Wintermar Deserves a Premium

WINS’ laggard movement vs JCI’s rally does not reflect the attractiveness of its: i) double-digit earnings growth forecasted for 2013/14, and ii) 42% and 37% 2013 P/E discounts to regional O&G services and OSV peers respectively. We see imminent re-rating and upside potential on the back of its margin expansion and fleet rejuvenation as well as positive impact from the cabotage policy.

2013 earnings growth driven by gross margin expansion
Several offshore support vessel (OSV) project tenders this year are restricted to only Indonesian-flagged vessels. Hence, we expect WINS’ margin to expand this year given the higher contribution from its owned vessel segment (60% in 2013; 59% in 2012), which should boost gross margin to 31% from 28% in 2012. We cut our 2013/14 earnings forecasts by 8% as we lower our 2013/14 revenue estimates for the owned vessel segment by 11% and 8% respectively to reflect several contract delays.

Casualty of negative industry sentiments; upside on the cards
We see WINS’ share price (-15% YTD underperformance) as being overly punished for the negative sentiments plaguing the whole industry, sparked by uncertainties following the dismissal of O&G regulator BP Migas as well as the declining national oil production. However, SKK Migas’ (replacing BP Migas) role is now clear despite several contract delays for WINS partly due to administrative reasons in the upstream sector. It is worth noting that Indonesia’s average daily crude oil production rose to 840k bpd in March, vs its FY13 target of 830k bpd, indicating that the regulator has halted the nation’s oil production decline.

Cheap valuation
WINS is currently trading at an undemanding 7x and 6x 2013/14 P/Es, a discount of 42% and 37% to regional O&G services and pure/near-pure OSV peers (2013 P/E values). Maintain BUY with IDR640 TP, implying a 10x 2013 P/E. WINS’ upside risk is the award of new exploration blocks leading to new potential OSV contracts. If this materializes, On-going expansion through further leverage is highly visible. Key risks include: i) a severe economic downturn (sustained fall in oil prices), ii) a slowdown in upstream O&G exploration investments, and iii) uncertainties in government regulations.

Expansion still intact
We expect WINS to acquire another eight mid- and high-tier vessels and scrap six low-tier vessels this year as part of its fleet rejuvenation. This year, its revenue is expected to grow at a more conservative 8% y-o-y as the company focuses on improving its cost efficiencies by selling off cost-inefficient vessels. We believe its capital-intensive fleet expansion strategy should translate into higher earnings as it would reduce exposure on its lower margin segment (re-chartered vessels).

In 2012, WINS’ own vessel segment had a gross margin of 46% while re-chartered vessels have a thin gross margin of 6%. Its owned vessel segment contributed around 50% of total revenue last year while re-chartered vessels accounted for around 40%. For this year, we expect earnings grow by 18% y-o-y. +12% or -12% change on earnings assuming +5% or -5% change in vessels utilization. Based on our sensitivity analysis, a 5% hike in utilization for all WINS’ vessel classes could increase the company’s 2013 and 2014 bottom lines by 12% and 11% respectively.

Blended rates should be attractive
We have limited data regarding WINS’ time charter rates, thus we are assuming flat charter rates forecasts. However, we believe the risk of a severe decline in charter rates is unlikely as Indonesia has decent positive macro drivers, which would help to cement the resilience of time-charter rates:
i. High demand for energy, and high oil prices
ii. High exploration and production (E&P) capex
iii. Increasing offshore activities as onshore fields mature
iv. Healthy demand for OSVs

Although charter rates depend on the supply and demand for OSVs, WINS’ expanding business portfolio should translate to higher blended charter rates, as it begins to focus on mid- to high-tier charter sales. Note that our guidance for low-tier rates/day is at <USD3,000, while mid-tier rates range from USD3,000/day to USD15,000/day and high-tier rates start at USD15,000/day.

According to Fearnley Offshore Supply, there are several indicators which are positive for OSV rates going forward:
Contrary to the situation in 2007, the majority of the players now believe that the market is at the beginning of an upward trend
Oil prices are high and experts expect them to stay at the current levels throughout the year
The North Sea spot market has picked up, with Feb 2013’s average rates close to outpacing the monthly average for the whole of 2012
5 years under-rated highlights should not put WINS to a steep discount to the market.

Several points about the company worth mentioning:
In 2008-2012, amidst a decline in the oil prices in the 2008-2009 global crisis, WINS achieved CAGRs of 23% and 27% in net profit and EBITDA respectively.

In 2012, supported by its consistent solid cash flow, WINS had been able to distribute 13.5% dividend payout in 2012 of based on 2011 earnings. It increased the number of its mid- and high-tier vessels to 32 (50% of total vessels) in 2012, from 10 mid and high-tier vessels in 2008 (16% of total vessels). Its full-year financial results for 2010 to 2012 have always beaten consensus’ expectations.

Relatively healthy balance sheet
Unlike the case studies on global shipping industry during the 2008-2009 crisis where unreasonable leveraging was conducted, WINS has a healthy balance sheet, as seen from its interest coverage ratio being consistently above 5x in the last few years, together with its relatively low net gearing level which is still below 0.6x. We believe further leverage would be necessary to unleash true earnings value from its vessel expansion and fleet rejuvenation. Furthermore, WINS is not significantly exposed to foreign exchange risks as the company is dollar earners with dollar debt exposures. With its consistently growing operating cash flow, it should remain in active expansion mode.

Cheap P/E, PEG below 1x, still-low dividends amidst expansion
WINS is trading at discounts of 42% and 40% to its regional O&G service provider peers’ 2013 and 2014 P/Es. It is also trading at 37% and 35% discounts to its regional pure/near-pure OSV peers – excluding Malaysia’s Bumi Armada (BAB MK: BUY; FV: MYR4.35) – for 2013 and 2014 respectively. Its 2013 PEG is at 0.4x while its five-year (2008-2013) PEG CAGR is at 0.2x.

Valuation
Our TP of IDR640 is derived from an implied 10x 2013 P/E, which is a 19% discount to the implied 2013 P/Es of its pure/near-pure OSV peers (excluding BAB). Its ROAE for 2013 is in line its peers’ 10%-15%. The industry’s dividend yield is at ~1%. We believe WINS is trading at a discount to its peers mainly due to liquidity issue.

Underperformed against the JCI by 5% since IPO
There are several reasons why WINS’ share price has underperformed against the Jakarta Composite Index (JCI) since its IPO:

Liquidity issues
Negative investor sentiment due to regulatory uncertainties for upstream industries, and declining national oil production.Investors are still wary about the outlooks of vessel-related industries post-2008-2009 global crisis

WINS vs MBSS
We have two vessel-related companies under our coverage, WINS and coal transportation company Mitrabahtera Segara Sejati (MBSS) (BUY; TP: IDR1,500) Below are several key comparisons between the two:

WINS have more margin expansion room compared to MBSS
WINS has high potential to unleash its earnings value and widen its margin through fleet expansion and the switch over to more high-margin vessels. WINS urgency to expand is evident, as Indonesia is seeking to boost oil production, which, in turn, would benefit WINS. Unlike MBSS, WINS has a capex budget of USD60m for expansion this year, which implies better opportunities within the industry. On the flip side, MBSS set aside minimal capex budget for this year, and its earnings growth target of 15% this year is derived on the back of last year’s fleet expansion.

More cabotage opportunities for WINS
The cabotage regulation will benefit WINS more than MBSS. MBSS tug and barge fleets are already protected by the cabotage law therefore the cabotage law does not give any edge for MBSS against its competitors in the fragmented coal transportation industry. The cabotage effect applies differently to WINS. WINS strategy to move to mid- to high-tier vessels gives it a first-mover advantage to grab a bigger market share off foreign-flagged vessels. Should any tenders be granted exclusively to Indonesia-flagged vessels, WINS stands to benefit as the barriers of entry to the OSV industry is high.

Which company (WINS or MBSS) is more resilient against down-cycle? MBSS has a minimum guaranteed volume contract with its long-term customers and thus, there is a minimum amount of coal delivery that coal producers have to commit to. In contrast, WINS’ deals with customers are on a time-charter basis, with short term contracts. However, WINS is less affected by the short-term volatility in oil prices compared to MBSS as it can pass on the fuel cost to its customers.

MBSS has a more attractive valuation
MBSS has a cheaper valuation, higher ROE and higher dividend yield compared to WINS (see Figure 15). However, WINS’ valuation is very attractive compared to regional peers. The coal industry has been somewhat depressed, which in turn, has hurt supporting companies such as MBSS.

We prefer WINS over MBSS for investors looking for a long-term fundamental play. If an investor is looking for a dividend play with lower risks and lower potential returns, we suggest MBSS as a more ideal pick.

Risks – Testing its down-cycle resistance
Dependent on the O&G sector
WINS is dependent on the O&G sector’s E&P projects, and hence, lower O&G capex and opex would affect the demand for OSVs. Fortunately, WINS’ business continuity is protected both in the short and long terms as its services cover exploration, production and post-production activities:

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 due to underinvestment in exploration activities, causing reserves to remain low at 4.2bn barrels. On the bright side, WINS has ongoing OSV projects for the exploration of offshore blocks, which were concessions awarded back in 2007-2008.

The government is looking to boost investments in exploration. It also aims to raise the current production level, by using several technologies such as the enhanced oil recovery (OER) system.

High interest coverage ratio and low net gearing level vs peers. WINS’ interest coverage ratio is relatively high compared to other domestic vessel-related peers and moderate compared to its regional pure/near-pure OSV peers, while its net gearing level is relatively low and low respectively compared to them.

Impact of positive industry events on WINS’ fundamentals
SKK Migas’ presence strengthens domestic bids
WINS faced delays in several big contracts due to dismissal of upstream O&G regulator BP Migas and its role being taken over by the Special Task Force for Upstream and Gas Business Activities (SKK Migas). However, we believe this is just a temporary shock and should not impact its long-term fundamentals as several big potential tenders for this year are only open to Indonesian-flagged vessels. Currently, the O&G companies prefer shorter-term contracts (ie less than one year) especially for exploration activities.

However, as the cabotage policy is enlarging WINS’ market share, we see that the tenders could be awarded to the company going forward. WINS encountered contract delays in 2H12, after SKK Migas emerged as the new regulator. As of Feb 2013, the company’s contracts in hand were valued at USD208m, a slight m-o-m pickup from January.

WINS vessels protected from cabotage policy
We see that most of WINS’ fleet, made up of foreign-flagged vessels, is protected from the cabotage policy. A major part of its fleet expansion is to acquire vessels such as anchor handling tug supply (AHTS) vessels, platform supply vessels (PSV) and diving support vessels (DSV). Several of the aforementioned vessels are exempted from the cabotage policy end of 2012, and more are set to be exempted by end-2013. With this regulation, foreign players are restricted from entering Indonesian waters, unless they overcome certain hurdles, such as having a 49% ownership in a company.

Increasing exploration activities from awarded blocks
We see significant activity ahead in the upstream segment of the O&G sector due to the higher number of authorization for expenditure (AFE) approved for the production and exploration blocks. The amount of AFE approvals surged by 85% to 1,257 in 2011, while the AFE for exploration blocks increased by 28% to 342 in the same year. WINS is set for a bright future, as the cabotage policy allows its foreign-flagged vessels to operate in the Indonesian OSV market. In addition, it is growing its market share through increasing exploration activities from concessions that were awarded back in 2007-2008.

Despite Indonesia’s declining oil production due to the nation’s previous underinvestment in exploration activities, WINS has been able to obtain contracts from the O&G companies and book consistent earnings growth. BP Migas (and SKK Migas now) projected the need for 235 OSVs from 2011 to 2015. From Feb 2010 to Dec 2011, the total number of OSV vessels had increased by 15% and the proportion of Indonesian-flagged vessels rose from 88% to 93%. WINS owns 21% of the new Indonesian-flagged vessels which entered the fray during this period. Given its first-mover advantage, we believe it should obtain a larger slice of the pie going forward.

Upside to the declining crude oil output

The Jakarta Globe on 10 April 2013 stated that Indonesia’s state budget for 2013 has set an oil output target of 900k barrels per day (bpd), but SKK Migas said production was more likely to average around 830k bpd, the lowest since 1969. The regulator has short-term and long-term targets for oil production. In the short term, it expects Indonesia to hit its 2013 target and reach 1m bpd in 2014. In the long term, SKK Migas targets an average of 1m bpd and this can only be realized if it increases enhanced oil recovery (OER) activities and begins projects on time.

On 22 April, Bisnis Indonesia newspaper quoted SKK Migas head Rudi Rubiandini as saying that 1Q13 oil production reached 831k bpd. With March production figures reaching 840k bpd, these means that SKK has halted the decline in oil production. This indicates that the short-term negative sentiment has already bottomed out for WINS, leaving only upside factors on the cards.

We believe the government’s critical role in securing energy such as oil reserves.
Indonesia net oil import has increased over the last couple of years as oil production declining while oil domestic consumption increases. Amid higher fuel imports, Indonesia is currently experiencing a negative trade balance. This has led to a 7% depreciation in the rupiah against the greenback since early 2012.

Fuel consumption is most obvious among consumers, as 4W and 2W automobile sales had grown by a CAGR of 21% and 9% respectively in 2007-2012, and will continue to grow by 15% and 5% respectively this year. The Central Statistics Agency (BPS) data indicated that Indonesia’s trade deficit reached USD1.63bn last year, weighed down by USD5.59bn deficit in the O&G trade arising from O&G imports totaling USD40.7bn in 2011 and USD42.25bn in 2012. We see that O&G investment activities are inevitable and thus, will stand to benefit WINS in the short-long term period.