Background
GSS Energy 7 month sales from 1 September 2014 to 31 March 2015 were flat yoy at S$44.3m, of which S$32.8m are from the Precision Engineering Segment and S$11.5m are from the Oil and Gas segment. However, gross profit surged 116% yoy to S$13.8m, PE segment contributed S$7.8m (23.9% GPM) while O&G segment contributed S$6.0m (51.8% GPM). PATMI for 7 months was S$0.6m which is 32.5% decrease yoy comparison of S$0.9m, excluding S$2.9m for one off corporate expenses with the acquisition of the stake in Cepu Sakti Energy Pte Ltd, core net profit of S$3.5m post a strong growth of 288% yoy.
GSS Energy (GSS) was transferred the listing status from Giken Sakata on 12 February 2015. Pursuant to a scheme of arrangement under Section 210 of the Companies Act undertaken by Giken Sakata, Giken Sakata became a wholly-owned operating subsidiary of GSS Energy. GSS operates on 2 business segments, mainly the precision engineering service to aerospace, healthcare, gaming, semi-conductor, oil and gas, automotive components and provide large format precision and engineering fabrication services.
The other business segment is the oil and gas segment. GSS acquired 53.7% of Cepu Sakti Energy (CSE) to develop and execute drilling program to extract crude oil from mature oil wells in Indonesia governed by the agreements with the Village Unit Cooperatives or Provincial State Owned Enterprises. The West Jambi project with Ramba Energy is the first “Kerja Sama Operasi” (KSO) project that GSS Energy is participating in. KSO agreement is a Production Sharing Contract (PSC) with Indonesia’s national oil company Pertamina. It gives Ramba Energy the right to explore and exploit the West Jambi block for 20 years starting from 2011.
Key takeaway from analyst results briefing:
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GSS Energy form a joint venture with oil trading company AFCO Energy on June 1 2015, subsidiary of FinCo Fuel Holding BV as a platform for production, marketing and distribution of mineral oil and crude oil products to central Java.
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GSS Energy will invest US$5m up to US$7m with Raba Energy West Jambi Limited to complete the drilling of 2 exploration wells in West Jambi Indonesia on 18 May 2015. An independent 2015 report from international petroleum consultancy DeGolyer & MacNaughton estimates the West Jambi block as holding gross contingent resources (3C) of approximately 23.1 million barrels of oil, 0.81 million barrels of condensate and 97 billion cubic feet of marketable gas, as at 31 December 2014.
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Drilling on two onshore wells at West Jambi block would commence in the second half of this year.
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In negotiations with Pertamina and local government to secure a KSO where the group can drill anywhere in its area of operations. Management highlight this is a safer agreement when oil price is at a level that makes cost recovery a concern. In comparison, KSO programs provide up to 90% of oil production cost as cost recovery.
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Under the PSC model, cost of drilling the well will be recover back to the group after First Tranche Production (FTP) cut from the government. Hence, the group has priority to recover its cost of operation before sharing profit with the government. However, there is a sign on bonus for the KSO program and it ranges from US$0.5m to US$1m.
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As the oil produced can only be sold in Indonesia, the group signs a yearly contract with Pertamina to fix on the price of oil at approximately 70% of Indonesia crude price. According to management, if Pertamina wishes to change the selling price, it also has to change the exchange rate of USD/IDR.
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Low capex for simple onshore wells as management estimate the cost to be between US$120,000 to US$160,000 per well. Management estimated operating cost to average around US$20 – US$22 per barrel.
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Payback period are short as once the oil wells start producing, it will generate cash flow immediately. Management estimated payback period of approximately 5 – 6 months of production.
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Precision segment are on track for bottom-line growth of 5 – 11% in FY15.
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Typical PSC/KSO in Indonesia
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CSE Cooperation Agreement
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Share
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~ 15-20%
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70%
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Offtake price
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Market price
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Discount to market price
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Scalability
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Low - Medium (depending on multiple factor
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Highly Scalable
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Income tax
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~ 44%
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25%
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Exploration risk
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~ 50%
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Close to zero
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Typical capex per well
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In excess of USD 5million
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~ USD 200,000
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Development period
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3 - 5 years
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A few months
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Our view:
At a price of S$0.174, GSS Energy trades at 1.2xPBR or 6.6x PNTA after excluding intangible assets of S$11.9m and Goodwill of S$42.9m. Goodwill was incurred for the acquisition of the stake in CSE. We calculate it’s annualise core FY15 PER of 13.7x was not undemanding, couple with the negative outlook on oil price and Indonesia Rupiah as well as the uncertain outlook in Indonesia. We view GSS is fully value in the short term.
According to PWC, Indonesia has issued a Presidential Decree No.39/2014 on May 2014. Its stipulation restrict investment companies (PMA entities) involved in both offshore and onshore drilling and oilfield services, it does not affect investments approved prior to this issue. Furthermore according to Reed Smith, Legislator in Indonesia has leaked provisions of the new draft law to the media which suggests that state-owned enterprises should control all production operations, with private investors providing only capital and technology. These provisions of the draft law would boost state-owned oil company Pertamina once more. The new law makes no mention of production sharing or cost recovery, both of which were an essential part of the current exploration system in Indonesia – foreign companies have long been sharing their production with the state, but recovering their costs for doing so. This draft law has not been implemented and will be finalized at the end of 2015.
GSS has a unique business model, it has a very limited exploration risk due to GSS Energy will drill new wells beside the old wells. The new wells are structurally stable and operable which can be drilled deeper than the old wells to increase the yield on each well.