Mero-3 FPSO project delays may hit hard
? President/Group CEO Datuk Yee Yang Chien met with investors and analysts
over two days on Wed and Thu this week.
? The somber message was to expect poor earnings in 2Q22F, due to work
delays and cost overruns at Mero-3 FPSO, as well as asset impairments.
? While our Add call is premised on crude tanker freight rate recovery, we think
that concerns over the Mero-3 issue may keep investors on the sidelines.
? Our SOP-based target price remains at RM8; we already cut the DCF value
of our Mero-3 FPSO time charter contract by 25% in our 27 May note.
Main points
? In the analyst session with President/Group CEO Datuk Yee Yang Chien yesterday,
MISC was very candid about the challenges that it was facing with respect to the
Mero-3 FPSO project. To recap, the FPSO project was awarded by Petrobras to MISC
in Aug 2020, and upon completion of construction, the FPSO will be leased to
Petrobras for 22.5 years. MISC awarded the engineering portion to Aker, and the
construction, topside fabrication and integration works to CIMC Raffles in Jan 2021.
The vessel is supposed to be handed over to Petrobras in late-2023F or early-2024F.
? Engineering delays at the start of the project caused the completion timeline to be
delayed by three months, a fact belatedly disclosed to analysts during the 1Q22
results briefing on 26 May 2022. MISC further disclosed yesterday that additional
delays were caused by the China lockdowns in Apr and May 2022, which will likely
push back Mero-3 FPSO’s completion by an unspecified number of additional months.
Even if the China lockdowns are fully removed, other issues may arise that could
cause a cascade of new delays throughout 2023F and into 2024F, in our view.
Nevertheless, for now MISC estimates that the total duration of the delays will be less
than 12 months even in the worst-case scenario.
? MISC has served two force majeure notices to Petrobras – one in relation to the
delays caused by the Russia-Ukraine war (which affected the delivery of certain parts
to equipment manufacturers) and another in relation to the China lockdowns. If
Petrobras accepts these force majeure notices, the Mero-3 project completion timeline
will be extended and MISC may be able to avoid the penalty of liquidated damages.
However, MISC will still have to bear the higher costs of completion, and because
Petrobras will not increase the previously-contracted daily charter rates, MISC’s
returns from this project will most probably be compressed. At our original capex
estimate of US$1.8bn, we calculate that MISC would have enjoyed a project IRR of
9.3% but, assuming a higher capex estimate of US$2.2bn (we penciled in this estimate
as MISC is not ready to provide new guidance), the project IRR may decline to 7.2%.
We incorporated our higher capex estimate in our 27 May note, causing the
contribution of the Mero-3 FPSO time charter contract to our SOP of MISC to decline
25% from 84 sen to 63 sen/share. The longer the delay, the higher the ultimate capex
cost, as bank interest costs will continue to be capitalised, and running costs of the
project team will also continue to accumulate.
? Given that the Mero-3 FPSO project is being accounted for as a finance lease, MISC
has been booking in construction profits since 4Q20, based on a percentage-ofcompletion method. Going forward, MISC’s estimate of the total construction profits
may have to be revised lower (due to cost overruns) and the estimated completion rate
may also have to be revised lower (due to execution delays); the result of both
adjustments is a reduction in to-date construction profits. To the extent that cumulative
construction profits recognised so far are higher, MISC will likely have to write-back
earlier recognition of construction profits; this is expected to take place in 2Q22F.
? Separately, MISC expects to make impairment provisions in 2Q22F against six Puteri
Satu class LNG vessels that are due to end their 20-year charters to Petronas within
the next three years. These are inefficient steam-turbine LNG vessels that, once new
global carbon emission rules (see our 6 Jul 2021 report) take effect on 1 Jan 2023F,
will be unattractive to charterers.