Investment Highlights

• Maintain 2020 oil price forecast at US$40-US$45/barrel and 2021 at US$45-50/barrel. YTD, Brent crude oil prices have averaged US$41/barrel while the current spot price has recovered to US$42/barrel currently from the year-low of US$14/barrel on 22 April 2020. Even though US crude oil inventories has risen near the recent all-time high to 539mil barrels, we maintain our crude oil price forecast at US$40-US$45/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 will still cut capex. Even though a measure of optimism has returned for crude oil prices, we expect oil producers to proceed with their planned production cuts for this year given that demand globally remains depressed amid the prolonged Covid-19 movement restrictions and social distancing measures across the new normal which could mean potentially long-term changes in energy usage. 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 similar to the 20% to 30% capex reductions for 2020 which were earlier announced by Exxon Mobil, Royal Dutch Shell, Saudi Aramco and Petrobras. In 1H2020, the new contract awards to Malaysian operators dropped 62% YoY to RM2.2bil, with the worst fallout yet to come in 2H2020 onwards.

• Most upstream 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.

• Caution warranted on selected highly geared companies. Against the backdrop of a sharp demand drop in upstream oil services, we remain cautious on companies with high gearing levels such as Sapura Energy, which needs to restructure its RM10bil debt 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 due to higher asset utilisation. 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 NEUTRAL view of the sector given our mixed number of BUY and SELL calls. Dialog Group and Serba Dinamik Holdings are BUY calls due to their resilient non-cyclical tank terminal and maintenance-based operations while Petronas Chemicals Group has a high correlation to the recent oil price upturn. However, as we continue to view the still low oil prices and earnings of upstream service companies to be worse than the previous 2015–2017 down-cycle which led to multiple financial distress to O&G corporations, we retain our SELL calls for Bumi Armada, Sapura Energy and Velesto Energy.
• We may upgrade to OVERWEIGHT based on: 1) crude oil prices rising sustainably above US$60/barrel, which supports the sanctioning of offshore activities on heightened project viability, 2) stronger than expected global economic growth, 3) accelerated consolidation of oil & gas operators, and 4) slower adoption of climate change prerogatives.
• However, we may downgrade to sector to UNDERWEIGHT as risks remain due to high volatility in global crude prices, due to: 1) resumption of rapid growth in shale production; 2) slower-than-expected global economic growth against the backdrop of worsening trade tensions; 3) accelerated adoption of fuel-efficient-cum-electric vehicles that could reduce consumption and lead to “peak oil demand”; 4) non-compliance by Opec members to their agreed quotas, which will again lead to aggressive measures to regain market shares; and 5) increasing exit from oil and gas stocks by ESG-compliant global funds.

Source: AmInvest Research - 14 Jul 2020