KS Energy - Adjusting for risk and warrants

KS Energy (KSE) announced on 4 June 2009 that it was offering warrants on a one-for-four basis at S$0.20/each. The warrants have a S$1.40 conversion strike price and a conversion period from 7-24 months after issuance.

In our opinion, the company’s issuance of warrants is an unusual choice for raising capital, as 1) it will not immediately raise a significant amount of capital (S$16m-18m in net proceeds from the warrant issuance), and 2) further capital-raising from warrant conversions is uncertain given that the warrants are ‘out of the money’. In our opinion, the warrant issuance is to improve the company’s working-capital liquidity, rather than prepare the balance sheet ahead of any imminent corporate action (eg, an asset acquisition).

We have made some modest adjustments to our FY09-13 balance-sheet and cash-flow assumptions, but no changes to our FY09-13 net earnings forecasts. Our EPS forecasts are also unchanged, as the warrants are currently anti-dilutive. Valuation

We have raised our six-month DCF-derived target price to S$0.92 from S$0.72, due mainly to a reduction in the assumed WACC, to 12.4% from 16.0%. The reduced WACC reflects investors’ shift away from the extreme risk-aversion that was evident from equity valuations in late-2008.Catalysts and action

KSE’s stock has risen significantly since the 28 April 2009 price of S$0.715 on the back of higher crude-oil prices and equity-market levels. However, we think that the company’s fundamentals should continue to be challenged from 2009-11 due to downcycles in jack-up and parts-distribution industries, despite the rebound in crude-oil prices to more than US$70/bbl from US$50/bbl as at 28 April 2009.

From an earnings perspective, KSE is theoretically ex-growth in FY09 and FY10 since it does not have a significant amount of equipment up for new contracts until late 2010. The company may see all four of its jack-ups come up for new contracts in late-2010 and 2011, making the state of the jack-up market very important. We expect jack-up day-rates to remain soft from 2010-11 due to a significant overhang of idle global jack-up capacity.

According to Daiwa’s view, the Straits Times Index and crude-oil prices are both currently more-than-fairly-valued and are at risk of a price correction over the next six months. We expect KSE’s share price to underperform the Straits Times Index if stock indices and/or crude-oil prices decline.

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