Investment Highlights

• 3Q2018 results disappoint yet again. Following the disappointment of 2Q2018 results, 3Q2018 report card deteriorated as the number of underperformers increased from 3 to 4 – Sapura Energy, Bumi Armada, MISC and Velesto Energy. Sapura Energy continued to record losses from low asset utilisation for its drilling rigs, offshore installation activities and fabrication yard, Bumi Armada was impacted by lower charter renewal rates for its Vietnam-based FPSO and persistently depressed vessel utilisation rates while MISC registered lower-than-expected rebound from higher petroleum tanker rates. Velesto’s losses stemmed from continued softness in rig charter rates and utilisation.

• Recapitalisation risks remain as sector core net profit dropped 30% YoY largely from losses from Bumi Armada and Sapura Energy. Excluding losses from Sapura Energy and Velesto Energy, the sector’s core earnings would have still declined by 3% QoQ as EBITDA margin declined by 1.8ppts. Amid these declining results, recapitalisation risks resurfaced as Bumi Armada missed a US$380mil debt repayment as negotiations are underway until January next year.

• Lowering 2019 crude oil forecast to US$65-70/barrel from US$70-75/barrel. Our 2018 crude oil price average forecast of US$70-75/barrel remains intact vs. the Brent average to date for 2018 at US$72.50/barrel, even though current prices have fallen by 30% from the year-high in September to US$58/barrel.
  However, we have cut 2019 price forecast to US$65-70/barrel from US$70-75/barrel given that US daily production has increased by 20% since the beginning of 2018 to an all-new record of 11.7mil barrels this month, almost within reach of the EIA’s forecast of 11.9mil barrels by the end of 2019. As a comparison, the EIA is projecting US$73/barrel for 2018 and a lower US$72/barrel for 2019, dampened by a projected 11% YoY increase in US daily production, which is likely to be revised following the strong production recently.

• Deteriorating price visibility. Amid the nuclear sanctions waiver for importers of Iranian crude, the strong production was a surprise as the doubling of pipeline capacity to 5.8mil barrels/day in the Permian region is only expected to commence operation in 2H2019, with some earlier reports indicating by 2020. As such, US crude oil inventories have risen by 14% since mid-September this year to 450mil barrels. However, we highlight rising oil price uncertainties as oil producing nations may yet undertake another round of production quota cuts similar to the 1.8mil cut in 2016 to rebalance supply amid deteriorating global economic growth outlook and trade tensions. Should the supply cutbacks come in below expectations during the OPEC meeting in Vienna on 6 December, we expect further oil price declines.

• Still expect moderate recovery in Petronas’ upstream capex rollout. As Brent crude oil prices for now are still above Petronas’ 2018 internal crude oil assumption of US$52/barrel for project feasibility studies, we do not expect any substantive changes to its field development activities notwithstanding the company’s special dividends of RM30bil as the group has a net cash balance of RM96bil.
  With Petronas’ 9M2018 declining 7% YoY to RM7bil, we expect a moderate recovery in domestic upstream rollouts as the group has introduced new fiscal terms enhancements involving self-adjusted cost recovery and a profit-sharing mechanism based on revenue over cost index for new deep-water production sharing contracts to attract new exploration investments and to open new fields in Malaysia. They are available for new deep-water acreage from nine open blocks — two off Peninsular Malaysia, four offshore and onshore Sarawak and three off Sabah.
• Contract awards on upward trajectory for now. As the oil price dropped recently, we have not seen any impact yet on the upward contract award trajectory with Malaysia’s 9M2018 contract awards rising 26% YoY to RM7.5bil due to the award of Pan Malaysia umbrella contract renewals, Sapura Energy securing the EPCIC work for the Pegaga CPP and Serba Dinamik’s EPC and O&M jobs. Offshore projects in Brazil, Mexico, the Middle East and West Africa may still be poised to gain traction with Sapura Energy and MMHE recently being selected for Saudi Aramco’s Long-Term Agreement programme, which will allow them to bid for the kingdom’s massive offshore projects which could reach US$150bil over the next 10 years.
• We have downgraded the sector to NEUTRAL from OVERWEIGHT given the deteriorating visibility in oil price direction over the next 6 months, the unresolved US-China trade dispute, deteriorating global economic growth outlook and easing of US pipeline constraints. Our top picks are still companies with stable and recurring earnings such as Dialog Group, Serba Dinamik and Yinson. We like the recurring income business model of Dialog and Serba Dinamik, which are involved in operation and maintenance services. Dialog’s earnings visibility is further secured by the Pengerang Deepwater Terminal project with its enlarged buffer zone while Yinson may secure another major FPSO contract next year. We maintain a SELL for Petronas Gas due to the Energy Commission’s upcoming announcement of the transportation tariff setting mechanism, which we expect to be value-eroding due to an expected lower targeted rate of return on asset values.

Source: AmInvest Research - 3 Dec 2018