Investment Highlights

• Slightly better 1QFY20 report card. The 1QFY20 results of the 9 companies under our coverage were slightly better as 5 companies came in line with expectations with 3 outperformers – MISC’s sharply higher tanker rates, Petronas Gas’ less-thanexpected impact from incentive-based regulatory structure on gas transportation tariffs and Petronas Chemicals’ surprisingly resilient margins. Only Sapura Energy disappointed with a 4QFY20 normalised loss of RM511mil from lower progress recognition and low margins for its engineering and construction division exacerbated by higher subcontractor costs in a volatile oil price regime, together with upstream losses from lower prices and provisions. For comparison, 4 companies had underperformed while only 2 companies registered above expected results in the previous quarterly reporting season.

• Core 4QFY19 net profit rose 11% QoQ and 9% YoY to RM1.6bil largely due to sharply higher petroleum tanker rates which drove MISC’s earnings by 2.1x (see Exhibit 3). However, excluding MISC, the sector’s core net profit would have dropped by 23% QoQ and 17% YoY, mainly from Sapura Energy’s huge losses. Despite increased operating income driven by MISC and Petronas Chemicals, the sector’s EBITDA slid 3ppt QoQ due to losses from Sapura Energy.

• Caution warranted on high gearing companies. Against the backdrop of a sharp demand drop in upstream oil services, we remain cautious on companies with high gearing levels. Excluding impairments and one-off adjustments, Sapura Energy registered a negative EBITDA of RM651mil, breaching net debt/EBITDA debt covenants for its RM10bil loans which need to be refinanced by the end of this year. However, the rest of the players are relatively comfortable at this juncture as Serba Dinamik has recently raised a 10% equity placement while Bumi Armada has reclassified a RM1.3bil short-term debt to long term. While there is a risk that Velesto could reverse to a loss in 2HFY20 due to lower rig utilisation, its gross cash position should be able to meet its debt obligations for this financial year.

• Maintain 2020 oil price forecast to US$35–40/barrel. YTD, Brent crude oil prices have averaged US$41/barrel while the current spot price has recovered to US$39/barrel from the year-low of US$14/barrel on 22 April 2020. With US crude oil inventories still steadily rising by 24% YTD to 534mil barrels, we maintain our crude oil price forecast at US$35–US$40/barrel for 2020 and US$45–US$50/barrel for 2021. For comparison, the EIA’s Short-Term Outlook projects crude oil price at US$34/barrel for 2020 and US$48/barrel for 2021.

• National oil companies cut capex. As Covid-19 has driven down oil prices and demand globally, national oil producers have cut back on capex. Petronas, which had earlier indicated intentions to maintain domestic capex, has announced cuts of 21% for capital and 12% operating expenditure this year. This is not a surprise given that Exxon Mobil, Royal Dutch Shell, Saudi Aramco and Petrobras have already announced capex cuts ranging from 20% to 30% this year. In 1Q2020, the new contract awards to Malaysian operators dropped 74% QoQ and 70% YoY to RM569mil, with the worst fallout yet to come in 2Q2020 onwards.

• Most service providers will be impacted. We maintain our view that most participants in the sector, except those in storage and recurring maintenance services, will be adversely impacted. Those with upstream production-sharing contracts such as Sapura Energy and Hibiscus Petroleum will suffer from lower prices and offtake, followed by fabricators such as MMHE and offshore support providers Bumi Armada and Velesto Energy. However, the earnings of service providers involved in maintenance and tank storage facilities such as Dialog Group and Serba Dinamik will be resilient against the cyclical nature of industry dynamics.

• Remain UNDERWEIGHT on the sector as fair values of selected stocks under our coverage remain pegged to 5-year P/BV lows. We expect the massive global demand destruction from the uncertain extent and duration of the Covid-19 pandemic to continue depressing industry sentiments extensively in the foreseeable horizon. As we continue to view the decimation in oil prices and companies’ earnings to be worse than the previous 2015–2017 crisis which led to multiple financial distress to O&G corporations, we retain our SELL calls for Bumi Armada, Sapura Energy, Petronas Chemicals Group and Velesto Energy. Our BUYs are Dialog Group and Serba Dinamik Holdings while we downgrade Petronas Gas to HOLD, as its share price has reached our fair valuation.

Source: AmInvest Research - 4 Jun 2020