KS Energy Services Ltd - Smaller net loss in 2Q11 (OCBC)

Maintain HOLD

Previous Rating: HOLD

Current Price: S$1.03

Fair Value: S$0.91

Smaller net loss in 2Q11. KS Energy (KSE) reported a 21.1% YoY fall in revenue to S$122.8m and a net loss of S$5.5m in 2Q11. This is significantly better than the net loss of S$27.1m in 2Q10 and slightly better than the net loss of S$8.3m in 1Q11. In 1H11, the distribution business remained the largest contributor to revenue, accounting for 72.3% of total revenue. The drilling business, which contributed 23.5% of revenue, was affected by the depreciating USD and rigs that were waiting for deployment. Gross profit margin slipped from 27.4% in 1H10 to 26.4% in 1H11.

Operating profit turned positive. After four consecutive quarters of negative operating profit, the group finally turned in a positive figure in 2Q11. This is mainly due to the reduction in costs such as other operating expenses (certain impairments were booked under this line previously), as well as lower distribution costs. Though we are encouraged to see an operating profit for the quarter, this is still not enough for the group to turn in positive net profit after deducting finance costs and taxes. It is also too early to tell whether the positive operating profit figure can be sustained, depending on the demand for the group's drilling assets as these come up for contract renewal.

Cautious about prospects for 2H11. KSE is cautious about its prospects for 2H11, considering the ongoing tensions in Africa and the Middle East as well as the global economic uncertainties. On a positive note, there is still room for the distribution business to streamline and reorganize its operations for efficiency improvements. The group is also hoping to expand its market share in this division as well. As for the drilling business, management is "starting to see the benefits of recent reorganizations" but holds a cautious view due to fluctuating energy prices.

Maintain HOLD. With the bleak outlook in the US and Eurozone, KSE is likely to search for opportunities in Asia. Besides growing its distribution business in China, the group is likely to focus on markets such as Indonesia which is familiar ground for the group. Still, with the time needed to see significant earnings contribution from such initiatives, as well as KSE's ongoing business reorganization, we think it is early days to turn positive on the stock. Maintain HOLD with S$0.91 fair value estimate.