Medserv — Update 21 November 2016

Industrials

Medserv

A hint of Eastern promise

Q3 trading update

Industrial support services

21 November 2016

Price	€1.50
Market cap	€81m

Net debt (€m) at 30 June 2016		47.1

Shares in issue	53.7m
Free float	35.1%
Code	MDS

Primary exchange	Malta SE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(3.2)	(16.7)	(10.4)
Rel (local)	(5.6)	(19.2)	(14.2)

52-week high/low

€3.1

€1.2

Business description

Medserv is a Malta-based provider of integrated offshore logistics and services in support of drilling operations in the Mediterranean. The acquisition of the METS companies in February 2016 diversified the company into onshore steel tube stockholding and servicing for countries in the Middle East.

Next events

Preliminary results

March 2017

Analysts

Andy Chambers	+44 (0)20 3681 2525
Roger Johnston	+44 (0)20 3077 5722

industrials@edisongroup.com

Edison profile page

Medserv is a research client of Edison Investment Research Limited

The Q3 trading update indicates that, despite the very challenging macro environment, Medserv is maintaining a robust overall performance aided by the initial contribution of METS. Opportunities, especially in the Eastern Mediterranean, continue to support a view of improved organic development in FY17. Our numbers are unchanged and our fair value calculation currently stands at €2.03 per share.

Year end	Revenue (€m)	PBT* (€m)	EPS* (c)	DPS (c)	P/E (x)	Yield (%)
12/14	32.4	3.1	5.0	4.3	30.0	2.9
12/15	42.8	6.1	9.7	4.3	15.5	2.9
12/16e	38.1	2.3	4.4	1.1	34.1	0.7
12/17e	49.2	6.6	11.0	4.4	13.6	2.9

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Q3 trading performance

Medserv has stated that it expects to be close to its revised target revenue of €38m for the full year on currently contracted work, although there is an element of timing with respect to new projects that could improve this. METS continues to see the benefit of a stronger than budgeted performance in Oman, with the UAE also performing well. While Iraq has proved problematic, cost reduction has returned the operation to break-even on current volumes since October. The first evidence of revenue synergy came from the completion of a pipe testing contract at the Hal Far facility in Malta, using both technology and expertise gained from METS.

Positive potential for 2017

Despite the challenging investment environment in the global oil & gas exploration and production market, management remains confident that FY17 should see a stronger performance. Apart from the full year contribution from METS, the major logistic and support contract let in 2016 for offshore work in Libya has been secured by Medserv Operations in Malta, underpinning the next three years’ activity. Medserv could also benefit from the previously announced deferred drilling programme in Portugal by ENI, as well as increasing offshore activity in both Egypt and Cyprus. An office has been established in Trinidad to pursue opportunities in the Caribbean, and Iran remains a longer-term potential should sanctions be lifted. A plan for a return to onshore Libya is in place when more stable conditions allow.

Valuation: Poised for any upturn

We are not adjusting our estimates at this time, as incoming contract activity in Q4 will clearly determine the outcome. Opportunities for growth next year and beyond remain significant which, together with a modestly lower WACC arising from the decline in the share price, drive our fair value to €2.03/share (from €1.90/share). Assuming the company can demonstrate positive progression next year this may be a realistic expectation.

Trading update and outlook

The spending in oil and gas E&P (exploration and production) capex has slumped by over 40% since the sharp drop in the oil price initiated the fall in investment and cost reductions by IOCs now in place around the world. With evidence of a greater stability in the oil price, commentators appear increasingly of the view that the current cycle may be close to the bottom. While territories like Libya, Iran and Iraq may still be operating below historic output levels, there is an expectation that market conditions for output recovery may be improving. Combined with the significant new field discoveries and developments offshore Egypt, which in turn is spurring renewed interest in other areas of the eastern Mediterranean such as offshore Cyprus, prospects remain encouraging for increased activity next year.

Medserv operates generally in lower-cost production areas, which is especially true for METS’s oil country tubular goods (OCTG) stockholding and service activity in the Middle East. It also provides locally unique capacity, expertise and capabilities in its offshore service base offering. These factors provide an element of stability, which could improve further as additional regional opportunities present themselves. We briefly summarise below the current prospects as we see them for each of Medserv’s current or potential exposures.

Regional prospects for 2017

We highlight the following potentials for development in 2017.

■

Malta: the major logistic contract that has been let by the sole IOC operating offshore Libya has been secured. This provides a baseload of activity for the Marsaxlokk base for the coming three years.

■

Libya: while the contracts in Malta are primarily for offshore Libya, the representative office in Tripoli is being maintained. A plan for a return to the country has been developed and, should the situation permit, a return to ground-based operations appears likely. Currently we do not expect this in 2017, although it is possible.

■

Egypt: the major offshore finds over the last couple of years are receiving continued support for development from the participating IOCs. With the office in place in Cairo, Medserv has been accepted on the vendor lists of two established IOCs operating offshore, with a first tender expected to be issued later this month. Management expects Egypt to become established as a new revenue stream from next year.

■

Middle East: METS continues to grow its business in the Middle East, especially in Oman. The Iraqi situation has been returned to break-even, and we expect a progressive uplift in production volumes to be beneficial at some stage when the current impasse in discussions between IOCs and authorities with respect to the concessions has been resolved. Given the delays to date, we would hope this may occur in FY17. The Iranian situation is nascent and still highly political, but appears to be an active potential with IOCs appearing increasingly interested.

■

Portugal: the deferred drilling programme in the Atlantic offshore Portugal is currently still mothballed pending an environmental audit by the government. Management still believes drilling could commence in Q117.

■

Cyprus: the loss of the tender for Total was disappointing, but the whole situation has been confused by the legal ramifications of the recent change of ownership of the Limassol docks. Although it may be going too far to expect a recovery of that business, other opportunities remain in Cyprus with ENI. Although the Larnaca base is currently mothballed, Medserv maintains its operational readiness should drilling commence next year. The third round of drilling concessions is also likely to be let soon, which could add blocks to the currently planned programmes.

■

Caribbean: Medserv has now established an office and has been added on two additional IOC vendor lists, in addition to the current tender where a decision is expected before the end of the year. Additional tenders could therefore be expected in 2017.

Financials

We have not changed our earnings estimates following the Q3 statement, although we note that no interim dividend has been declared. In line with our comment in our half year update, given the ongoing challenging macro environment, we feel Medserv is likely to seek to protect capital and reduce the current year payout ratio temporarily from the 40% level. We therefore maintain our assumed 25% payout level for the FY16 dividend before reverting to 40% as earnings recover in 2017.

Sensitivities

Medserv’s exposure to the macro-affected oil and gas exploration and development market remains undiminished, as does its presence in certain geopolitically sensitive regions. It has long-established relationships with both the major IOCs and NOCs to which it provides services, but contract and project work can be quite lumpy with uncertain timing. ENI remains the major customer historically accounting for c 50% of revenues, but the diversification into the OCTG market via METS adds other significant customers such as Sumitomo. The acquisition of METS extended regional presence, with the established relationships and technical necessity of METS’s service offering provide an element of resilience in most circumstances.

Valuation

Our capped DCF currently returns a value of €2.03 per share (from €1.90) using a WACC of 7.7% (from 7.9%) and terminal growth rate of zero. The WACC has reduced slightly due to the higher proportion of debt funding resulting from the decline in the equity value. The sensitivity of this value to differing assumptions for the WACC and terminal growth rate is shown below, with the closest value to our calculated assumption highlighted.

Exhibit 1: Capped DCF sensitivity analysis to WACC and terminal growth rate (€/share)

2.0	6%	7%	8%	9%	10%	11%	15%
0%	2.89	2.33	1.92	1.60	1.34	1.13	0.56
1%	3.49	2.75	2.22	1.82	1.51	1.26	0.63
2%	4.40	3.33	2.62	2.11	1.73	1.43	0.70
3%	5.91	4.20	3.18	2.49	2.00	1.64	0.78

Source: Edison Investment Research estimates

Exhibit 2: Financial summary

	€m	2014	2015	2016e	2017e
Year end 31 December		IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		32.4	42.8	38.1	49.2
Cost of Sales		(23.2)	(27.2)	(25.3)	(31.4)
Gross Profit		9.2	15.5	12.8	17.8
EBITDA		5.9	10.3	8.5	14.3
Operating Profit (before amort. and except.)		4.2	7.6	4.9	9.4
Intangible Amortisation		0.0	0.0	0.0	0.0
Exceptionals		(0.0)	(0.1)	(0.9)	(1.7)
Other		(0.1)	(0.2)	0.0	0.0
Operating Profit		4.1	7.3	4.0	7.7
Net Interest		(1.1)	(1.5)	(2.6)	(2.8)
Profit Before Tax (norm)		3.1	6.1	2.3	6.6
Profit Before Tax (FRS 3)		3.0	5.8	1.4	4.9
Tax		(0.9)	(1.3)	0.1	(0.5)
Profit After Tax (norm)		2.3	4.8	2.4	6.0
Profit After Tax (FRS 3)		2.2	4.5	1.5	4.4

Average Number of Shares Outstanding (m)		46.1	46.1	52.9	53.7
EPS - normalised (c)		5.0	9.7	4.4	11.0
EPS - normalised and fully diluted (c)		5.0	9.7	4.4	11.0
EPS - (IFRS) (c)		4.2	8.9	2.7	8.1
Dividend per share (c)		4.3	4.3	1.1	4.4

Gross Margin (%)		28.4	36.3	33.5	36.2
EBITDA Margin (%)		18.1	24.0	22.4	29.1
Operating Margin (before GW and except.) (%)		13.0	17.8	12.9	19.2

BALANCE SHEET
Fixed Assets		23.3	24.0	49.5	46.4
Intangible Assets		0.0	0.0	16.6	14.9
Tangible Assets		23.3	24.0	32.9	31.4
Investments		0.0	0.0	0.0	0.0
Current Assets		57.5	57.1	65.9	72.7
Stocks		0.0	0.0	0.2	0.3
Debtors		13.4	12.2	14.5	18.7
Cash		1.1	1.0	9.4	11.4
Other		43.0	43.9	41.7	42.3
Current Liabilities		(15.3)	(13.3)	(5.7)	(7.3)
Creditors		(10.4)	(9.5)	(5.7)	(7.3)
Short term borrowings		(4.9)	(3.8)	0.0	0.0
Long Term Liabilities		(56.1)	(56.7)	(85.3)	(85.3)
Long term borrowings		(21.1)	(22.4)	(51.2)	(52.0)
Other long term liabilities		(35.0)	(34.3)	(34.0)	(33.2)
Net Assets		9.5	11.1	24.4	26.5

CASH FLOW
Operating Cash Flow		(1.7)	10.4	7.5	8.7
Net Interest		(1.1)	(1.5)	(2.6)	(2.8)
Tax		(0.9)	(1.3)	0.1	(0.7)
Capex		(13.4)	(3.8)	(0.5)	(3.4)
Acquisitions/disposals		0.0	(2.6)	(31.6)	0.0
Financing		(0.2)	0.5	12.4	0.0
Dividends		(0.7)	(2.0)	(1.9)	(0.6)
Net Cash Flow		(18.0)	(0.3)	(16.6)	1.2
Opening net debt/(cash)		6.9	24.9	25.2	41.8
HP finance leases initiated		0.0	0.0	0.0	0.0
Other		0.0	(0.0)	0.0	(0.0)
Closing net debt/(cash)		24.9	25.2	41.8	40.6

Source: Edison Investment Research

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Frankfurt +49 (0)69 78 8076 960

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Germany

London +44 (0)20 3077 5700

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London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

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New Zealand

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