Coastal Contracts Bhd

Market cap: MYR1.19 bil (MYR2.17 per share)

Sector: O&G
Written by: Ng Hao Yuan (dated 4 August 2023)
Investment thesis:

With a conservative estimate of an annual FCF of MYR193 mil over the next 5-10 years, the stock is
very cheap. The stock is depressed due to a combination of the rise in ESG investing, complicated
accounting, and its client Pemex being the most indebted oil major in the world. Intrinsic value is easily
over MYR2 bil. Holding Coastal for 2-3 years is likely to yield a 100-200% total return.

• Coastal is an integrated O&G service provider, currently running 3 gas processing projects in
Mexico (currently contributes around 80% of their profit). The company is also involved in the
shipbuilding and chartering business.

• Through these 3 gas processing projects, the FCF generated is recurring in nature, depending
on its yield and efficiencies in processing. The income is not dependent on gas prices as they
are fixed-priced contracts.

• The company is trading at a market cap of MYR1.19 bil. Upon completion of their gas
processing plant, Coastal is expected to receive partial repayments of their loans to JV,
amounting to MYR330.2 mil. In addition, Coastal is disposing of some OSVs for MYR287 mil.
With the cash proceeds, the company will be trading at an EV of MYR775.8 mil. It is trading at
a forward EV/FCF of 4x with very conservative estimates. If loans from JV are fully repaid
(expected to be within the next 5 years), Coastal will be trading at a forward EV/FCF of 2x.

• Coastal is currently eye-ing other comparable long-term contracts of similar size. As PEMEX
ramps up production, it will require more gas processing plants. There is also less competition
in the gas processing division, with only 5 solid companies in the field (including the group).

• Coastal is exposed to geopolitical and operational risks in Mexico, with its client PEMEX being
the most indebted oil company globally (USD110 bil).

• Conversations about Pemex often conclude that the government will help it pay its debt to avoid
a restructuring that requires the company to negotiate with its lenders. However, as the end
of President Andrés Manuel López Obrador’s six-year term ((a very pro-Pemex administration)
approaches, some are being vocal about the possibility that a default is on the cards.

• I believe what will most likely happen is some sort of restructuring. A restructuring is equivalent
to a default, as it would require the company to negotiate with its creditors a new plan in which
investors would be willing to give up some returns.

• Being the national oil company of Mexico, PEMEX is unlikely to cease operations, if a
restructuring happens, fields that generate cash quickly (where Coastal operates in) will
be given priorities. This should result in increased production from these fields and
faster payment to contractors. This is evident from Coastal's successful collection of
payments for their work on their projects.

• In addition, Coastal's assets in Mexico are currently focused on oil fields that are
considered "easy" because they are located in shallow water or onshore. This means that the
costs of extracting oil are relatively low, and the process is faster.
Details of each of the contracts:

AGOSTO 12 (JUGCSU)
Bareboat charter for a JUGCSU, used to produce and supply compressed sour gas to PEMEX (Mexico's
national oil company) for injection into the reservoir the high content of associated gas to oil, to help
maintain reservoir pressure and maximize the exploitation of hydrocarbons

Location: Cantarell Field, Gulf of Mexico

Max Contract Sum: USD372 mil (MYR1.69 bil)
Duration: 8 years + 4 years extend option
Client: PEMEX
Commencement date: August 2016
Initial CAPEX: MYR582.8 mil

PERDIZ PLANT (Secured by Coastoil JV)

To provide EPCOM for the onshore gas sweetening plant

Location: Ixachi field, Veracruz

Max Contract Sum: MYR258.7 mil (increased to MYR371.8 mil)
Duration: 32 months (excl. plant construction period)
Client: PEMEX
Commencement date: July 2021
Initial CAPEX: MYR100 mil
Capacity: 150mmcfd (modified to 180mmcfd in June 2022)
PAPAN PLANT (Secured by Coastoil JV)
To provide EPCOM for a gas conditioning plant and its related infrastructure

Location: Ixachi field, Veracruz

Contract Sum: MYR4.50 bil
Duration: 10.6 years (including plant construction)
Client: PEMEX
Commencement date: since February 2023
Initial CAPEX: RM1.37 bil
Capacity: 300mmcfd

Calculations of FCF:

Calculations for FCF generated by Agosto 12 project

*Huge capex spent in FY2021 is not explained clearly, which could be due to other vessel projects, the
estimates here however include the full amount in to be conservative, to note that the Agosto12 project
is a bareboat charter, therefore it requires no capex from Coastal
Calculations for FCF generated by the Perdiz project

Calculations for FCF generated by the Papan project

Total annual free cash flow: Agosto 12 + Perdiz + Papan = MYR92.9 mil + MYR 24.4 mil + MYR76 mil
= MYR193 mil

Assumptions:

• Annual operating costs/maintenance capex is assumed to be 10% of capital cost, as per

research dated 2004 (Section 11.5).

• Last 4Q EBITDA for PERDIZ is MYR140 mil as provided by management. Based on these
numbers, it is very likely that my estimates (MYR24 mil) are vastly understated. According to
research by RHB analyst Sean Lim, annual gross EBITDA for Papan is estimated at MYR120-
200 mil, compared to my estimates of MYR76 mil.

• Management reported EBITDA after tax and should be close to FCF, since the construction
cost is capitalised and spent already, but only depreciated after production starts.

• The reason for such a large disparity between my estimates and management guidance is a
lack of information based on their current accounting structure. Coastal is by principle a 50-50
JV. However, the JV partner has yet to sign the share transfer. The accounts are currently
consolidated, making it hard to extract numbers for each segment.

• It is also unclear that the EBITDA reported by management is accounted for the 50-50 JV. As
a JV, the company would just record 50% of the share of profits in their books and should not
have depreciation or amortization. The point here is that the accounting is confusing. Pending
the share transfer, I will be using my estimates for valuation purposes just to be conservative.
Coastal’s balance sheet:

• The amount due from JV of MYR724 mil was proposed financial assistance for the construction
of the Papan plant.

• Although Coastal has shareholders’ approval to lend up to USD220 mil to the JV, the actual
loan amount is expected to peak at USD170 mil (MYR774 mil).

• Given the above, the outstanding amount due from JV is expected to reduce to USD90 mil
(MYR394 mil) by 3QFY23. This is following full collections of Papan’s EPC billings. This will
mean that Coastal will be receiving cash of MYR330.2 mil. (MYR724.2 mil - MYR394 mil)

• Thereafter, the Group intends to refinance the bulk of this outstanding amount, which is
currently funded by a bridging loan. Management is inclined to refinance this loan to a 3- to 5-
year short-term loan under the Group (instead of under the JV). This is given the Group’s lower
cost of borrowing that enables Coastal to earn the interest spread from the JV.

• On 4 April 2023, Coastal announced the disposal of 2 OSVs for MYR287.3 mil (expected to
book a profit of MYR100-120 mil as per Stockbiter @penglam’s estimation
https://stockbit.my/post/11068762). Recall that management intends to sell off its OSV fleet
given that the industry is cyclical and has low barriers of entry.
Additional Catalysts:

• Potential new projects underpinned by PEMEX’s needs to boost field efficiency in Cantarell
and reduce gas flaring in Ixachi.

• Management reports that PEMEX needs 8 JUGCSU units over the next 20 years, but there
are currently only 2 units in operation: Agosto 12 and one owned by a Spanish company. In
comparison to the Spanish unit, Agosto 12 is more easily transportable and can be connected
to other facilities.

• Coastal is also eyeing various gas projects for its Nuvoil JV in Mexico. This includes (1) Ixachi
gas conditioning plant (large), (2) Gas storage project (large), (3) Oil Processing plant (medium),
and (4) Gas dehydration plant (small).

• According to management, if the Ixachi field reaches peak production by 2026, PEMEX will
need to construct 3 additional gas conditioning plants to process the field's associated gas
output for the next 25 years. It is estimated that during this period, the gas production at Ixachi
will peak at 1,100 million standard cubic feet per day (mmscfd), which is more than the
combined processing capacity of the existing and upcoming plants at the Papan and Perdiz
fields (480 mmscfd).

• Venture into the offshore energy market through the chartering of liftboats. Coastal owns
80% stake in a liftboat, Teras Conquest 7 (TC7) that was built in 2015. Meanwhile, the
remaining 20% stake belongs to a strategic partner, JUB Pacific Pte Ltd.

• Coastal purchased TC7 in February 2021 from Ezion Group, a Singapore-based company that
has since been declared insolvent. The acquisition price of USD 13 million was a bargain, which
should result in lower depreciation costs and enable the company to offer competitive tender
rates.

• Liftboats are self-propelled, multi-functional, self-elevating platform-based vessels. They are

often deployed at offshore wind farms for installation and maintenance work. The CAGR for the
global offshore wind market in the next five years is 8.3% as it is expected to grow from 21.1GW
in 2021 to 31.4GW in 2026, based on the 2022 Global Wind Energy Council report.
Valuation:

As of 4 August 2023, Coastal is trading at a market cap of MYR1.19 bil. Assume loans of MYR330.2
mil are repaid along with the sales of OSV for MYR287 mil, Coastal will be trading at an EV of MYR775.8
mil, with a free cash flow of MYR193 mil, it is trading at a forward EV/FCF of 4x.

Market cap 1.19b

Cash MYR195.6 mil

Amount due from JV partially repaid upon completion of construction of Papan plant MYR330.2

Cash received from the sale of OSV MYR287 mil

Total cash after receiving partial loan payment and sale of OSV MYR812.8 mil

Total borrowings MYR398.6 mil

EV MYR775.8 mil

Annual FCF MYR193 mil

EV / FCF 4x

If the outstanding loans are fully repaid, forward EV/FCF is 2x. This is with very conservative estimates
and not considering their other business segments like the chartering of liftboats and potential new
contract wins.

EV before the amount due from JV is repaid MYR775.8

mil

Additional cash received from the remaining amount due from JV after the loan of MYR394 mil
MYR330.2 mil is paid

EV after the amount due from JV is fully repaid MYR381.8

mil

Annual FCF MYR193 mil

EV / FCF 2x