Logindo Samudramakmur Accumulating Offshore Cash

LEAD to book net profit CAGR of 83% for the three years to 2014, spurred by strong fleet expansion to higher-tier vessels. LEAD has relatively young fleet age & lucrative margins. Its strong track record with well-known O&G companies is a precursor for greater things to come. We have a BUY call with TP IDR3,450, implying 8.5x 2014 PER coupled with PEG pegged 0.2x. Despite headwinds Indonesia is facing currently, we believe LEAD is a solution to finding alpha in the market.

Company background
Logindo Samudramakmur (LEAD IJ) was founded in 1995 by the Logam brothers. In 2005, LEAD started acquiring vessels and operating in Indonesian waters, basking in the comfort of the cabotage principle imposed by the Government the same year. It has been serving Total E&P Indonesie for 15 years and providing the latter outstanding service. LEAD initially started by providing services to Total E&P’s tug and barges but along the way, started serving higher-end vessels and recently acquired 12k hp AHTS, one of the few high-ends in the industry operating under indo-flag.

Strong industry growth
Despite the headwinds Indonesia is facing ahead and the economy’s gearing towards stable economy, we expect our Indo Offshore Support Vessel (OSV) universe to book relative strong net profit growth of 41.1% CAGR 2011-14 given: 1.) High O&G investment allocation by the government, 2.) Cabotage regulation which allows Indo-flag vessels to move to higher-tier vessels. We believe that Indonesia still has a long-way to go for further vertical expansion in the OSV business as to support the upstream O&G offshore activities.

BUY with confidence
We believe the high barriers to entry and cabotage protection should keep vessel supply tight, thus supporting high charter rates and utilisation levels. Beginning of this year, LEAD already has a comfort backlog amounting to USD35m. We estimate LEAD’s fair value (FV) at IDR3,450, an 8.5x implied PER for 2014, which is a 23% discount to its peers (market cap below USD400m) which are trading at average of 11x. Key risks are: 1.) Significant drop in oil price, 2.) Lower-than expected utilization rate, 3.) Highly leveraged.

Executive Summary
One of the largest OSV companies in Indonesia
Since Indonesia amended its cabotage law in 2011, domestic fleet owners have been grabbing market share and climbing up the value chain. With the current limited crude oil reserves and declining oil production, the Government hopes to increase existing production and invest in exploration activities.

The number of oil and gas (O&G) blocks awarded in the offshore areas underpins the strong offshore support vessel (OSV) demand in Indonesia. By being one of the largest OSV player in the Indonesian waters equipped with diversified OSV fleet, we believe LEAD could be a one stop shop by catering the various needs in the O&G offshore blocks.

A wealth of management experience
In 2011, Pacific Radiance (PACRA SP) – through Alstonia Offshore – acquired the maximum 49% stake in LEAD, which bought with it strong operating and human resource improvements. Backed by a strong local network and exposure, we believe this synergy would allow LEAD to tap into the abundant opportunities in Indonesia’s offshore scene.

PACRA SP is an established OSV company and a subsea-services provider with very senior players inside the company such as Pang Yoke Min (the founder of Jaya Holdings). On the other hand, Eddie Logam (founder of LEAD) is also known as a veterans in the Indonesian waters and has carried a strong reputation in the OSV industry.

Efficient and integrated OSV player
LEAD has a relatively young fleet of nine years of age on average and is one of the few Indonesia-flagged vessel owners that owns anchor handling tug supply (AHTS) vessels with 12k brake horsepower (BHP). This is testimony to LEAD’s commitment to shift its portfolio to higher-tier vessels. With intensive concentration in the East Kalimantan waters serving Total E&P Indonesie as its major customer, LEAD has a competitive advantage in providing full and responsive services.

The group plans to diversify its customer portfolio across Indonesian O&G offshore waters, riding on the robust demand. It is worth noting that LEAD has maintained a 15-year relationship with Total E&P Indonesie, the largest gas producer in Indonesia. It started off by serving the latter’s small scale tug and barges before gradually scaling up its service to higher-end vessels.

Fleet expansion to higher value-added vessels
We expect LEAD to allocate capex of USD164m from 2014-15 to purchase mid- and high-tier vessels to raise its fleet from 58 vessels in 2013 to 69 vessels by 2015. We expect LEAD to command a higher blended tariff mix when more higher-tier vessels join its fleet. Given the strong OSV demand in the industry, we believe LEAD’s utilization rate would be intact.

Although several of its high-end vessels obtained contracts from exploration activities which in nature usually have shorter-term contracts, LEAD’s strong network and strong back up from Pacific Radiance should boost confidence in vessel expansions in a risk-adjusted return manner.

Valuation range of IDR1,786bn to IDR2,807bn
We believe the high barriers to entry and cabotage protection should keep vessel supply tight, thus supporting high charter rates and utilization levels. We estimate LEAD’s fair value (FV) at IDR3,450, based on FY14 target P/E of 8.5x, which is a 23% discount to its regional peers (market cap below USD400m) which are trading at average of 11x.

Valuation Summary
Benchmark against peers that benefit from cabotage or local content ruling
We believe LEAD should be rated against the regional peers in Southeast Asia that benefit from cabotage or local content ruling as these companies enjoy higher vessel charter rates, stronger fleet utilisation, favourable reinvestment opportunities and higher earnings visibility. We also filter down the peers comparison to companies with less than USD400m market cap to reflect the small/mid-cap discount. In Indonesia, we believe LEAD’s closest peer is Wintermar , a pure-play OSV player listed on the Jakarta Stock Exchange in November 2010.

Peers FY14F P/E range from 5.0x to 13.3x, with an average of 11.0x
Based on our data, the average FY14F P/E in our peers’ compilation is 11.0x based on regional companies’ market cap which are below USD400m.

We value LEAD at a fair value of IDR3,450
Our fair value of IDR3,450 is derived from a target PER of 8.5x to its 2014 PER, which is still a 23.5% discount to its regional OSV peers (market cap below USD400m) based on their current share price.

We believe LEAD should not trade below WINS given: i) its more aggressive capital structure enables them to achieve higher ROE of 18% versus WINS’ 16%; ii) stronger net profit growth of 88% in FY13F and 36% in FY14F and; iii) LEAD’s partnership with Singapore-based Pacific Radiance allows the company to access a bigger pool of vessels and tap Radiance’s expertise in vessel financing.

Company Profile
History of Logindo Samudramakmur
Logindo Samudramakmur (LEAD) was founded in 1995 by two brothers, Eddie K. Logam and Rudy K. Logam. The duo’s first generation family business provided sea-logging transportation from Kalimantan to Java, which was a stepping stone to expand into the higher-end game later on. In 2005, LEAD started acquiring vessels and operating in Indonesian waters, basking in the comfort of the cabotage principle imposed by the Government the same year.

It has been serving Total E&P Indonesie for 15 years and providing the latter outstanding service. LEAD initially started by providing services to Total E&P’s tug and barges but along the way, started serving higher-end vessels such as landing craft transport, diving support, crew boats, anchor handling transport supply (AHTS), hooper barges and accommodation work barges. It is worth noting that LEAD possesses two 12,000 bhp AHTS this year, which is the largest Indonesian-flagged AHTS vessel. This is a testament to Logindo’s commitment to the OSV business.

Business profile
As at Jan’14, Logindos’ possessed USD141m worth of contracts with Total E&P Indonesie accounted for 81.5% of its total contracts, while Pertamina and others holds the remaining 18.5%. Most of its contracts are long-term contracts around 2-3 years. We see that LEAD’s exposure to long term contracts with its customers provides a safeguard for future earnings. It is worth noting that by end of 2013, LEAD possessed 59 vessels, with a utilization rate of 87.7%.

The majority of its contracts are on time charters for a specific time based on negotiable charter rates agreed upon by both parties. During the tenure of the contract, the customer is liable to pay all the trip costs including fuel, port and agent commission costs. LEAD is mostly responsible for the crew, maintenance, spare parts and other operating costs.

We view time charter contracts as a fairly safe business as LEAD can pass on the volatility in fuel costs to its customers. The group has a shipyard and repair workshop in Muara Kembang, East Kalimantan for repairing its own OSVs, providing employee training and for storing spare parts. LEAD is ISO 9001:2008-certified by Lloyd Body’s Quality Assurance Ltd’s Registers.

Management background
LEAD’s commissioner and management comprise three family-related parties – Eddie K. Logam (president director; founder), Rudy K. Logam (director; founder) and Merna Logam (commissioner; Eddie’s wife). From the Pacific Radiance, meanwhile, is represented by three individuals – Pang Yoke Min (president commissioner), Mok Weng Vai (director) and Loo Choo Leong (director). We believe such a composition gives rise to strong synergy, with LEAD providing the local exposure and Pacific Radiance contributing knowledge, management skills and experience.

Technically-superior OSV fleet
We like LEAD’s portfolio of 59 vessels, which range from low-end vessels such as tug and barges to 12k bhp AHTS vessels. LEAD has a relatively young fleet age of nine years. Given its experience in dealing with Total E&P Indonesie, its largest customer, LEAD has the opportunity to operate a variety of vessels, such as tug and barges, AHTS, accommodation work barge (AWB), crew boat, diving support vessel (DSV), landing craft transport (LCT), mooring boat, and platform supply vessels (PSV).

Operating these vessels, which have their own crews and captains, require sound theory and on the ground knowledge. We believe LEAD’s strong ties with Total E&P Indonesie reflects discipline and professionalism in getting the job done, which would in turn attract other O&G companies when it tenders for jobs.

Facility shipyard to support OSV services to its customers
LEAD’s strength lies in its strong after-sales services, such as providing its customers 24-hour quick and accurate services for engine troubles, docking problems and others, through its shipyard and maintenance centre in Muara Kembang in East Kalimantan, which is open 24 hours every day. This gives LEAD a service advantage against its competitors.

Established base of satisfied customers
Besides having Total E&P Indonesie as its largest customer, LEAD also cooperates with Pertamina, also among its largest customers. The group has obtained awards and recognition in several areas from its customers, including: i) the Health, Safety and Environment award from Total E&P’s marine & logistic division for safety, awareness and good housekeeping category, ii) quality, health, safety and environment award from BP Migas & CNOOC for having minimal accidents in 2011, iii) third ranking in the Mahakam award from Total E&P for health, safety and environment performance for high risk category in 2012, and iv) INSA best offshore shipowner/operator for 2012.

Macro & Industry Outlook
Offshore O&G industry plays critical role
Indonesia, with the fourth largest population in the world of around 237m, is the largest archipelago country with the ocean comprising two-thirds of its total area. Indonesia used to be a member of Organization of the Petroleum Exporting Countries (OPEC) until 2008/2009, six years after becoming a net oil importer. Oil production has been declining for more than a decade due to underinvestment in exploration activities, causing reserves to remain low at 3.7bn barrels, equivalent to roughly 10-12 years of mine life.

On the back of declining reserves since 2004, the number of oil exploration blocks awarded has increased significantly, from around seven blocks in 2005 to a peak of around 40 blocks in 2009. These blocks are mainly located in deeper waters in the eastern part of Indonesia. Indonesia government plans to offer 27 O&G blocks this year as to cope in the rise in energy demands and in attempt to reverse the declining domestic output. The awards of these blocks which are expected mostly in offshore areas point to a bright outlook for the OSV industry, which in turn would benefit LEAD.

O&G investment to book 19.7% CAGR 2009-2014
SKK Migas expects 2014 O&G investment to increase by 32.6% y-o-y amounting to USD25.6bn. From the 2014 O&G investment breakdown, exploration activities to reach USD3.8bn (+104.6% y-o-y), administration to reach USD1.6bn (+6.2% y-o-y), development to reach USD5.3bn (+23.1% y-o-y) and production to reach USD14.9bn (+24.6% y-o-y). Exploration investments have booked 43.4% CAGR 2009-2014, as for the government to cope up with the decline in oil production for the last couple of years. As LEAD’s vessels cater exploration to production activities, we believe demand for its vessels are aplenty.

East Indonesia a long term story
Eastern Indonesia is not well explored compared to the western part of Indonesia, which has been explored for 125 years. This is due to the region’s deep waters, poor infrastructure, remote onshore location and the lack of understanding of its geology. Exploration activities in deeper waters requires high-end vessels.

We believe the OSV business in Indonesia should be sustainable in both short and long terms, given that it serves exploration and production activities. According to figure 14, it takes 20-30 years from oil and gas discovery to the highest peak of the production cycle.

Dishing out more incentives to draw investment to offshore blocks
Indonesian O&G companies operate under various production sharing contract (PSC) arrangements based on SKK Migas regulations. Generally, the split for oil is between 65:35 and 85:15, while for natural gas, the split is from 60:40 to 70:30 after a contractor has recovered its costs. Better incentives have been proposed for deep water O&G projects such as: i) a larger PSC portion for contractors of deepwater investments, ii) exemption on land and building taxes, and iii) zero import duty. This should attract further offshore investments in Indonesia, which in turn would indirectly benefit OSV players.

OSVs in Indonesia divided into 3 classes
Indonesia’s OSVs are divided into three classes based on agreements between O&G regulators and associations. Group A types of vessels are already Indonesian-flag registered, Group B has several Indonesia and foreign-flagged vessels whereas Group C is dominated by foreign-flagged vessels. Groups B and C require larger investment (~USD15m and ~USD40m respectively) compared with Group A. However, with the cabotage regulation pushing towards higher-end vessels which have larger capital requirements, such investments would be protected.

More vessel jobs needed going forward
Based on Figure 19, 235 OSVs is needed from 2011 to 2015. AHTS features most prominently this year given the cabotage deadline for AHTS-type vessels. Several listed players have been expanding their fleet with AHTS vessels, as in the case of LEAD, which has purchased several AHTS vessels. The Government has set 2014 as the cabotage deadline for higher-end vessels used for O&G drilling purposes such as the seismic, geophysical and geotechnical survey types of vessels.

The 2015 cabotage deadline will apply to rigs for drilling purposes such as jack-up rigs, semi-submersible rigs, deep water drill ships, tender assist rigs and swamp barge rigs. We see more capital required by OSV players to better cater to the vessel needs arising from heightening exploration activities.

The youngest AHTS fleet
According to Clarkson Services, there are 90 AHTSs, 14 AHTs and 6 PSVs registered as Indonesian-flagged vessels as per August 2013. Pertamina, Baruna Raya Logistic, Bahtera Niaga and Wintermar have more AHTS vessels than LEAD, but the latter has the youngest average AHTS fleet age among Indonesian-flagged vessels. We believe that LEAD is one of the leading players in the OSV industry and has expanded its fleet at right time when cabotage is strictly enforced.

Key Investment Themes
Right time for fleet expansion
We believe this is the best time for vessel operators to expand their fleet to capitalize on the cabotage ruling and gain market share in Indonesia. We expect to see capex for fleet expansion amounting to USD329m from 2013 to 2017, funded mostly by debt. Net gearing is expected to be 91% in 2013 before gradually declining to 88% in 2017.

As the OSV industry is capital intensive in nature, one of the key business decisions is to determine when to leverage. In view of the cabotage regulations and tight supply market conditions, it is reasonable to have a net gearing level of above 100% as long as the equity and loan payback are accounted for.

We expect LEAD to add 3-5 vessels per annum from 2013 to 2017
The group will expand its fleet with higher-tier vessels to garner higher economies of scale. It is worth noting that its fleet expansion from 2013 to 2017 is expected to command blended charter rates of around USD17,000-21,000/day whereas existing vessels are commanding blended charter rates of USD7,500-7,800/day. The blended rates for existing vessels (pre-2013) is lower than the new vessel rates as the low-rate tug barge revenue component is still high.

We classify LEAD’s low mid and high tier vessels based on the tariff for each vessel type charged to its customers. We categorize flat top barges, landing craft transport, tugs, crew boats and AHT/utility vessels as low-tier vessels and AHTS, diving support and AWB as mid to high-tier vessels. From the 21 vessels we expect to be delivered from 2013 to 2017, 16 vessels are in the mid to high-tier category.

High margin, young age fleet, high utilization rate
LEAD has a relatively high attractive EBITDA margin of around 48-55%. This is because its vessel revenue is fully derived from its own vessels, rather than a mix of its own vessels and back-to-back third party re-chartered vessels as its revenue source. In Figure 26, we believe that LEAD’s vessel expansion from 2013 to 2017 will provide attractive blended gross margin at the 50% level.

LEAD has a high utilization rate of 88% for its existing vessels and 32% for its new vessels that arrived last year. We expect the utilization rate for its new vessels to gradually increase from 32% in 2013 to 83% in 2017.

LEAD has an average fleet age of nine years, relatively young vs peers’
Based on Drewry Maritime Research, as of July 2011, vessels classes such as AHT, AHTS, PSV and supply base have age profiles of >10 years. LEAD’s fleet diversification should be able to cater to the demand for a variety of O&G offshore fields.

Solid backlog to support 2014-15 revenue
Based on its ongoing contracts as at January 2014, the company has already locked in contracts amounting to USD35m and USD15m for 2014 and 2015 respectively. We expect more contracts to come ahead to support our 2014 and 2015 revenue assumptions. LEAD is selective in its vessel purchases and is inclined towards long-term contracts to ensure favorable utilization rates. It also prefers visible and favorable equity payback periods of 3-4 years. Jobs ahead will have a mix of short-term and long-term contracts.

Short-term contracts will be a trend going forward given that the industry will partially shift to exploration activities, which have shorter working contracts but command much relatively premium charter rates. However, given the increasing O&G offshore exploration demand, there are vast opportunities for renewable short-term contracts or numerous new OSV work tenders. Note that only two of LEAD’s vessels are operating in exploration activities while its remaining vessels are in production activities.

Ready to become a national OSV hero
LEAD has the strong ability and discipline to cater projects surrounding the Kalimantan waters. This is one of the reasons why LEAD has been Total E&P’s largest OSV client, accounting 18% of Total E&P’s demand. Equipped with high expertise, strong track record and diversified fleet, we believe LEAD could penetrate further to offshore areas throughout Indonesia.

It is worth noting that LEAD has solid experience in Kalimantan waters and has invested its planted assets (offices and shipyard) there to make its operations economically efficient. This gives it an edge in serving its clients, making it one of the few to be able to offer a 24-hour response time for any complaints and strong after sales services.

Strong support from foreign partner Pacific Radiance Group
LEAD is categorized as a foreign investment company after Pacific Radiance Group, a well-known OSV company based in Singapore, acquired the former’s 49% stake. It is worth noting that the acquisition is in accordance with the maximum foreign ownership in a domestic-flagged vessel company based on Government regulation PP Indonesia no.36 2010. At the point of acquisition, LEAD already owned five AHTS vessels with 3,200 bhp, 3,800 bhp and 5,150 bhp.

This indicates that the domestic partner already has local experience in the OSV and is willing to pursue further expansion to leverage on the cabotage momentum. Meanwhile, the main businesses of the Pacific Radiance Group are shipbuilding, ship operations and maintenance, ship equipment rentals and technical related services. LEAD believes that Pacific Radiance Group’s experience and network will give it added value.

Serving top-tier O&G clients
LEAD’s top two clients are Total E&P Indonesie and Pertamina. Total E&P is Indonesia’s largest gas producer and the third-largest oil producer in Indonesia, based on March 2012 data from SKK Migas. Pertamina, a state-owned company, is Indonesia’s fourth-largest gas producer and the second-largest oil producer. Highly experienced in serving its top-tier clients, LEAD is equipped with high professional standards to meet new challenges in Indonesian waters. Based on SKK Migas’ 2013 state budget O&G target, only five companies are able to exceed work, planning & budget (WP&B) gas volume realisation, with Total E&P Indonesie ranked as the highest in terms of exceeding the WP&B.

Key Risks
Dependent on O&G
The O&G sector is a highly cyclical industry, with capex and opex of O&G companies determined by fluctuations in oil prices. However, given the strong exploration activities in Indonesia and its cabotage regulation, the nation’s OSV industry should not be affected by short-term volatility in oil prices.

Concentration risk
A large portion of its contracts is derived from its largest customer, Total E&P Indonesie. If LEAD has a contract default with the latter, its earnings could be significantly affected.

Lower-than-expected utilization rates
Fewer jobs secured by its OSV players could threaten its earnings. At present, we like LEAD’s long-term contracts portfolio with secure earnings. However, the current trend in exploration activities is skewed towards short-term contracts. For LEAD to aggressively expand, it needs to increase exposure to short-term contracts as well, which may lead to higher utilization risks.

Forex gains/losses
Almost all of its revenue is in USD, while a large part of its operational costs is in IDR and its debt is a mix of IDR and USD. Significant changes in the currency exchange could impact LEAD’s earnings.

A highly-leveraged industry
The OSV industry is a highly leveraged business. As vessel purchases require huge investments, hefty loans or equity-raising from financial institutions is a norm.

Financial Analysis And Forecasts
Robust revenue growth
LEAD posted a revenue CAGR of 46.2% for 2011-2014. We expect its 2013-14 revenue to rise by 72.6% and 35.4% y-o-y respectively, driven by its fleet expansion to mid- to high-tier vessels. The addition of nine vessels in 2013 and 2014 is expected to contribute 11.5% and 38.4% respectively to 2013 and 2014 revenue.

Stable gross margin
We expect gross profit CAGR of 47.9% from 2011-2014. LEAD’s gross margin was relatively stable at 49-53% from 2010 to 2012. We estimate gross margin of 50.6% in 2013 and 50.4% for 2014. The group’s major cost of sales are depreciation, salaries and fuel, which respectively ate up 28.8%, 20.3% and 19.9% of its 9M13 revenue.

Operating profit growth even more attractive
We expect operating profit to record an attractive 54% CAGR for 2011-2014. Following Pacific Radiance’s emergence as a stake holder in 2011, several operational improvements were made, such as in human resource management and strategic functions within the organization. This led to an upward salary adjustments and positive developments. Note that in 2012, post-Pacific Radiance’s entry, opex-to-sales ratio declined to 12.1%, compared with 14.7% in 2011.

Strong net profit growth
We expect LEAD to record a net profit CAGR of 83.0% for 2011-2014, mainly spurred by its fleet expansion. It is worth noting that as shipping/vessel companies are liable for a final tax rate of 1.2%. LEAD’s effective corporate tax rate is <10%, lower compared with the general corporate tax rate of 25%.

Balance sheet analysis
Backed by its vessel expansion capex, we expect LEAD to book gross fixed asset CAGR of 45.6% from 2011 to 2014. Note that net gearing declined to 1.2x in 2011 from 2.2x in 2010 due to capital injection from Pacific Radiance. In 2011, the majority of LEAD’s borrowings were from local banks and finance companies at very high interest rates. LEAD subsequently refinanced its local borrowings to offshore loans with Singaporean banks at cheaper rates. This was the main reason its interest coverage ratio increased in 2012 to 4x from 2.1x in 2011.

Sensitivity Analysis
Utilization rate sensitivity analysis. In our utilization rate sensitivity analysis for LEAD’s vessels, we found that a 2% change in utilization rate could impact net profit by +/- 7%, while a 6% change in utilization could impact net profit by +/- ~21%, and a 10% change in utilization rate could affect net profit by +/- ~35%.