US oil production has consistently surpassed 9 mmbpd since November 2014. While slower-than-expected demand growth is partly to blame, it is widely acknowledged that the recent oil price plunge was more supply-led, particularly outside of OPEC nations, which saw output growing at the fastest rate. According to the EIA, non-OPEC countries produced 2.2 million more barrels per day in 2014 than they did a year ago,

with the US leading the way at 1.6 million barrels. The US accounted for 58% of non-OPEC supply growth in 2014. Despite falling oil prices, production of US oil in the first week of March rose to a multi-decade record of 9.37 mmbpd, from 9.32 mmbpd the week earlier. Weekly data show oil production has consistently surpassed 9 mmbpd since November, the longest stretch since the 1970s.

US crude oil production continues to rise above 9 mbpd, approaching the historical high of 10 mbpd in 1970

Source: EIA (Last updated 27 Feb 2015) Shale oil to remain a growing part of US supply till 2020 at least The EIA expects US production to sustain at these levels. It has recently revised its 2015 oil production expectations higher to 9.35 mmbpd, from 9.3 mmbpd. But it has also reduced its 2016 forecast to 9.49 mmbpd from 9.52 mmbpd in anticipation of production declines in North Dakota's Bakken

fields and Eagle Ford in Texas. The EIA expects US shale (tight oil), which currently accounts for almost half of US oil production, to remain a top source of incremental supply in the near to medium term. Growth will be definitely slowing down from 2015 onwards, but shale oil production is likely to keep growing until it peaks out around 2020-21 at just below 5 mbpd, according to EIA estimates.

US Shale production likely to keep growing and peak out around 2020

Source: EIA

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Shale oil production may be more resilient than you think. Lower oil prices have so far failed to drive US shale producers out of business. The majority of liquid shale (E&P) activities are profitable at current prices. It is estimated that the average

West Texas Intermediate (WTI) breakeven oil price for the main shale plays in the US is around US$58/bbl (against a misperception that majority of shale oil producers require more than US$80/bbl to survive).

Breakeven production cost estimates for US shale oil plays lower than expected

Source: Rystad Energy Research & Analysis Breakeven prices for shale are falling every year. A recent analysis shows breakeven prices for shale are falling every year for the main shale players due to a reduction on well cost and an increase in oil recovery per well. The reduction in well cost is due to shorter drilling time (increased pad drilling) and shorter completion time (increased use of zipper fracs). An

increase in oil recovery rates has been observed when estimating it at 30 years with wells decreasing initial decline. This is thanks to better well placement and advances in known completion techniques, that is, modified zipper fracs. We believe advances in technology could bring down the cost of shale production further.

Breakeven production cost estimates for US shale oil plays falling every year

Source: Rystad Energy Research & Analysis


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The industry’s resilience to lower oil prices reduces the power of OPEC to set global prices at higher levels. Frackers can also react with more flexibility to oil price shifts compared with conventional E&P operators. This is because of the relative ease of bringing new wells into production or shutting flows. Any price-induced reduction of US shale production would thus be short-lived. The industry’s resilience to lower oil prices reduces the power of OPEC to set global prices at higher levels.

Top US shale producers cutting capex though. Having said that, lower oil prices have discouraged investment into some of the higher-cost shale projects and this will adversely impact the development of US shale in the longer term. The top ten US shale producers have announced capex cut by 23% on average for 2015.

Top US shale producers cut capex budget by 23% on average

Top shale oil producers in the US Capex (US$ bn)

2014 2015 yoy chg

EOG Resources 8.3 4.9-5.1 -40%

Anadarko Petroleum 7.8 5.4-5.8 -28%

BHP Billiton Limited* 13.8 11.7 -15%

Chesapeake Energy 6.7 4.0-4.5 -36%

Cabot Oil & Gas Corp 1.5-1.6 0.9 -42%

ConocoPhillips 13.5 11.5 -15%

Concho Resources Inc 2.6 2.0 -23%

Encana Corporation (USA) 2.5 2.0-2.2 -16%

Apache Corporation 8.5 7.23 -15%

Total 65.3 50.3 -23%

*BHP's financial year end falls in Jun. Capex figures are computed based on average number of two financial years Source: Various companies Meanwhile, US rig counts have fallen since December 2014. The rig count is a reflection of the number of rigs actively exploring for, or producing, oil and natural gas. US rig counts had continued to rise during June to November 2014 despite the

falling oil price. The sharp fall begun a week after OPEC’s official statement of no production cut on November 27, which sent oil price on a freefall, from US$70/bbl to US$55/bbl within a month.

US rig counts have fallen by 51% from 1929 as of end Nov-2014 to 954 on Apr 17, 2015

Source: Baker Hughes

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Land Offshore


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Near-term production levels will be protected by hedges. Against a backdrop of fairly resilient shale oil production, the EIA expects US growth to decline from almost 1.5 mmbpd in 2014, to about 0.5 mmbpd in 2016. But production is unlikely to fall. By 2017, however, the EIA expects additional growth from the US to be a more meagre 160 mbpd, as the shale capex cuts take effect, and around 300 mbpd thereafter until the end of the decade.

OPEC has tried to dent US shale oil production through lower oil prices. However, the impact of this tactic might not be as decisive in the near term as hoped for. Some of the shale oil companies will be shielded from the full effect of falling oil prices owing to hedges already in place – mostly at around US$80-90/bbl levels. According to public filings, a number of oil companies, such as EOG Resources Inc, Anadarko Petroleum Corp, Devon Energy Corp and Noble Energy Inc, have hedged some of their 2015 production at prices of $90/bbl or more.

US production will still be a significant proportion of non-OPEC supply growth in 2015/16

Source: EIA 4. Structural Changes: Is the Global Economy Less Oil-Intensive and Demand Less Elastic to Oil Prices? Global oil demand was up by less than 1 mmbpd in 2014. That is the lowest level of growth in the past five years, and the lowest in the last decade, if we take out the global financial crisis years of 2008-09. In the run-up to the financial crisis, we reckon oil

demand growth was the strongest between 2002-07, when China was asserting itself on the global map as a manufacturing superpower.

Global oil consumption and consumption growth Source: EIA

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Comparison of oil demand CAGR over certain periods

2010 – 2014 CAGR: 1.2% 2007 – 2010 CAGR: 0.5% 2002 – 2007 CAGR: 2.0% 1995 – 2002 CAGR: 1.6% 1990 – 1995 CAGR: 1.1%

Source: EIA Global oil demand forecasts for 2015/16 not that encouraging. The EIA expects global consumption to grow by 1.0 mmbpd in 2015 and 2016. That’s not too far off from the 0.9 mmbpd growth in demand in 2014. While demand from non-OECD countries is expected to be around 0.8 mmbpd in 2015, OECD consumption, which fell by 0.3 mmbpd in 2014, is expected to grow by 0.2 mmbpd in 2015 and then stay relatively flat in 2016. There have been a number of downgrades to global demand estimates for 2015/16 despite the fall in oil prices, largely led by lower demand projections from Russia and China. Fall in consumption in Europe and Japan is structural. Japan and Europe accounted for almost the entire 2014 decline in OECD oil consumption. Consumption in these areas is expected to continue declining over the next two years, albeit at a slower rate than in 2014. Developed countries tend to use oil more for the transportation sector rather than industrial/manufacturing usage and hence, oil demand growth is slower. Taxes on oil usage for vehicles and other policy mechanisms also ensure that oil efficiency in these countries improves, thus reducing demand per capita over time. This tends to lower the elasticity of oil demand even in the face of strong economic growth. Moreover, the economies in OECD countries

tend to have larger service sectors relative to manufacturing. As a result, strong economic growth in these countries may not have the same impact on oil consumption as it would in non-OECD countries. Stronger US dollar will also affect the extent to which countries enjoy low oil prices. The US dollar has been climbing steadily over the past year, fuelled by expectations of US interest rate hikes and the relative strength of the US economy compared with other developed countries, particularly Europe. The US dollar index, a closely-watched measure of the currency against a basket of other currencies, just hit 100. That is the highest level since April 2003. Given that most oil trade is denominated in US dollars, an appreciating greenback adversely affects import costs in local currency, which means that some of these countries will not be able to fully reap the benefit of falling oil prices. The US is probably the only bright spot among OECD countries. The US is the leading contributor to projected OECD consumption growth, with US consumption projected to increase by 0.3 mmbpd in 2015 and by 0.1 mmbpd in 2016.


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5. What is China’s Impact on Global Oil Prices? China has been the biggest driver of oil demand for much of the last decade. As China moved into its strongest phase of growth over the last decade with a big push in manufacturing and infrastructure development, oil demand skyrocketed. From 8% of global oil demand in 2005, China now accounts for close to 12% of global oil demand. That represents a CAGR of 5.2% over the last ten years, and an even stronger run up of 5.7% CAGR over the last five years following the financial crisis years. Compare this with global oil demand growth rates of around 1.2% and you know how important China is to the oil producers.

In terms of incremental growth, China accounts for roughly 40% on average of all incremental growth in global oil consumption over the last five years. But is that going to be sustained going forward? We think it is unlikely, given the structural changes happening in China’s economy. Asia will still be a key driver of oil demand, but China’s role will likely diminish to an extent. The EIA projects annual average increase in demand from China of 0.3 mmbpd in both 2015 and 2016, down from growth of 0.4 mmbpd in 2014.

Growth of oil consumption in China

Source: EIA

Speed of demand growth from China likely to halve over next 5 years. Going by current projections, China’s demand for oil will grow at 2.5% to 3.0% over the next five years, roughly half the pace seen in recent times. Global oil experts like the EIA and the IEA have been downgrading demand numbers for China in recent months. This is to reflect significant changes in China's growth patterns, economic policies and energy efficiencies. Policy shifts in China visualise reduced oil demand

with the closure of excess capacity in many industries, most notably coal and steel. Additionally, there are government efforts to satisfy tighter clean-air regulations and a “new normal” of lower economic growth rates. The International Monetary Fund (IMF) projects Chinese GDP growth rates of 6.8% and 6.3% in 2015 and 2016, respectively, down from the heady days of 7-8% growth. All these factors together point to slower growth in oil demand.

7%

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11,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

China Petroleum Consumption (mbpd)

% global consumption from China

CAGR 5.2%


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6. Will the Stronger US Dollar Weigh Negatively on Oil Prices?

The greenback has been traditionally negatively correlated with oil prices. The US dollar has gone from strength to strength in recent months as oil prices have fallen. The Dollar Index is up almost 25% since June 2014. The US dollar’s rise came as support drained away from the euro. When the European Central Bank (ECB) launched a massive quantitative easing programme in March to boost growth, expectations grew of an interest rate hike by the US Federal Reserve.

Oil, like most global commodities, is quoted in US dollars and it often falls when the US dollar is strong. The current decline in oil prices has not been fundamentally caused by US dollar rally. However, it has exacerbated the situation by preventing the oil price from rebounding off its lows to any significant extent.

If the US dollar continues to rally, it will negate the benefits of lower oil prices to oil-importing countries with currencies not pegged to the US dollar. So, the demand for cheaper oil will not materialise to the same extent if the US dollar had stayed flat.

High negative correlation between US dollar and oil prices

Source: Bloomberg Finance L.P./DBS Group Research

Oil prices would have been closer to US$68/bbl now if US dollar had not rallied so strongly

Source: Bloomberg Finance L.P., DBS Group Research

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7. What are the Geopolitical Risks Ahead? Unplanned global supply outages are averaging around 3 mmbpd currently. In February 2015, unplanned crude oil supply disruptions among OPEC producers averaged 2.7 mmbpd. That was an increase of 0.1 mmbpd compared with the previous month. This was mainly attributable to rising outages in Iraq, Nigeria, and Libya. Unplanned OPEC crude supply disruptions averaged 2.4 mmbpd in 2014, 0.5 mmbpd higher than in the previous year. The high level of OPEC

disruptions contributed to higher crude oil prices during the first half of 2014. Unplanned supply disruptions among non-OPEC producers averaged slightly less than 0.6 mmbpd in February 2015, similar to the previous month. South Sudan, Syria, and Yemen accounted for more than 85% of total non-OPEC supply disruptions in February. The EIA estimates that unplanned non-OPEC supply disruptions averaged slightly more than 0.6 mmbpd in 2014.

Key potential problem areas

Libya – production at high risk owing to civil unrest, production still way off pre-civil war levels of 1.6 mmbpd. Iraq – production has been averaging around 3.3 mmbpd, despite ISIS issues and loss of wells in the northern part of the

country. However, risks of conflicts intensifying could impact production. Nigeria – facing rising threats of militancy amidst continuing social, economic and political unrest. Iran – production of 2.8 mmbpd amidst sanctions. Removal of sanctions could easily open the tap, given Iran’s estimated

capacity of around 3.6 mmbpd.

Libya oil production has been volatile in recent months but hasn’t made a dent to overall OPEC numbers

Source: EIA

Six countries – Libya, Iran, Nigeria, Syria, Iraq and Yemen – are expected to contribute to the bulk of unplanned supply disruptions, going forward. Unplanned supply disruptions could still affect crude oil prices in the future, but it seems that the rise in US production has more than offset the outages and offered the market a safer barrel of oil from a geopolitical perspective. In light of robust global production and increases in inventory levels worldwide, the threshold of supply disruptions that the market can bear has risen.

What is the near-term risk of lifting sanctions on Iran? Negotiations toward a possible US nuclear deal with Tehran have advanced in recent weeks, which have led to fears that this could allow more Iranian oil exports. The deal would remove Western sanctions that have been in place against Tehran for some time now and Iran officials have stated that it could take them a matter of a few months to increase oil exports by up to 1 mmbpd if sanctions are lifted.

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8. How Will the Response of International Oil Companies Affect the Long Term? Most oil companies believe low oil prices are here to stay. “We have now entered a new and challenging phase of low oil prices through the near and medium term,” cited the CEO of BP Group, Bob Dudley in February. He cautions that it could be three years before oil comes out of a US$40/bbl to US$60/bbl price range and a “long time” before oil returns to US$100/bbl.

In an analyst briefing in early March, ExxonMobil echoed BP’s view that the world should settle in for a period of relatively low oil prices. ExxonMobil now assumes oil price of US$55/bbl for global crude in next three years, in a presentation to investors outlining its business plans through 2017. While Shell is sharing the same views that oil price may stay relatively low and volatile in the next three years, it is keeping the long-term price expectation beyond US$90/bbl.

Supermajors’ views on oil price in the short term (1 year) and longer term (3-5 years)

Oil Majors Oil Prices (ST) Oil Prices (LT)

Shell

The short-term movements in the oil price can be driven by perception, and prices tend to overreact, both on the upside and on the downside. We don't have much visibility as to how long this downturn will last – months, years.

In the medium term, supply and demand fundamentals tend to reassert themselves again around the marginal cost of supply. We have not changed, therefore, our long-term planning assumptions of US$70 to US$110 Brent because the long-term outlook remains robust and industry underinvestment today simply leads to more upside risk in oil prices in the future.

Bullish

Chevron CEO John Watson: "Very few large oil projects will go ahead if crude stays below US$50/bbl, setting the scene for a rebound in prices.

Long-term market fundamentals remain attractive. The fall-off in new investment, combined with the inevitable decline of output from existing fields and rising global demand, would work to push oil prices higher again.

ConocoPhillips

CEO Ryan Lance expects oil prices to stay low for 2015.

Prices are expected to make a gradual recovery, but not to the peaks seen in the last three years.

TOTAL SA CEO Patrick Pouyanne: "Oil prices are unlikely to rebound in the first half of the year."

CFO, Patrick de La Chevardiere said TOTAL's objective is to cut its breakeven point by US$40/bbl to about US$70/bbl.

ExxonMobil

CEO Rex Tillerson does not see oil prices strengthening anytime soon. The world should “settle in” for a period of relatively weak oil prices, in view of the ample global supplies and relatively weak economic growth. US shale production is more resilient than many people had expected. There is enormous amount of global capacity in geopolitically unstable areas, which could be released when things stabilise.

Exxon assumes a price of US$55/bbl for global crude in next three years, in a presentation to investors outlining its business plans through 2017.

BP

BP boss Bob Dudley is very bearish on oil price. He says this feels the same as 1986, when oil slumped from US$30/bbl to US$10/bbl and didn’t recover until Iraq invaded Kuwait in 1990.

Oil prices may stay in a range below US$60 for as long as three years. “It will be a long time before we see US$100 again.”

Source: Companies, Upstream


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Low oil prices have already taken a toll on earnings and cash flow of oil majors. The oil price collapse since June 2014 has pulled down profits of E&P companies significantly in the 2014 December quarter. The supermajors saw adjusted profit after tax and minority interests (PATMI) falling 54% year-on-year in the 2014 December quarter, dragged lower by over US$5 billion losses reported by TOTAL SA.

BP is leading the pack in asset impairment, having reported a substantial headline loss after a US$3.6 billion impairment on upstream assets. The other peers, however, did not make significant asset impairment in the 2014 December quarter, taking a positive stance on longer term oil price above US$90/bbl.

Supermajors reported an average 21% y-o-y decline in 4Q14 adjusted PATMI

Supermajors Release 4Q13 4Q14 YoY Chg

date PATMI Adj PATMI* PATMI Adj PATMI* PATMI Adj-PATMI

US$ bn US$ bn US$ bn US$ bn % %

ExxonMobil 2-Feb 8.4 8.4 6.6 6.6 -21% -21%

Chevron 30-Jan 4.9 4.9 3.5 3.5 -30% -30%

Shell 30-Jan 1.8 2.1 0.6 2.7 -67% 29%

BP 3-Feb 1.0 2.8 (4.4) 2.2 nm -19%

ConocoPhillips 29-Jan 2.5 1.7 (0.0) 0.7 nm -57%

TOTAL SA 12-Feb 2.2 2.2 (5.66) (5.7) nm nm Total 20.8 22.1 0.5 10.1 -97% -54%

*Adjusted for exceptional items Source: Bloomberg Finance L.P., Companies Oil majors are slashing capex to safeguard shareholder return. BP and ConocoPhillips started guiding down 2015 capex since early December 2014 following OPEC’s resistance to output cuts that sent the oil price into a freefall. Following the fiscal year 2014 results announcement, the six supermajors plan to reduce 2015 capex by 14% on average, vis-à-vis guidance prior to the oil plunge.

The smaller E&P companies, for instance, Continental Resources, Concho Resources, Cresdent Point, Lundin Petroleum, Linn Energy, are projecting a steeper cut of 30-50% on capex in 2015.

Supermajors trim 2015 capex budget by 14% on average

Capex for 2015 Jun-14 Dec-14 Jan-Mar-15 Dec Chg Jan-Mar Chg Total chg US$ bn US$ bn US$ bn % % %

ExxonMobil 37 37 34 No chg -8% -8% Chevron 40 40 35 No chg -13% -13% Shell 37 37 32 No chg -14% -14% BP 26 24 20 -8% -17% -23% TOTAL 25-26 25-26 23-24 No chg -8% -8% ConocoPhillips 16.9 13.5 11.5 -20% -15% -32%

Sub-total 182 177 156 -3% -12% -14%

Source: Companies, Upstream Global E&P capex could drop 17% in 2015 Assuming WTI averages US$70/bbl, global capex for oil and gas E&P projects could drop 17% to US$571 billion in 2015, according to a survey of 476 oil and gas companies’ E&P capex budgets. The decline represents the third largest in

global expenditures since 1985. The largest was the 33% plunge in 1986 when oil prices tumbled below $10/bbl. Spending is expected to hold up in the Middle East, where small increases will come from Abu Dhabi National Oil Co.


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(ADNOC), Kuwait Oil Co., Saudi Aramco, and Qatar Petroleum. Cost-cutting measures, layoffs, pay freezes, share repurchase curtailment. Several oil producers and service companies have announced layoffs and cost cutting programmes in addition to reductions in spending on new drilling projects. BP is cutting mid-level supervisors in its oil production and

refining businesses and in back-office corporate functions in an effort to streamline activity and increase efficiency throughout the group. It would also freeze pay for 2015.

Chevron is scrapping its 2015 share repurchases

programme as part of the effort to curb spending. In addition, "significant cost-reduction efforts” are also underway, and layoffs are possible, according to CEO John Watson.

ConocoPhillips has also pre-empted its employees that

layoffs could be on the way. The layoffs and an accompanying pay freeze will supplement cost-control steps it has already taken, such as slashing its E&P budget.

Capex deferral does not mean it is forgone forever though. The capex reduction in the current low oil price environment is an interim measure to manage returns, cash flow, and shareholders’ dividend expectation. Capex is expected to trend down in next two to three years with the completion of major projects and delay of greenfield projects. Nevertheless, the capex commitment cannot be held back forever as prolonged periods of underinvestment will lead to future supply shortages and driving up oil prices consequently.

National oil companies feel the pinch, but production targets remain. In addition to capex cuts by the supermajors and the smaller independent oil companies, who are driven by shareholder returns in the short term, some of the national oil companies have also been forced to announce lower levels of investment. Petronas among the first in Asia to trim capex. Malaysia’s state-owned Petronas said in November 2014 that it would cut 2015 capex by 15-20% following the decline in crude oil prices. Therefore we expect a total annual capex spend of 45-50 billion Malaysian ringgit (RM) in 2015 by Petronas. The group typically spends 55-60% of their annual capex on Malaysian projects while the remainder is spent on international projects and acquisitions. In 2012-13, Petronas spent RM 32 billion per annum in Malaysia. And, in the first nine months of 2014, the group spent RM 24 billion. Another point to highlight is that Petronas is also reviewing its operating expenditure (OPEX) and reports indicate that they might slash it by up to 30%.


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Petronas’ capex split

Source: Petronas

CNOOC’s deep capex cut took market by surprise. CNOOC, China’s state-owned oil producer, announced on February 3, 2015, that it would slash its capex by 26-35% to between US$11.19 billion and US$12.79 billion. It also vowed to cut costs and boost efficiencies, as the nearly 50% slide in oil prices are putting a heavy burden on oil companies across the globe. The magnitude of capex cut took market by surprise, far bigger than the 8% forecast earlier by analysts. Other major oil firms in China, including PetroChina and Sinopec, are also expected to announce lower budgets for the current year.

Most of capex cut will be coming from delaying non-priority and less-prospective projects, some pricey deepwater exploration drilling, and to a lesser extent, bargaining down service providers’ fees. It will review its asset portfolio and consider selling those with poor quality and prospects, and consider whether it needs to book impairment charges on its assets due to sharply lower oil prices. However, CNOOC would not relinquish its high-cost shale gas and oil sands projects in North America, according to its chief executive, Li Fanrong. This is because the loss from shutting them down would be higher than keeping them running. Quoting an example, one of the oil sands producers in Canada saw their output fall by one-third post resumption from a six-month shut-down. And CNOOC production still projected to raise by 10-15%. The exploration budget will be chopped by 29% to 38%, with two-thirds of the remaining spend to go on wells off China. About 67% of capex is expected to be spent on development to raise production to between 475 and 495 million barrels of oil equivalent (boe), representing a 10-15% year-on-year increase in production.


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Despite being in rocky waters, Petrobras could also pump up production in near term Brazil is a net oil importer currently, and the falling oil price threatens the viability of its pre-salt reserves, which are believed to have a breakeven oil price of US$45-52/bbl. However, domestic production is expected to turn around this year with forecasts it will rise to 2.5 mmbpd, the first step to doubling output by 2020. But, Petrobras will have to clean up its operations and save itself from a credit crunch scenario though. Petrobras has been undertaking the world’s largest corporate capex programme, valued at up to US$221 billion over five years (2014-2018), to exploit its “pre-salt” discoveries, which lie up to seven kilometres beneath the waters of Brazil’s southeast coast. We estimate that its yearly E&P capex accounts for approximately 5% of global E&P capex, larger than supermajors’ 3-4% each. Petrobras’ capex breakdown, US$221bn for 2014-2018

Source: Petrobras

But weak balance sheet…Petrobras, as the state-run oil company, was made the sole operator of the pre-salt fields. This has overburdened its balance sheet over time. Furthermore, it has to juggle with the expensive local content programme and to subsidise domestic fuel prices to help the government control inflation. These have led to delays and the missing of output targets over the past few years. … and corruption allegations have thrown Petrobas into disarray of late. Making thing worse, Petrobras has been thrown into disarray by an investigation by Brazilian police and prosecutors alleging that former senior executives, construction companies, and politicians of President Dilma Rousseff’s Workers Party-led ruling coalition creamed billions of dollars off Petrobras’ contracts. Police have arrested senior executives both within Petrobras and in some of the country's largest construction and engineering firms that work with the oil major. Petrobras is also the most highly indebted oil giant. It has lost direct access to capital markets while awaiting the release of its audited results, leaving it vulnerable to a cash crunch given its huge capex programme.

E&P, 69.8%

Downstream, 17.5%

Gas & Energy, 4.6%

International, 4.4% Other, 3.7%


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All these capex cuts will pave the way for higher prices in the longer term. All these announced capex cuts won't necessarily translate into significantly lower production in the near term. It is likely that the most productive projects will go ahead while costs are also likely to decline along with the oil price. It is hard to gauge, but we could expect some impact on supply

in the medium term given it typically takes five to seven years to bring a greenfield into commercial production. In the next one to three years, there could be some easing on supply pressure as oil majors shelve higher-cost projects in their development phase, but the impact may not be as substantial as market expected it to be.

List of deferred / scrapped oil & gas projects

Company Project Location / Area

Description (Short) Type Est. Capex (US$ bn)

Status

ConocoPhillips Permain

Basin, Niobrara, Montney and Duvernay

North America, Canada

Plans to slow activity in US shale oil and gas exploration. Will defer work in several of the newer emerging areas for shale development in North America, including the Permian Basin of west Texas, the Niobrara shale of Colorado, and the Montney and Duvernay formations in western Canada.

Largely shale oil and gas

- Deferred

Chevron Oleska shale

gas field

Ukraine Chevron lost interest in the western Ukraine shale exploration project after findings in nearby Poland and Lithuania with similar geology showed worse-than-expected reserves.

Shale gas 10 Scrapped

Chevron Canadian Arctic drilling

Beaufort Sea, Canada

Cited "economic uncertainty in the industry" as oil prices fall.

Exploration - On Hold

Chevron Shale gas drilling in Poland

Poland Chevron will discontinue its shale gas project in Poland as it no longer makes business sense.

Shale gas - Scrapped

Qatar Petroleum / Shell

Al Karaana Emirate Qatar Petroleum and Royal Dutch Shell Plc (80:20) ended plans to build a US$6.5 billion petrochemical plant in the emirate, one of the biggest casualties of slumping oil prices so far, as producers scrap projects to conserve cash.

Petrochemical 6.5 Scrapped

Shell Arrow Greenfield LNG

Queensland, Australia

Shell has abandoned its plans for what would have been a fourth coal seam gas-LNG project at Gladstone in Queensland.

LNG 20 Scrapped

Shell Carmon Creek Phase III and IV

Canada Slowed down the pace in deepwater. Will delay phase three and four of the Carmon Creek project in Canada.

Upstream - Deferred

Premier Oil Sea Lion Falkland

Island The Falkland Islands’ first commercial oil discovery will be delayed until crude prices start to recover. It is estimated that the project requires an oil price above US$80/bbl to be economically viable.

Exploration 2.0 On Hold

Husky White Rose

Extension Canada Husky Energy will defer the final investment

decision on its offshore West White Rose oilfield extension project for a year.

Development 2.8 Deferred

Statoil - Greenland Statoil had handed back three exploration

licences on the west coast of Greenland, an area considered one of the highest-cost frontiers in the industry.

Exploration - -

Source: Upstream, various companies


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Conclusion

How each of these structural issues is likely to impact oil prices

Key Issues Short term impact Long term impact

OPEC Response

Inventory Buildup

Profile of US shale production

Structural changes in global oil demand

Role of China in oil demand

US dollar strength

Geopolitical issues

Response from global oil majors

Source: DBS Bank


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Volatility will prevail in the near term. Some rebound expected in the medium to long term. We believe that oil prices will recover in some way over time as demand-supply fundamentals improve. But it would tenuous at best to predict the timing and extent of such a recovery. Forecasting oil prices nowadays involves more than a simple demand-supply equation. There are too many extraneous factors involved. We believe unfavourable trends on both the supply and demand fronts, as well as the strong US dollar will keep oil prices from breaking out before the second half of 2015 at least. As the storage capacity in OECD countries nears peak levels, there could be high volatility in the market from spillover fears, until we see production cuts. We can see a market bottom for oil prices at US$45/bbl which was last seen in January 2015. Of course, this could be affected by occasional variables in the coming months. That said, we are reasonably confident that oil prices will not tank and sustain at lower levels for long, as we do not expect OPEC to maintain production levels below US$40-50/bbl

because of budget pressures on its weaker members. From the second half of 2015 onwards, we expect production cuts to kick in and support higher prices. But, unless this is matched by a strong global demand push, the recovery could be a little limp. Overall, our base case scenario forecast for oil prices for the rest of 2015 is around US$55-65/bbl. For 2016, we project oil prices could be in the range of US$65-75/bbl.

However, we also cannot totally discount a “blue skies scenario” under which oil prices could rise to near pre-crash levels in the next two years. But that would need a combination of forces to come together. For starters, non-OECD countries would have to generate stronger economic growth. Moreover, OPEC and non-OPEC oil producing nations – like the US and Russia – would need to set mutually agreed output levels. Of course, nothing is impossible but the odds of this happening are long.

Oil price forecast scenario

Source: Bloomberg Finance L.P., DBS Bank forecasts

0

20

40

60

80

100

120

140

Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Jul-15 Dec-15 May-16 Oct-16

US$/bbl

Blue skies scenario

DBS Base case scenario


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Key short-term and long-term catalysts for oil price – up and down

SHORT TERM LONG TERM

• Drop in US rig count, if it yields any immediate sharp production declines

• Unexpected supply disruptions owing to geopolitical tensions intensifying in the Middle East or elsewhere

• Cuts by OPEC at its next meeting or at any intermediate point of time

• All the OPEC nations cannot withstand low oil prices forever – financially weaker countries will need to take affirmative action at some point

• Low oil prices stimulating new demand growth, especially in developing Asia

• Cut in E&P capex over next two years will lead to supply decline beyond 2017, especially if deepwater offshore projects are delayed

• No big decline in shale production in 2015 owing to hedged revenues of producers

• Huge oil inventory buildup in the US and elsewhere

• Saudi seems intent so far on limiting growth of non-OPEC oil and Saudi has enough financial muscle to withstand low prices

• Lifting of sanctions on Iran

• Impact from speculative oil trades

• Shale oil drilling pretty elastic in terms of lead time – quick resumption of supply will negate oil price gains

• Continuing low economic growth across the world

• Impact from structural changes to demand for oil, especially in developed countries and even China

• Lack of a big new demand centre now that China’s growth has peaked

Source: DBS Bank


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APPENDICES

Appendix I: What is Regression?

What is Linear Regression?

In a cause-and-effect relationship, the independent variable is the cause, and the dependent variable is the effect. Linear

regression is a method for predicting the value of a dependent variable Y, based on the value of independent variables Xn.

Y = β0 + β1 X1 + β2 X2 β1, β2= the slope of the line β0 = Y-intercept, i.e. the value of Y where the line intersects with the X-axis

Assumptions and Conditions for Regression

Regression can be a very useful tool for finding patterns in data sets. However, not all data fit to a regression line. Regression can only be performed on quantitative variables, i.e. data must be a set of numbers. One should check that the variables have actual units and that they are measuring something that makes sense. Validity. Most importantly, the data one is analysing should map to the research question he/she is trying to answer. This sounds obvious but is often overlooked or ignored because it can be inconvenient. It is vital to ascertain the cause and effect between variables as well as the rationale and logic behind. Often, the dependent variables may be influenced not only by quantitative variables (such as output, prices, etc.), but also by qualitative variables (gender, religion, geographic region, etc.). A dummy independent variable (also called a dummy explanatory variable) may be included as "proxy" variables or numeric stand-ins for qualitative facts, that are expected to shift the outcome. This can be done by assigning value to the qualitative factor, for instance, 0 for female and 1 for male. There are four principal assumptions which justify the use of linear regression models for purposes of inference or prediction:

1. Linearity and Additivity

The most important mathematical assumption of the regression model is that its deterministic component is a linear function of the separate predictors. The best way to check this condition is to make a scatter plot of the data. If the data looks like it can roughly fit a line, regression can be performed. For other types of regression (like exponential regression), eyeball the scatter plot to

make sure it roughly follows the shape of the regression that one is expected to perform.

2. Independence of Errors The next important assumption is the statistical independence of the errors, in particular, no correlation between consecutive errors in the case of time series data (auto-correlation) If scatter plots show that points are following a clear pattern, it might indicate that the errors are influencing each other. The errors are the deviations of an observed value from the true function value.

3. Homoscedasticity (constant variance) of the errors The scatter plot is good way to check whether homoscedasticity (that is the error terms along the regression are equal) is given. If the data is heteroscedastic, the scatter plots looks like a cone instead of tube.

4. Normality of Error Distribution Ideally, at any point in the X-values, the data points should be normally distributed around the regression line. The values should be fairly close to the line, evenly distributed with only a few outliers. Linear regression should not be run on values that are not normally distributed.


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Appendix II: Regression of Singapore Rigbuilders’ PE Regression analysis supports our argument. We have run a linear regression to examine our hypothesis that O&G stocks shall not test GFC levels despite similar oil price levels. We regress the rigbuilders’ PE on oil price and STI PE, given oil price is a key leading indicator of rigbuilding activities and STI valuation could reflect overall market and macro conditions. At the current oil price level, Singapore rigbuilders look fairly priced at c.10x PE. Rigbuilders’ PE = -8.1492 + 0.052*Oil Price + 1.0968*STI PE

Sensitivity of Rigbuilders’ PE over oil price and STI PE

Source: DBS, companies, Bloomberg Finance L.P.

Results of the multiple regression for Singapore rigbuilders’ PE against oil price and STI’s PE

Regression Statistics

Multiple R 0.92 R Square 0.85 Adjusted R Square 0.85 Standard Error 1.26

Observations 97

ANOVA

df SS MS F Significance F Regression 2 854.6788 427.3394 271.0003 0.0000 Residual 94 148.2283 1.5769

Total 96 1002.9070

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -8.1492 0.8872 -9.1850 0.0000 -9.9108 -6.3876 -9.9108 -6.3876 STI 1.0968 0.0595 18.4184 0.0000 0.9785 1.2150 0.9785 1.2150

Oil Price 0.0520 0.0058 9.0374 0.0000 0.0406 0.0634 0.0406 0.0634

Source: DBS, Companies, EIA

85% of the variation in rigbuilders’ PE can be explained by changes in oil price and STI

P-value <0.05 suggesting that the independent variables and regression model are statistically significant in explaining the variations

85% of the variation in rigbuilders’ PE can be explained by changes in oil price and STI

0 8 Peak + 1 SD Cu rren t - 1 SD 0 9 G F C2 0 .8 1 5 .8 1 3 .5 1 2 .4 9 .2

3 5 16.5 11.0 8.5 7.3 3.84 0 16.7 11.3 8.7 7.5 4.04 5 17.0 11.5 9.0 7.8 4.34 9 17.2 11.7 9.2 8.0 4.5

5 0 17.3 11.8 9.3 8.1 4.5

5 5 17.5 12.0 9.5 8.3 4.86 0 17.8 12.3 9.8 8.6 5.16 5 18.0 12.6 10.0 8.8 5.37 0 18.3 12.8 10.3 9.1 5.6

7 5 18.6 13.1 10.6 9.4 5.8

8 0 18.8 13.3 10.8 9.6 6.18 5 19.1 13.6 11.1 9.9 6.49 0 19.3 13.9 11.3 10.1 6.69 5 19.6 14.1 11.6 10.4 6.9

1 0 0 19.9 14.4 11.9 10.7 7.11 0 5 20.1 14.6 12.1 10.9 7.41 1 0 20.4 14.9 12.4 11.2 7.71 1 5 20.6 15.2 12.6 11.4 7.9

ST I PE

Bre

nt

Cru

de

Pri

ce (

US

$/b

bl)


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Appendix III: Scorecard Details SCORECARD The oil price collapse has taken a toll on oil and gas-related stocks, with share prices tumbling by an average of 40-50% since Sept’14. While low oil price is affecting the businesses across the supply chain, not everyone will be hit in the same manner and magnitude. The listed companies in Singapore, Malaysia and Indonesia are exposed to different parts of the value chain and have different business models – be it shipbuilding, owning vessels, or providing services. We propose a scorecard to better identify the long-term winners. Scorecard to identify long-term winners. Some O&M players will have relatively better financial strength, earnings visibility, and offer favourable risk/reward investment opportunities, for exposure to the sector over the cycles. How the scorecard works. Our final selection is based on a bottom-up approach, after examining the fundamentals of each company with respect to: 1) Business model, 2) Asset quality, 3) Earnings visibility, 4) Operational efficiency, and 5) Balance sheet strength. We grade the companies under our coverage on 15 criteria under the broad headings above on a scale of 1 (lowest) to 4 (highest) based on defined thresholds. We then calculate the weighted average score (out of 4) with the average scores in each broad bucket weighted as follows: business model (20%), asset quality (15%), earnings visibility (15%), operating efficiencies (20%), balance sheet strength (25%). An additional 5% weight bonus is accorded for trading liquidity score. 1) Shallow water vs Deepwater. We attempt to access the sustainability and resiliency of businesses in a low oil price environment through their exposure in the supply chain - shallow water vs deepwater segment, production vs exploration phase, clientele, and the company’s long-term vision. Shallow water productions/projects are at lower risks of abandonment given the breakeven oil price for shallow water exploration activities is low at around US$30-60/bbl vis-à-vis deepwater’s US$40-80/bbl. Those who have over 60% of FY15F revenue exposed to shallow water segment score 4 while those <20% score 1. Most of the stocks under our coverage score 3 or 4. Ezra and Vard are the outliers who have greater exposure to the deepwater segment. 2) Production vs Exploration phase. Supermajors have slashed their 2015 capex budget by 14% on average. A greater cut is seen in exploration spending, which is costly, uncertain and requires long gestation periods. On average, the progress from exploration to production phase could take 5-7 years. Production of oil and/or gas can last up to 40 years or more depending on the size and accessibility of reserves. It is estimated that Exploration cost is around US$10-15/bbl, Development cost is about US$10/bbl while cash cost to

extract oil is typically low at below US$50/bbl (for deepwater production). Hence, oil companies will likely continue producing if oil prices are above their cash costs. Hence, exposure to the production phase should be relatively more resilient as compared to exploration phase. Those who have over 60% of FY15F revenue exposed to production phase score 4 while those with <20% score 1. Most of the players score 3 or 4 in this session except Ezra, which is estimated to have only 20% exposure to production phase and almost zero for UMW. 3) Customer profile. We believe the default or solvency risks are relatively lower for established players such as the national oil companies (NOCs), international oil companies (IOCs) and international operators. We would be mindful of highly geared young E&P players and operators, which can run into financial distress in the current low oil price environment. We give a score of 4 for companies that have a strong customer base that derive >80% of revenue from established players and 1 for those with <20%. Ezion scores best among the Singapore-listed players, followed by Mermaid. Malaysia players generally fare well, given the captive demand from NOC - Petronas. 4) Long-term vision. This is a qualitative criterion that reflects our opinion and judgment on a company’s vision based on industry trends and company strategies. We are optimistic on Ezion’s long-term vision to be the liftboat builder in Asia Pacific, given the rising endorsements of liftboats, Ezion’s first-mover advantage, and prudent approach. We have ascribed a score of 2 for Nam Cheong and Ezra. For Nam Cheong, the Build-To-Stock model can be risky especially during a downturn, though it has proven its ability to project industry trends over the years. For Ezra, it has one of the most advanced and high-end fleets that caters to deepwater and ultra deepwater operations, which shall propel the company's long-term earnings as the trend is to move towards deeper water. However, in the near-to-medium term, it may be under pressure to maximise utilisation of the high-end vessels in a low oil price environment. 5) Fleet profile. For asset owners (i.e. rig and offshore support vessels) and service providers, a good mix of assets sharpens their competitive advantage, allowing them to cater to market demand at a good charter rate. Based on asset class, we believe liftboat/service rigs have brighter prospects in the medium term, while OSV supply/demand is healthier than the previous cycle. We are less upbeat on drilling rigs which will be in supply glut these two years. 6) Fleet age. In general, a younger fleet is preferred for its technical capabilities, fuel efficiency, safety and lower maintenance costs. Sometimes, oil companies may require the vessels supplied to be below a certain age. Most of the Singapore and Malaysia players have an average fleet age of <10 years. A


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special highlight on Ezion, while it has only taken delivery of its first liftboat in 2010 and hence the average age of its fleet should have been <5 years if the refurbished jackups were to be considered “new”. However, refurbished jackups are converted from old rigs, typically 25-35 years' old, with life extension programme. Conservatively, it is probably fair to say that Ezion's fleet age is around 15 years' old. 7) Confidence on earnings forecast. This criterion helps us to rank the confidence and stability of earnings projections for the companies, and is important if there is an unforeseen sudden cyclical slowdown. This is based on the company’s previous execution track record, especially during GFC crisis, and weigh on the downside risks based on our oil price forecasts. We are more convicted with Ezion’s forecasts buffered by our recent prudent revision of a 5% rate cut across the board. Earnings might be a little patchy for Ezra, Vard and Mermaid, partly owing to company-specific issues. 8) Book-to-bill. Existing contracts provide the necessary buffer during difficult times. We look at the order backlog/FY15F revenue: those with >2.5x score a 4 and those with 1.5x score a 1. Among Singapore companies, Ezion boasts the largest book-to-bill ratio of 3.7x. Among Malaysian players, Bumi Armada, Dayang and Deleum can count on their burgeoning order books to offer clear visibility, but UMW has to aggressively bid for more contracts, given the lack of long-term jobs. 9) Operating margin. We used a combination of operating margins, return on capital and free cash flows as the defining metrics to determine operational efficiency and the strength of the business model. Those with >40% operating margin in FY15 score a 4 and those with <10% operating margin score a 1. Among Singapore stocks, Ezion has the best score while Vard, Mermaid and Ezra scored the worst due to operational challenges. Among Malaysian stocks, all scored reasonably well likely due to the relatively less competitive market, as a result of strict enforcement of local content requirements. 10) Return on Equity. To measure shareholder value creation, we used FY15F ROE to gauge how efficiently companies deploy capital. Those with excess returns of >15% score a 4 while those with <5% score a 1. Again, Ezion stands out among Singapore companies, followed by Nam Cheong. Among Malaysian companies, Dayang topped the list while Bumi Armada scored the least. 11) Free cash flow yields. To measure cash flow generation, we divided projected FY15 free cash flow by market cap to adjust for size. Companies with decent operating cash flows but large outstanding capex commitments will fare relatively poorly here. Those which FCF yield >10% score a 4 and those with <0% score a 1. Most of the Singapore and Malaysian companies fared poorly due to high capex plans, except

Pantech, Dayang and Deleum which do not have large capex commitments. 12) Net gearing. Companies with stronger balance sheets would have a better advantage in a cyclical upturn in activity, and be able to weather potentially higher funding costs. Companies that are projected to be in a net cash position score a 4, while those with net gearing >1.0x by end-FY14 score a 1. Most of the Singapore companies have net gearings of 0.5-1.0x, while Ezra and Vard fared the worst with >1.0x net gearings. Among Malaysian companies, Dayang stands out with minimal borrowings and strong cash flow generation. 13) Net debt / EBITDA. As a rule of thumb, net debt/EBITDA of over 4x raises a red flag on credit risk. Companies that are projected to be in a net cash position score a 4, while those with net debt/EBITDA of >4.0x by end-FY14 score a 1. Most of the Singapore companies have kept their net debt below 4.0x EBITDA with the exception of Ezra, Vard and POSH. Among Malaysian companies, SapuraKencana and Bumi Armada look overstretched with 6-10x of net gearing /EBITDA. 14) Liquidity ratio. We have included current ratio (current assets/current liabilities) in the scorecard to measure a company's ability to pay short-term obligations. This is particularly crucial in the downcycle where we might see earnings declining and customers delaying payments. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. It does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign. Companies with current ratio <1.0x by end-FY14 score a 1 while those with >2.0x score a 4. Nam Cheong, Mermaid, Pantech and Coastal Contracts top the list while POSH is the only one under our coverage that has <1.0x current ratio. 15) Cash conversion cycle (CCC). This measures the company’s ability to generate working capital and ties in with balance sheet strength. Companies with lengthy cash conversion cycles typically stretch their balance sheets because they would need short-term financing. Here, companies with CCC of <50 days score a 4 while those with CCC of >200 days score a 1. Shipbuilders like Nam Cheong and Vard score poorly here because of the nature of their businesses, while Ezion and POSH seem to be collecting charter income more promptly than others. 16) Share trading liquidity. We included this because this sector has many small/mid-cap stocks. The measure we use is average daily value traded over the past 12 months. This is relevant as illiquid stocks could deter investors in a meaningful way, notwithstanding the fundamentals of the company. Here, those with >S$10m average daily turnover score a 4 while those with <S$1m average daily turnover score a 1. Ezion and SapuraKencana are the most liquid stocks in our universe, while Deleum and Pantech are poorly traded in the market, which could affect valuations to an extent.


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How the scores stack up. Ezion and Dayang are the clear leaders among the stocks under our coverage in the region, followed closely by Deleum and Dialog, mainly because of their niche positioning. SapuraKencana and Pantech also scored highly, given their exposure to protected markets. They are followed by Vard Holdings, Bumi Armada, UMWOG,

Coastal Contracts, POSH, Pacific Radiance, Nam Cheong and Mermaid Maritime. Ranking low on our scale are Ezra Holdings and Vard.

Top picks – balancing scorecard against valuations Scores for Singapore stocks pegged against valuations


Scores for Malaysia* stocks pegged against valuations

* Excluded outlier UMW OG which is trading at over 30x PE and 4.5x PB Source: Companies, Bloomberg Finance L.P., DBS Bank

Ezion

PACRA

POSH

Ezra

Mermaid

Nam Cheong

Vard

2

3

4

5

6

7

8

9

10

11

12

1.50 2.00 2.50 3.00 3.50

PE (x

)

Scores (max = 4)

Ezion

PACRA

POSH

Ezra

Mermaid

Nam Cheong

Vard

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.50 2.00 2.50 3.00 3.50

PB (x

)

Scores (max = 4)

SapuraKencana

UMW OG Bumi Armada

Dayang

Coastal

Deleum

Pantech

6

7

8

9

10

11

12

13

14

15

16

2.00 2.50 3.00 3.50

PE (x

)

Scores (max = 4)

SapuraKencana

UMW OG

Bumi Armada

Dayang

Coastal

Deleum

Pantech

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5

2.00 2.50 3.00 3.50

PB (x

)

Scores (max = 4)


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Offshore oil & gas service players – Singapore (Part 1/3)

Variable Definition Ezion PACRA POSH EZRA Mermaid Nam

Cheong Vard

Business (20%)

Shallow water % FY15 revenue

Score 1: <20% 1

2: 21-40% 2

3: 41-60% 3

4: >60% 4 4 4 4

Production % FY15 revenue Score 1: <20%

2: 21-40% 3

3: 41-60% 3 3 3

4: >60% 4 4 4

Customer profile NOCs/IOCs/international operators % FY15F revenue

Score 1. <20% 1 1

2. 21-50% 2 2 2

3. 51-80% 3

4. >80% 4

Long-term vision Score 1. Less optimistic

2. Average 2 2 2

3. Above average 3 3 3

4. Optimistic 4

Asset quality (15%)

Attractiveness of asset mix Score 1. Less desirable 2. Average 2 2 3. Above average 3 3 3 3 4. Desirable 4

Fleet age Average age Score 1. >15 years 1 2. 11-15 years 2 2 2 3. 6-10 years 3 3 4. <5 years 4



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Variable Definition Ezion PACRA POSH EZRA Mermaid Nam Cheong

Vard

Earnings visibility (15%) Confidence on forecasts

Confidence on FY15-FY16 earnings forecast

Score 1: Low 1 1 1 2: Average 2 3: Above average 3 3 4: High 4 Book-to-bill Orderbook / FY15F

revenue

Score 1: <1.5x 1 1 1 1 2: 1.6-2.0x 2 2 3: 2.1-2.5x 4: >2.5x 4

Operational efficiency (20%)

Operating margin FY15F operating margin (%)

Score 1: <10% 1 1 1 2: 11-25% 2 2 3: 26-40% 3 4: >40% 4 Return on Equity FY15F ROE Score 1: <5% 1 2: 6-10% 2 2 2 3: 11-15% 3 4: >15% 4 4 Free Cash Flow Yield FY15F FCF / Share price

(%)

Score 1: <0% 1 1 1 1 1 2: 0-5% 2 3: 5-10% 4: >10% 4


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Variable Definition Ezion PACRA POSH EZRA Mermaid Nam

Cheong Vard

Balance Sheet Strength (25%)

Net gearing FY14 Net gearing (x) Score 1: >1.0x 1 1

2: 0.6-1.0x 2 2

3: 0.1-0.5x 3 3 3

4: Net cash

Net debt / EBITDA FY14 Net debt / EBITDA Score 1: >4.0x 1 1 1

2. 2.1-4.0x 2 2 3

3: <2.0x 3

4: Net cash

Liquidity ratio FY14 Current ratio Score 1. <1.0x 1 2

2. 1.1-1.5x 2

3. 1.6-2.0x 3 3

4. >2.0x 4 4

Cash conversion cycle FY14 Cash conversion

cycle (days)

Score 1: >200 days 1 1 2: 101-200 days 2 3: 50-100 days 3 4: <50 days 4 4 4

Trading liquidity of shares (5%)

Trading liquidity of shares Past 12 months' avg daily valued traded (S$ m)

Score 1: <S$1m 2: S$1-5m 2 2 2 2 2 3: S$5-10m 3 4: >S$10m 4

Weighted score (out of 4)

3.34 2.49 2.46 1.74 2.23 2.40 1.98 Rank 1 2 3 7 5 4 6



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Offshore oil and gas players – Malaysia / Indonesia (Part 1/3)

Variable Definition SAKP BAB UMW OG

DLG DEHB COCO DLUM PGHB Wintermar Logindo

Business (20%)

Shallow water % FY15 revenue

Score 1: <20%

2: 21-40%

3: 41-60% 3 3 3 3

4: >60% 4 4 4 4 4 4

Production % FY15 revenue Score 1: <20% 1

2: 21-40%

3: 41-60% 3 3 3

4: >60% 4 4 4 4 4 4

Customer profile NOCs/IOCs/international operators % FY15F revenue

Score 1. <20% 1 1

2. 21-50%

3. 51-80% 3 3

4. >80% 4 4 4 4 4 4

Long-term vision Score 1. Less optimistic

2. Average 2 3 2

3. Above average 3 3 3 3 3 3 3

4. Optimistic

Asset quality (15%)

Attractiveness of asset mix Score 1. Less desirable 2. Average 2 3 2 3. Above average 3 3 3 3 3 3 3 4. Desirable

Fleet age Average age Score 1. >15 years 2. 11-15 years 3. 6-10 years 3 3 3 3 3 4. <5 years 4

Source: Companies, Bloomberg Finance L.P., DBS Bank, AllianceDBS


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DLG DEHB COCO DLUM PGHB Wintermar Logindo

Earnings visibility (15%)

Confidence on forecasts

Confidence on FY15-FY16 earnings forecast

Score 1: Low 2: Average 2 2 2 2 2 3: Above average 3 3 3 3 3 4: High Book-to-bill Orderbook / FY15F

revenue

Score 1: <1.5x 1 1 2: 1.6-2.0x 2 3: 2.1-2.5x 3 3 4: >2.5x 4 4 4

Operational efficiency (20%)

Operating margin FY15F operating margin (%)

Score 1: <10% 2: 11-25% 2 2 2 2 2 2 3: 26-40% 3 3 3 3 4: >40% Return on Equity FY15F ROE Score 1: <5% 2: 6-10% 2 2 2 2 3: 11-15% 3 3 3 4: >15% 4 4 4 Free Cash Flow Yield

FY15F FCF / Share price (%)

Score 1: <0% 1 1 1 1 1 2: 0-5% 2 2 3: 5-10% 3 3 4: >10% 4



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DLG DEHB COCO DLUM PGHB Wintermar

Logindo

Balance Sheet Strength (25%)

Net gearing FY14 Net gearing (x) Score 1: >1.0x 1

2: 0.6-1.0x 2 2 2

3: 0.1-0.5x 3 3 3

4: Net cash 4 4 3

Net debt / EBITDA

FY14 Net debt / EBITDA

Score 1: >4.0x 1 1

2. 2.1-4.0x 2 2 2

3: <2.0x 3 3 3

4: Net cash 4 4

Liquidity ratio FY14 Current ratio 1 Score 1. <1.0x 2

2. 1.1-1.5x 2 2

3. 1.6-2.0x 3 3 3 3

4. >2.0x 4 4

Cash conversion cycle

FY14 Cash conversion cycle (days)

Score 1: >200 days 1 1 2: 101-200 days 2 2 3: 50-100 days 3 3 4: <50 days 4 4 4 4

Trading liquidity of shares (5%)

Trading liquidity of shares

Past 12 months' avg daily valued traded (S$ m)

Score 1: <S$1m 1 1 1 1 2: S$1-5m 2 2 2 3: S$5-10m 3 3 4: >S$10m 4

Weighted score (out of 4)

2.69 2.65 2.56 3.08 3.30 2.50 3.13 2.69 2.40 2.21 Rank 4 6 7 3 1 8 2 5 9 10



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Appendix IV: Qualitative Analysis

Qualitative analysis of Singapore-listed O&G companies under coverage

Variable Strategy Assets Track Record Financial

Ezion

The Liftboat King

Enjoys first-mover advantage introducing service rig to SEA. Prudent fleet expansion backed by back-to-back charter contracts.

Liftboat sees rising acceptance in SEA and has progressed from infancy to growth phase.

Excellent execution and earnings delivery. Delivery reschedulings are usually led by shipyard delays for which Ezion is not held responsible.

Huge order backlog of US$2bn which translates into 3.7x revenue coverage alleviates concern of relatively high gearing c.1.0x.

Pacific Radiance Cost competitive OSV player

Management knows market requirements in shallow water OSV space very well and builds ahead of curve using virtual shipyard strategy.

Shallow water assets, young age of fleet, low cost of ownership ensures good margins in general. However, counterparty risks are present.

Track record has suffered over the last two quarters owing to difficulty in chartering out subsea vessel fleet.

No issues on balance sheet but interest rates are higher than peers.

POSH Strong parental backing

Focus on higher-end market and global presence backed by financially strong parent.

Assets are very young and can compete with Western counterparts in global markets.

4-5 diversified business divisions may have spread management attention too thin, execution issues in quite a few areas.

Gearing is relatively low, short-term borrowings look high at first glance, but are easily rolled over owing to Kuok Group shareholding.

Mermaid Shallow water subsea IRM specialist with relatively less advanced and old fleet

Aiming to be the shallow water subsea IRM specialist in ME and SE Asia region. Built up a good geographical presence and relationships with oil majors. Assets may be the weak point.

Fully owned DSVs are not that advanced. Few of the older vessels are off hire and drag on earnings in near term. Has to charter in expensive vessels to fulfil contracts from time to time.

Generally, utilisation of subsea fleet has been improving, and earnings turned around last year. However, contract durations are short and hence, needs to win a lot of contracts to plug gaps.

No balance sheet stress now, but big newbuilding capital commitments in 2016 could stretch balance sheet in future.

Ezra Holdings Tier-2 subsea service contractor with execution challenges

Aims to be a Tier 1 subsea service contractor, but integrating Norwegian and Asian businesses can be challenging.

Has not been actively investing in OSV assets last few years owing to capital commitments of subsea business. Subsea fleet shaping up well though.

Earnings delivery has been patchy since acquisition of subsea business owing to legacy issues and high cost base. Execution and strategy at OSV division has also faltered in recent past, leading to changes in management.

Balance sheet highly leveraged, short-term refinancing needs are high. Scores low on profitability and return on asset metrics as well.



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Qualitative analysis of Singapore-listed O&G companies not under coverage

Variable Strategy

Assets Track Record Financial

Swissco

A rising star in service rig

Made the strategic move to diversify into rig-owning business in mid-2014 through the acquisition of Scott & English (JV partner of Ezion).

We like their service rig assets which have better earnings visibility and better outlook. Other support vessels such as AHTS, crew boats, utility tugs are exposed to spot charter which utilisation and day rates can be volatile.

Gaining traction with the new service/drilling rig business; traditional OSV business tends to be bumpy.

Gearing is high at c.1x. Current ratio falling below 0.8x as of end Dec raises concern over short-term funding.

Ausgroup

Marine Supply Base to drive turnaround

Acquisition of Port Melville turns the wheel of fortune for Ausgroup. It will monopolise the marine supply base in the Northern Territory being in close proximity to the LNG projects there. Marine Supply Base is expected to be the major earnings contributor in the medium term.

We believe Port Melville is a strategic supply base with robust demand. Though, Ausgroup's existing fabrication and maintenance side of business for mining and O&G sector is probably less rosy.

Earnings delivery has been patchy and disappointing in the past, partly due to the nature of business and industry headwinds (particularly mining sector). Port Melville is a new business and yet proven but we find comfort with Captain Larry at the helm.

Net gearing is healthy at 0.4x as of end-Dec after a few rounds of fund raising in the past 1.5 years. Current ratio above 2x looks decent. Cash flow should improve with contribution from Port Melville.

Swiber

Building up orderbook

A pure EPC contractor after spinning off OSVs to Vallianz. Aggressively bidding for projects to ensure high utilisation of its fleet.

The fleet caters for development phase in the shallow water segment, hence should be less affected by low oil prices.

Swiber seems to have deepened its foothold in India and Africa. High overheads and operating on thin margins are more susceptible to industry downturn.

Net gearing is alarmingly high at 1.5x. Liquidity position appears tight with total cash of US$166m insufficient to meet short-term debts of US$350m.

Vallianz

Actively bids for new charter contracts in its prospective markets. It also plans to enhance its cost efficiencies and financial management.

Operates 29 OSVs with relatively young fleet of over two years' old. Vessels are deployed to support exploration and production activities in shallow water.

Relatively short track record as injection of OSVs asset from Swiber only took place in early 2014.

Net gearing is alarmingly high at over 2x. Liquidity position also appears tight with total cash of US$21m insufficient to meet short-term debts of US$120m. Free cash flow was negative in FY14.

Marco Polo

Awaits charter contract for its first drilling rig

Bold move to speculatively build jackup rigs without charter contracts in anticipation of impending cabotage law in Indonesia. Scaling back tug & barge business, which is very competitive.

Operates about 15 mid-to-large OSVs at average age of <5 years' old. Predominantly operates in protected market - Indonesia. Tug and barge is fragmented and competitive.

Earnings has been a little bumpy especially in the barge segment. Taking delivery of first jackup rig by end of the year, but has yet to secure charter.

Net gearing looks manageable at 0.8x as of end-Dec. However, we are concerned over the funding of the first jackup rig order that costs over US$200m (more than double Marco Polo's NAV) if charter contract is not secured prior to delivery.



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Qualitative analysis of Malaysia O&G companies under coverage (Part 1/2)

Variable Strategy

Assets

Track Record Financial

SapuraKencana

Acquisition machine

Has grown significantly via mergers and acquisitions and is Malaysia's only fully integrated offshore service provider with significant hydrocarbon reserves. Leverages on strong relationships with PETRONAS and Seadrill.

World's leading tender rig player with strong traction in SEA. Installation and other marine assets are largely backed by long-term contracts. Production fields have significant gas reserves.

Solid track record and earnings delivery. However, earnings have become more volatile due to crude oil price exposure via production business.

Huge order backlog of RM25bn which translates into 2.3x revenue coverage alleviates concern of relatively high gearing of 1.3x. We expect growth to cool until crude oil prices fully recover.

Bumi Armada

Growing FPSO player

Fast growing FPSO player which is now the 6th largest globally. Global player not dependent on PETRONAS.

All FPSO assets are tied to long-term contracts. Three new FPSOs being built are also with contract. OSVs seeing declines in utilisations.

Missed earnings on several occasions due to volatile earnings from the OSV and Transport & Installation divisions.

Huge order backlog of RM35bn which translates into 10x revenue coverage alleviates concern of relatively high gearing of 0.9x. No earnings excitement expected until new FPSOs become operational in 2017.

UMW Oil & Gas

Drilling for profits

Fast growing jackup drilling rig owner which has grown its fleet by more than 100% in two years. However, market is getting saturated, so recent expansion not very timely.

Out of seven rigs, five are on short-term contracts, which increases overall risk profile

Earnings delivery has been on-point with strong margins from drilling contracts.

Clean balance sheet but lacks earnings visibility going forward due to rigs on short-term charter. Expecting lower utilisation going forward.

Dialog Group

Tank-terminal champion

Dialog is almost a monopoly player for tank terminal construction and operations in Malaysia, via strong partnerships with PETRONAS and companies like Vopak, the group has several concessions for tank terminals in Malaysia.

The group's tank terminals are well maintained and operated with minimal downtime. Dialog also has minority stakes in upstream assets which have potential for more.

Steady earnings delivery with the exception of some cost overruns in their EPCC business in Singapore. Otherwise, earnings supported by tank terminal concessions

Clean balance sheet but lacks earnings excitement until Pengerang is fully operational in 2019.

MMHE

Challenging orderbook outlook

MMHE has the largest fabrication yard in Malaysia and is positioned as the only yard able to take on fabrication of deepwater floating production systems.

The group struggles to fill out its orderbook and at least 30-40% is generally left unutilised.

Disappointing results as fabrication margins are thinning and orderbook is lumpy and the group has seen several cost overruns in the past.

Clean balance sheet but lacking earnings visibility due to orderbook <1x book-to-bill


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Variable Strategy Assets Track Record Financial Dayang Enterprises

Brownfield services leader

Via a solid execution track record, Dayang has grown into Malaysia's leading brownfield service provider.

The group has workboats and barges which enable it to carry out its services and are therefore all fully engaged.

Earnings have been steady and on a growth trajectory. Slow rollout of projects has affected earnings only minimally.

Earnings growth to cool in FY15 onward as the group has limited capacity to take on new work. Furthermore, PETRONAS is slowing its opex and this is affecting brownfield services. Otherwise, its balance sheet is strong with potential for acquisition.

Coastal Contracts

Build and Sell OSV player

Coastal has boldly ventured into the drilling business with the speculative order of two jackups . The group has also diversified into gas compression supply to Pemex.

Vessel sales are secured but jackups remain uncontracted. The group is also looking to sell if possible.

Earnings delivery has been steady and predictable.

2.2x book-to-bill provides earnings visibility. However, uncontracted jackup rigs raise uncertainty going forward.

Deleum

Brownfield niche player

Deleum has recently become the industry leader for the provision and operation of slickline services. This is on top of their market leader position for small gas turbines.

The group's slick line units are all fully engaged with a PETRONAS contract.

Steady and predictable earnings as the group's business is backed by long-term contracts

Clean balance sheet but lacking earnings excitement going forward. PETRONAS capex cut could affect demand for gas turbines and slow slick line services.

Pantech

RAPID play Pantech is positioned to benefit from pipe, valve and fittings demand as construction at RAPID kicks off. The group is making additional warehousing space and actively tendering and securing vendor list approvals.

Warehousing and production facilities in Malaysia are the largest and most complete in terms of stocks.

Earnings have been slightly lacklustre with slow demand from the offshore oil & gas industry.

Clean balance sheet with good cash flow management. Earnings outlook is positive as we expect demand from RAPID to kick in during late 2015 and more in 2016.



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2. DBS Bank Ltd., DBSVS, DBSVUSA, their subsidiaries and/or other affiliates may beneficially own a total of 1% of any class of common equity securities of the company mentioned as of 28 Feb 2015.

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Compensation for investment banking services: DBS Bank Ltd., DBSVS, DBSVUSA, their subsidiaries and/or other affiliates have received compensation, within the past 12 months, and within the next 3 months may receive or intends to seek compensation for investment banking services from the Ezion Holdings, Ezra Holdings, Nam Cheong Ltd, Pacific Radiance Ltd, PACC Offshore


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DBS Bank Ltd.

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Regional Industry Focus Offshore & Marine Regional Industry Focus Offshore & Marine Page 3 INVESTMENT SUMMARY Structural issues make forecasting a more difficult affair this time around.

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