Ezra Holdings (DBSVickers)

BUY S$1.52 STI : 3,145.67

Price Target : 12-Month S$ 2.20
Reason for Report : Post conference update
Potential Catalyst: Contract awards

Poised for a re-rating
• Positioned for more orders amid buoyant subsea market.
• New charters in FY11 despite weak OSV market underscore its competitive strengths.
• Possible rationalization of non-core businesses to free balance sheet and reduce gearing.
• Maintain BUY, S$2.20 TP.

Positioning itself for more subsea orders. We note that 3 major subsea EPIC peers have posted robust 1Q2011 new orders, +89% y-o-y on aggregate, and see strong order momentum in the quarters ahead. This bodes well for Ezra as it positions itself to add to its current subsea backlog of US$276m, with AMC’s integration on track, vessel fleet expansion and continued solid project execution.

Offshore support business’ competitive strengths shine amid weak market. Despite the still challenging OSV market, Ezra has announced new charters for 12 vessels worth US$189m in FY11 YTD; its fleet utilisation rate of >90% is far superior vs. the global OSV fleet at c. 66%. We believe this underscores Ezra’s competitive strength of operating a diverse fleet of young, deepwater capable vessels.

Rationalisation of business would free up balance sheet. The group plans to rationalize the business over the next 12 months, potentially divesting its non-core units to free up its balance sheet. This could raise c. US$150-200m cash for the group and reduce FY12 net gearing to 0.84-0.89x, without the need for new equity.

Maintain BUY, S$2.20 TP. Confidence in AMC builds with the integration progressing on track, a growing subsea order backlog and successful execution of 2 projects recently. Ezra is well positioned to build up its order backlog, providing positive catalysts and enhancing earnings visibility going forward. No change to forecasts. Maintain BUY, TP of S$2.20 implies 45% upside.

Deepwater Subsea division to lead Ezra’s growth

Major subsea EPIC players record robust order intake in 1Q 2011… The major subsea EPIC players, namely, Subsea 7 SA (the merged entity of Acergy SA and Subsea 7 Inc), Saipem and Technip have earlier reported a sustained, high level of tendering activity. (For a more detailed analysis on the deepwater subsea market, refer to our 5 April 2011 note on Ezra, “More than the sum of its parts”.) Our latest checks reveal robust subsea order intakes in 1Q2011: this was up between 65-224% y-o-y and 6-40% q-o-q; on an aggregated basis, 1Q2011’s order intake by the trio was US$5.0bn, +89% y-o-y and +27% q-o-q, leading to swelling order backlogs, up between 10-33% y-o-y.

… and continue to guide for robust order book momentum. Looking ahead, these players continue to guide for strong order book momentum in the coming quarters, underpinned by sustained high oil prices and high levels of tendering activities. A number of major SURF (subsea, umbilicals, risers, flowlines) contracts are expected to be awarded in 2011, with the offshore installation phase to commence in 2012 or later. Regions of high activity include Australia, Brazil, West Africa and the North Sea while activity levels in the Gulf of Mexico are also expected to pick up, following the resumption in the issue of drilling permits. However, timing of recovery remains uncertain.

Sizeable backlog just 3 months from completion of acquisition. EMAS-AMC’s announced order backlog currently stands at US$276m, up from US$254m as of midApril. This was due to the upsizing of the Noble Energy Tamar project by US$22m to US$110m from the expansion in work scope. If we were to include the US$32m LOI for the provision of subsea support services announced in April 2011, this will bring order backlog to US$308m – a sizeable backlog in just 3 months following the completion of the AMC acquisition.

Bidding for c. US$3bn worth of projects; maintains 12 months order backlog target of US$1bn. Notwithstanding the ongoing integration between the two companies, EMASAMC continues to actively bid for subsea construction and installation contracts globally, with c. US$3bn worth of projects under tender. Management remains confident in achieving its order backlog target of US$1bn within 12 months, which implies a >3x increase in order book from current levels if it materialises.

Positioning to take on more projects. We see several factors in play which we believe will set up EMAS-AMC well to build up its order backlog amid a sustained, robust outlook for subsea order flows.

1) Integration on track; combined entities to boast expanded capabilities against an enhanced asset base. The integration of Ezra and AMC remains on track, which will see the combination of AMC’s capabilities and track record in the subsea EPIC/SURF market combined with Ezra’s larger and growing fleet of installation vessels covering all IMR and SURF installation segments (including flexible and rigid pipelay capabilities deployable in up to 3,500m water depths). This will enable EMAS-AMC to penetrate a market characterised by high barriers to entry on high technical complexity and high capital intensity. Indeed, the market is highly consolidated, with typically only 3 to 4 other players competing for the same contracts.

2) Strengthened management team. Ezra has appointed Mr CJ D’Cort as CEO of EMAS-AMC. Mr D’Cort is veteran of the industry with >30 years of experience and was most recently the CEO of SapuraAcergy, where he had amassed an order backlog of US$1.7bn with a single asset. His diverse experience includes the offshore construction/ marine operations, engineering, platform, pipeline and subsea installations (shallow and deep water), project and corporate management. He also has an extensive track record of working with oil majors and national oil companies.

3) Expanding asset base to support expected build up in order backlog. The Lewek Crusader, a newbuild DP3 subsea construction vessel, was finally delivered in April, bringing the subsea fleet size to 3 units. By late FY11/early FY12, we expect the subsea fleet to grow to 6-7 units with the addition of another 3-4 vessels. These include the Lewek Ambassador (IMR vessel, currently under refurbishment), Lewek Falcon (newbuild deepwater multi-function construction vessel), Lewek Champion (heavy lift pipelay barge, currently deployed on a project till late FY11, to be bareboat chartered-in from EOC), and the Lewek Toucan (AHTS with deepwater installation and construction capabilities; to be re-designated to the subsea division following the conclusion of its current charter under the Offshore Support division). Delivery of the newbuilds AMC Connector in early 2012 and the Lewek Constellation in 2013 will provide further boost to the asset base, and will allow EMAS-AMC to build and execute a larger backlog.

4) Building on solid project execution track record. The recent successful completion of the Popeye project for Shell in the GOM and the installation of the Skarv FPSO for BP in Norway continue to build on EMAS-AMC’s solid project execution track record.

Subsea division to lead growth of the Ezra group. We project FY11/12/13F revenue for the Deepwater Subsea division of US$140m/US$294m/US$532m, on assumed subsea order wins of US$350m/US$500m/US$600m. This will underpin our projected 38% FY10-13 revenue CAGR for the Ezra group.

Subsea revenue can be lumpy. Management guides that while the engineering work typically commences 6-9 months ahead of actual project execution, revenue recognition for subsea contracts will only commence once the vessels are mobilised to the project site. With actual project execution typically 3-4 months long, this makes revenue on subsea projects inherently lumpy. Note that for modelling purposes, we have assumed a recognition period of 18 months from date of contract award – this is to take into account projects that commence at a later date.

But cash flow impact generally neutral to positive. On cash flow, EMAS-AMC would typically receive 10-20% downpayment upon contract signing, and another 10-20% upon the mobilisation of vessels to the project site, with the remainder upon project completion. This ensures projects are typically cash flow neutral to positive.

Offshore Support division remains a core business; targeting annual revenue growth of 10-20%

OSV market remains challenging overall. The overall AHTS market is still nursing a hangover from the newbuilding party of 2005-2010. Since 2005, this segment has seen 769 AHTS delivered, vs. 486 PSVs. The AHTS to rig ratio jumped from 2.3x in 2004 to 2.9x currently, driven mainly by the <8,000 BHP AHTS category. The increase in PSV to rig ratio was more moderate, at 2.5x from 2.2x over the same period.

As such, it is not surprising that the utilisation rate in the global AHTS market continues to decline, at c. 68% as of end 2010, according to ODS Petrodata. For PSVs, the decline in global utilisation rates appears to have bottomed at around 72% at end 2010, likely due to a healthier demand/supply balance.

Some bright spots for PSVs and large AHTS. The demand/supply scenario is also reflected in vessel day rates, with all classes of PSVs now fetching higher day rates vs. the recent trough. This is not the case across the whole AHTS market, with day rates for the <10,000 BHP category still languishing near the bottom. However, we note some bright spots for the larger vessels (i.e. >10,000 BHP), which have been fetching improved day rates. We believe this can be attributed to the healthier demand/supply balance vs. the smaller AHTS categories, with vessel to rig ratio of 2.4x (>8,000 BHP AHTS) vs. 3.2x (<8,000 BHP AHTS).

Demand for OSVs expected to grow across 2011, in line with higher projected rig count. We use contracted offshore rig count as a proxy for OSV (both AHTS and PSVs) demand. According to data from ODS Petrodata, the demand for offshore rigs (jackups, semisubmersibles and drillships) is projected to grow by 93 units by end 2011, representing a growth of 18% from current levels. We believe this will underpin near term growth in demand for OSVs.

PSV market to pick up ahead of AHTS. We believe any pickup in demand for OSVs will have a more significant impact on the PSV market vs. the AHTS market given 1) the current healthier demand/supply balance of PSVs to rigs (2.5x), vs. AHTS (2.9x); 2) smaller orderbook to existing fleet (10.9% vs. 12.2% for AHTS); and 3) more staggered delivery profile of the outstanding orderbook across 2011-2014.

We expect a more significant recovery in AHTS demand from 2012 onwards, as the market continues to digest the additional capacity still being delivered from the orderbook.

We expect this to be led by the >8,000 BHP sized categories as E&P activities move into more demanding environments, supported by a healthier demand/supply ratio of 2.4x AHTS (>8,000 BHP) per rig (floater) vs. 3.2x for the smaller AHTS (<8,000 BHP) category.

Ezra well positioned to benefit from recovery in OSV market.

1) Young fleet averaging 4 years old. Ezra boasts a young offshore support fleet averaging 4 years old, vs. the industry average of c. 17 years. We believe this is a significant competitive advantage as the continued delivery of newbuilds from the yards into an already saturated market enable end users to choose from a wider pool of available assets, favouring younger, more reliable tonnage and resulting in the idling of old tonnage (i.e. 20 years and older). Further, older assets could present a greater possibility for equipment failure and compromise safety during operations offshore. Younger vessels, on the other hand, are less prone to technical issues which can lead to costly vessel downtime and high maintenance and repair costs. This translates into high efficiency and utilisation rates for both the vessel owner and charterer.

Indeed, data from ODS Petrodata reveals a growing divergence in utilisation rates between younger and older vessels, similar to what has been observed in the rig market (refer to our 10 March 2011 Offshore & Marine report “Offshore on the radar”).

2) Focus on deepwater capable assets. Around 70% of Ezra’s fleet is deepwater capable, vs. 29% of the global AHTS fleet. Its fleet of 30 AHT/AHTS/MFSV averages c. 9,645 BHP, with 18 units >8,000 BHP capacity. More recently, Ezra took delivery of its first newbuild MFSV, Lewek Fulmar, from the yard on 25 April 2011. It is the world’s first multifunctional ultra deepwater AHTS of the UT788 CD design, which also achieved a record-breaking bollard pull of 402.4 tonnes. We understand that it has also been deployed on term charter. We believe Ezra’s focus on deepwater capable assets positions it well to leverage on the broader industry trend which is gravitating towards E&P activities in deeper waters and harsher environments.

3) Expanding PSV fleet to meet growing popularity in Asia Pac. In addition to the better demand/supply balance of PSVs vs. AHTS, data from ODS Petrodata reveals that PSVs are becoming more widely used in Asia Pacific, accounting for 13% of global term demand vs. just 7% 10 years ago. Ezra has grown its fleet of PSVs to 6 units currently, in a span of around 12 months. In addition to these existing units and the two 5,200 dwt PSVs being built by Remontowa in Poland, the group is building another two 3,200 dwt PSVs, with scheduled delivery in 2H2012. These will expand Ezra’s PSV fleet to 10 units by end 2012. We understand these 2 units will not have any capex implications as they will be bareboat chartered in under sale and leaseback arrangements.

New charters for 12 vessels in FY11 YTD underscore Ezra’s competitive strengths in the offshore support segment. Despite the still challenging conditions in the OSV market, Ezra has secured new charters for 12 vessels in FY11 YTD worth a total of US$189m. These charters cover 6 AHTS and 6 PSVs for deployment across the Asia Pacific region and have a blended average charter duration of >2.7 years, vs. the overall charter duration of c. 3 years for the fleet. Indeed, Ezra continues to post superior fleet utilisation rate of >90%, vs. ODS Petrodata’s estimate of current global OSV fleet utilisation at c. 66%. We believe this underscores Ezra’s competitive strengths of operating a diverse fleet of young, deepwater capable vessels.

Targeting stable 10-20% annual revenue growth for the Offshore Support division. Going forward, the Offshore Support division will remain a core business of the group. However, given that this part of the business is more mature, the group is targeting a more stable annual revenue growth of 10-20%. We believe this is not unreasonable – we project y-o-y growth of 18% / 14% / 12% across FY11/12/13F, supported by an expanded fleet with 8 additions in FY11 (5 PSVs, 2 AHTS, 1 MFSV), 2 newbuild PSVs in FY12 and another 2 PSVs in FY13.

Fabrication yards to play supporting role, help manage group’s costs.

Yards to play supporting role, help manage group’s costs. Going forward, Ezra guides that its fabrication business will play a more complementary role in the group. The yards will be used to support the group’s subsea and offshore support divisions, executing repair and maintenance (i.e. the mandatory vessel surveys and dry dockings) for Ezra’s vessels as well as serving as a mobilization and logistics base. This is expected to enhance cost control for the group overall.

Flattish revenue to be expected. While being a complementary business, the yards will continue executing third party fabrication contracts. However, management has guided for flattish revenue from this division (booked under Marine Services). We estimate the yards’ orderbook as of end 2Q11 stood at c. US$200m, with around FY11 YTD order wins of US$90-120m vs. our order wins assumption of US$130m for FY11.

Capex requirements funded

Outstanding capex of US$380m. Ezra’s committed capex plan calls for another US$80m to be incurred in 2H11, and US$150m each in FY12 and FY13. This will be for outstanding amounts for Lewek Falcon and the AMC Connector, the 2 newbuild PSVs at Remontowa, and the Lewek Constellation. Management guides that there is no more significant capex plans beyond current commitments.

Funding for Constellation secured. The newbuild Lewek Constellation will be Ezra’s second DP3 subsea construction vessel with ice-class, deepwater subsea multi-lay, heavy-lift capabilities. Construction is underway, with delivery scheduled for 1Q2013. Total capex for this asset is c. US$400m, of which 75% will be debt funded. We understand that funding for the asset has been secured.

Possible rationalization of non-core businesses could free up balance sheet, reduce gearing

Possible rationalisation of non-core businesses could raise cash proceeds US$150-200m. Net gearing currently stands at 0.90x, and is projected to increase to 0.98x by end FY11. While debt covenants in place allow a net gearing ceiling of 2.5x, management intends to keep this below 1x. To this end, management has been guiding that it is looking towards rationalizing its businesses, focusing on those in which the group has the potential to be a leading player within the industry (i.e. the offshore support and deepwater subsea businesses), while potentially divesting (partial or fully) those in which is unlikely (i.e. the yards and the energy services units). This rationalization process is expected to be executed over the next 12 months, and could raise cash proceeds of US$150-200m for the group.

Net gearing could be reduced within internal threshold without requiring any capital markets exercise to raise new funds. Assuming the rationalization process is completed in FY12 with no gains from disposal, we estimate net gearing could be reduced to 0.84-0.89x from our 1.04x projection. This would bring net gearing down to within Ezra’s internal threshold, without needing to tap the market for more funds.

Financials and valuation

Earnings visibility on EMAS-AMC is weak in near term, but improves in the medium term. Earnings visibility on EMAS-AMC is weak in the near term but improves in the medium term as order backlog builds. We estimate that 34%/70%/12% of our revenue projection for EMAS-AMC over FY11/12/13F is backed by its US$276m announced subsea order backlog.

No change to numbers, introduce FY13F. We have kept our FY11/12F estimates and introduce our FY13 projections. We expect FY12/13F growth of 71%/12% to be underpinned by 1) AMC’s return to profitability on a larger expected subsea order backlog and an expanded offshore fleet; and 2) higher associate/JV contributions with full year contributions from the Chim Sao FPSO project.

BUY maintained, +45% upside to TP of S$2.20. Maintain BUY on Ezra as confidence in the acquisition of AMC continues to build with the integration progressing on track, a growing subsea order backlog and successful execution of 2 projects recently. We believe Ezra is well positioned to build up its order backlog amidst a buoyant deepwater subsea market characterized with high tendering activity and contract awards. This will not only provide positive catalysts for the stock, but also improve earnings visibility of the group going forward. Our TP for Ezra is unchanged at S$2.20. This is based on 14x and 12x PE for its core businesses and EOC respectively, on a fully diluted FY12 EPS.