Sell Aban Offshore - Elara Capital

• Aban Offshore
• Rating : Sell
• Target Price : INR575
• Downside : 13%
• CMP : INR664 (as on 14 June 2010)

In a tight corner

Reeling under debt, loss of Aban Pearl deals a killer blow

We initiate the research coverage on Aban Offshore with a Sell rating and TP of INR575/share, downside of 13% from the current levels. Though Aban would be able to meet its planned FY11 debt repayment of ~USD410mn, we estimate a shortfall of USD366mn for FY12, and an overall shortfall of USD571mn for FY12-14. As a result, Aban is most likely to opt for debt restructuring, equity dilution or a combination of both. Earnings would be impacted in either case, as we estimate ~15% earnings impact with a 1% interest rate hike and ~25% equity dilution even if the company raises USD150mn. To its credit, Aban has done well by successfully deploying its idle rigs during the past 12 months. But now considering its current situation, the risk-reward ratio seems highly unfavorable for investors.

Limited upside from jack-up markets, no relief to de-leveraging

Looking at the planned global jack-up additions (8% to the existing fleet), we think an upside in dayrates of more than 5-10% from the current USD130k/day levels is unlikely. Thus, we remain skeptical about a higher cash flow possibility when Aban's jack-up contracts come up for renewal. The possible upside may come from the start of a potential rig replacement cycle led by the recent offshore mishaps, but Aban may not benefit as it does not have any jack-ups on spot contracts. We would back Asian rig builders to gain if this replacement cycle kicks in.

What would make us positive? – Only valuations

In our view, Aban's shares have gradually started to build in distressed valuations and we would be buyers of the stock around INR500-550/share levels based on our replacement cost analysis. We believe that Aban can be a fundamental buy only after FY12-end if the company reduces its current D/E of 6.5x to ~3.0x and if there is a transparent de-leveraging plan in subsequent years. We continue to be bullish on the Indian oil service sector and recommend investors to switch to Shiv-Vani Oil & Gas, a much less riskier and an attractive play.

Valuation

We arrive at our TP of INR575/share based on our DCF valuation and assumptions of WACC of 10.8%, and a terminal growth rate of 2.0%. In our view, with Aban's unsystematic risk being so high, investors would now be focusing more on its intrinsic value rather than peer valuations. Still, if compared to global peers, despite the recent 37% hit, Aban stock is trading at an EV/EBITDA of 6.6x on FY12 earnings while peers are trading at 5.0x. At our TP of INR575/share, the stock would still be trading at an EV/EBITDA of more than 6.0x. Lastly, we believe that with the overall market outlook being cautious, highly-levered stocks are likely to take a beating as seen during the previous market downturn in 2008.

Source : Equity Bulls

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