MARC has assigned a preliminary rating of AA-IS on Malaysia Marine and Heavy Engineering Holdings Berhad’s (MHB) proposed RM1.0 billion Sukuk Murabahah Programme with a stable outlook. MHB is involved in offshore and marine services, in particular engineering and construction works, vessel conversion and repair services for the oil and gas sector. The proceeds from the sukuk issuance will be utilised mainly for upgrading MHB’s yard facilities under its yard optimisation programme.

The assigned rating and outlook reflect MHB’s competitive position as the largest domestic offshore oil and gas fabricator and marine repair service provider with strong strategic partners and track record of completing large oil and gas production facilities. The rating also incorporates MHB’s strong capital position as reflected by its low leverage position and significant financial flexibility attributed to its good access to capital market and strong shareholders. MHB, which is listed on Bursa Malaysia, is majority-owned by MISC Berhad (MISC), which in turn is a subsidiary of national oil and gas company PETRONAS. The rating is moderated by MHB’s lumpy orderbook that has often resulted in uneven financial performance, its significant project execution risk associated with the complexity of offshore engineering and construction projects, and intense competition from domestic and international players. 

MHB operates the largest yard in Malaysia at Pasir Gudang with an annual offshore construction capacity of 129,700 MT and maximum load-out capacity of 55,000 MT, a measure of the maximum weight of the structure that can be built. MARC notes that the sizeable capacities have enabled MHB to undertake the construction of large structures, strengthening the group’s competitive position as the only domestic offshore oil and gas fabricator with the capability to construct large deepwater oil and gas production platforms. This is further supported by the engineering strength of MHB’s long-term joint-venture partner and shareholder, Technip SA (Technip); this collaboration has enabled the group to undertake the full spectrum of engineering, procurement, construction, installation, hook-up and commissioning (EPCIC) contracts.

Notwithstanding its competitive advantage as the largest domestic yard operator, MHB faces intense competition from international players for domestic construction contracts. MHB’s order book stood at RM1.8 billion as at end-June 2014, having declined from RM2.6 billion as at end-December 2013 given the lack of order book replenishment in the first six months of 2014 (1HFY2014). MARC observes that two major contracts, the Malikai TLP and SK316 projects for Sabah Shell Petroleum Company Ltd and PETRONAS Carigali respectively, account about 85% of the total. The current order book only provides earnings visibility until end-2015, by which date both Malikai TLP and SK316 are expected to be completed. MARC notes with some concern that the lumpy and cyclical nature of MHB’s order book, which tends to be characteristic of companies involved in the fabrication of offshore floating facilities, has historically contributed to irregular revenue and operating performance. In addition, MHB continues to be reliant on the domestic O&G exploration and production contracts, which are derived directly from the PETRONAS group or PETRONAS’ production sharing contractors. MARC opines that the replenishment of order book will continue to be dependent on PETRONAS’ planned capital expenditure.
 
MARC observes that MHB’s marine business unit, which mainly undertakes vessel repairs and conversion into floating structures, has been able to secure more work from external companies outside the PETRONAS group. For FY2013, revenue contribution to marine business unit from external companies rose to 80.8% from 37.0% in FY2012. MHB has the only domestic yard that can undertake repairs on energy-related vessels such as liquefied natural gas (LNG) carriers, aided by its collaboration with Korea-based Samsung Heavy Industries, a prominent builder of LNG carriers. In respect of vessel conversions, the group has completed 12 floating structures and converted two mobile offshore drilling units to two mobile offshore production units as at end-June 2014.

MHB’s offshore business unit, which is mainly involved in construction of offshore production platforms, contributed about 90% of total revenue of RM1,652.4 million and 65% of total operating income of RM57.8 million respectively in 1HFY2014 (1HFY2013: RM1,708.6 million; RM108.7 million), underscoring the importance of offshore construction contracts to the group’s financial performance. In 1HFY2014, MHB’s overall operating profits registered a 46.9% year-on-year decline largely due to slower profit recognition on its two major projects which are still at their front-end phases. In addition, intense competition for offshore construction projects has also resulted in margin compression in its offshore business unit, with the overall operating profit margin declining to 3.5% (FY2013: 6.8%; FY2012: 7.3%). Nonetheless, MARC notes the relatively low fixed costs, which amounted to about 10% of total operating costs and the marine business unit’s higher margins attributed to the energy vessel repairs segment provide some support to the group’s performance.

Cash flow from operations (CFO) has remained negative in FY2012 and FY2013 mainly due to high working capital requirements arising largely from timing differences between progress billings on the contracts and costs incurred. The group has funded its operations primarily from its strong cash position attributable to proceeds from MHB’s initial public offerings in 2011. The cash balance has declined to RM737.9 million as at end-1HFY2014 from RM2,085.6 million as at end-FY2011. In 1HFY2014, MHB recorded a positive CFO of RM209.6 million due to release of working capital following project completion during that period. Given the preliminary stage of current projects, MARC opines that CFO for the full year 2014 will likely to be pressured by higher working capital requirements. Additionally, MARC expects free cash flow (FCF) to be negative in the near term taking into account the capital expenditure requirement for the yard optimisation programme MHB embarked on in 2006. The company, which has spent RM1.1 billion to date of the total RM2.5 billion budgeted for the programme, has mainly relied on internal funds. Proceeds from the proposed sukuk issuance will not only address MHB’s capital expenditure requirement of about RM338 million and RM151 million for FY2014 and FY2015 respectively but will also shore up its liquidity buffer in light of the group’s erratic cash flow generation. MARC notes that on full drawdown under the sukuk programme, MHB's debt-to-equity ratio would rise from a low 0.1 times as at end-1HFY2014 to 0.4 times, which is commensurate with the current rating band.

The stable outlook reflects MARC’s expectation that MHB will maintain its business and financial risk profile as well as prudently balancing the risks associated with the upstream oil and gas services sector. Downward rating pressure could emerge in the event of a significant deterioration in the company’s order book replenishment.

Contacts:
Oo Chin Kai +603-2082 2260/ chinkai@marc.com.my
Sharidan Salleh, +603-2082 2254/ sharidan@marc.com.my