Four of COSL’s seven jack-up rigs working on the big drilling order in the Middle East were told to suspend operations by the client. While the impact on the company’s bottom line may not be very significant, it is an unexpected setback on its aggressive expansion in the Middle East. As the price of its H shares has surged 44% in past one month, we advise investors to lock in profit at this stage. We downgrade our call on its H shares from BUY to HOLD and reduce our target price to HK$9.69.

Key Factors for Rating

The suspension of four jack-up rigs for the big Middle East drilling order is a negative surprise as all the seven rigs in the order just started operations last year, with most of them in 2H23. When the company disclosed the contract, the market got excited and its share price rallied.

We believe the suspension is caused by the recent decision of Saudi Aramco (ARAMCO AB/SAR30.45, NR) to abandon the expansion of its sustainable production capacity from 12m bbl/day to 13m bbl/day by 2027. Hence, it may have to delay the development of its offshore oil projects. In fact, Shelf Drilling (SHLF NO/NOK19.28, NR) also got four jack-up rigs suspended.

Assuming the four affected rigs will be suspended for 2Q-4Q24 and COSL will receive half of the assumed day rate of US$100k/day during the suspension period, we estimate COSL’s 2024 earnings will reduce by around 5%. It is not that significant as the company has altogether 46 jack-ups and 14 semi-subs.

While the hit on earnings may not be very significant, it is a negative surprise to the market as the Middle East is one of the two areas that COSL focuses on in its overseas expansion. COSL will talk to the client regarding how long the rigs will be suspended, what to do with the suspended rigs and how it will get compensated. While COSL can try to get new clients for the suspended rigs, it is not easy as we now suddenly have eight more rigs in Middle East looking for clients.

Key Risks for Rating

Further significant progress in market development in overseas market.

Higher-than-expected earnings.

Valuation

We reduce our target valuation of its H shares from 1.05x 2024E P/B to 0.95x in view of the deteriorated earnings outlook. Hence, we lower our target price from HK$10.71 to HK$9.69.

We also lower our target price for its A shares from RMB21.76 to RMB19.69. We still base our target price on its 3-month average A-H premium which is at 120%.