RAM Ratings lifts Rating Watch, reaffirms Kencana’s AA3 ratings with stable outlook

Published on 23 March 2012

RAM Ratings has reaffirmed the AA3 ratings of Kencana Petroleum Berhad’s (“Kencana”) RM700 million Sukuk Mudharabah Programme (2011/2026) (“Sukuk Mudharabah”) and proposed RM350 million Sukuk Mudharabah (with detachable warrants) (“Sukuk Mudharabah-W”) (collectively known as “the Sukuk”). Concurrently, we have lifted the Rating Watch (with a developing outlook) and reinstated the stable outlook on the long-term ratings.

We highlight that the ratings are based on the premise that the proposed merger between Kencana and SapuraCrest Petroleum Berhad (“SapuraCrest”) will be successfully completed. Pursuant to the completion of the proposed merger, the merged entity, which will be known as SapuraKencana Petroleum Berhad (“SapuraKencana” or “the Group” (formerly known as Integral Key Berhad (“IKB”)), will assume repayment responsibility on the Sukuk Mudharabah. Meanwhile, the proposed Sukuk Mudharabah-W will be aborted in order to comply with certain conditions of the corporate exercise. RAM Ratings will then withdraw the rating on the Sukuk Mudharabah-W.

To recap, the ratings had been placed on Rating Watch in July 2011, following the announcement that IKB (a special-purpose vehicle incorporated to undertake the corporate exercise) had proposed to acquire Kencana’s entire business and undertakings, including its assets and liabilities, for RM5.98 billion in total; the offer would be satisfied by IKB shares and cash. IKB had simultaneously made a similar acquisition offer to SapuraCrest for RM5.87 billion.

Post merger, we expect the Group’s business profile to be substantially stronger than Kencana’s stand-alone position. The merged entity will become the country’s largest provider of oil-field services and rank among the top 10 world players by market capitalisation. We opine that the enlarged asset base and wider range of services provided will augur well for the Group’s prospects on securing additional global contracts. In particular, the Group is expected to clinch more turnkey engineering, procurement, construction, installation, and commissioning projects. “The merged entity will combine Kencana’s strength in fabrication and engineering with SapuraCrest’s formidable presence in the installation of pipelines and facilities,” observes Kevin Lim, RAM Ratings’ Head of Consumer and Industrial Ratings.

In Malaysia, the Group, along with other local providers of oil and gas support services, benefits from the favourable policies implemented by the Government and Petroliam Nasional Berhad, aimed at nurturing local expertise and reducing dependence on foreign players. The ratings also reflect the Group’s recurring income; Sapura-Kencana is expected to derive 20%–30% of its operating profit before depreciation interest and tax from long-term contracts (mainly for the hire of its drilling rigs). We note that the Group’s pro forma outstanding order book was valued at over RM11 billion as at end-January 2012.

On the flipside, the Group’s financial profile would be weaker given its heftier debt load. We anticipate that the merged entity’s debt burden will balloon to about RM6 billion (pre-merger pro forma: RM2.10 billion as at end-October 2011). This figure takes into account the debts assumed to fund its sizeable capital expenditure and some RM2 billion of borrowings to part finance the merger. The Group’s gearing ratio would thus increase to about 0.9 times (pro forma end-October 2011: 0.60 times). Furthermore, its funds from operations debt coverage ratio is envisaged to weaken to around 0.15–0.2 times in FY Jan 2013 and FY Jan 2014, before recovering thereafter. Taking into consideration cash dividends from the Group’s joint ventures (“JV”), SapuraKencana’s FFO debt cover ratios would recover at a faster pace, particularly once it begins receiving contributions from its JV in Brazil.

Despite the anticipated benefits from the merger, we opine that there is considerable complexity in attempting to integrate the businesses of the 2 large corporations. We note that the merged entity will have an executive committee, comprising an equal number of representatives from SapuraCrest and Kencana, which will oversee key strategic matters. RAM Ratings will closely monitor how this arrangement will affect the Group’s decision-making agility and risk appetite in the future. In the meantime, we note that an integration committee and various task forces have been set up to map, implement, and monitor the integration process.

RAM Ratings will publish the Sukuk rating rationale within a week.

Media contact
Low Li May
(603) 7628 1175
limay@ram.com.my