• Industry spending to recover
• 4Q16 to see impairments
• But largely priced in

Upstream investment predicted to recover this year

According to Wood Mackenzie, global capital spending by exploration and production (E&P) companies will total US$450b in 2017, up 3% compared to 2016 after two years of steep declines. Breakeven costs of upstream companies have fallen as deflation across the oil industry supply chain has been achieved where a significant portion from the cost savings has been reaped from squeezing margins of oil service companies.

Still, E&P investment in 2017 is expected to remain 40% below the level in 2014, and we expect the operating environment to remain challenging for many companies. Longer term investors, however, may choose to look beyond this and pick up beaten-down stocks whose negatives have been mostly priced in.

4Q16 to see impairments, but negatives largely priced in

As Ezion is modifying a few more of its existing service rigs and taking delivery of two or three new units by the end of 2017, managing its cashflow and gearing is imperative. As such, it may 1) dispose at least another existing service rig, 2) delay or cancel a few of its past committed projects that no longer make economic sense, and 3) invite potential JV partners to co-own assets. Estimated capex for FY16 is US$80-90m, while FY17 may see US$160-180m of capex.

Looking ahead, we expect the group to report impairments in its upcoming FY16 results from the cancellation of certain past committed projects that no longer make economic sense, as deposits paid to yards and suppliers have to be written off. These are non-cash items, and the stock’s current low valuation (0.4x book) has largely priced in the negatives.

Raise FV to S$0.54, based on 0.55x book

Oil prices are probably already past their worst as major oil producing countries have signalled their resolve to cut production to support prices. Though the operating environment may still be challenging for companies in the industry, we think confidence is on the up. Based on a conservative 0.55x FY17F book, we raise our fair value estimate for Ezion to S$0.54, representing an upside potential of about 30% from current levels. Upgrade to BUY.

Source: OCBC Research - 13 Jan 2017