Investment Highlights

Withdrawing appeals against Sarawak sales tax. According to media reports, Petroliam Nasional (Petronas) has decided not to fight against the sales tax imposed on the national oil firm by the Sarawak state government. At the Court of Appeal, Petronas and the Sarawak state have mutually withdrawn the appeals over Petronas’ failed judicial review application against the Sarawak government and the state's Comptroller of State Sales Tax amounting to RM2bil sales tax which was imposed as an additional 5% tax on all petroleum products sold in the state starting January 2019.

When the extra sales tax issue arose as both Sarawak and Sabah were in talks with the Pakatan Harapan government on their share of oil revenue under the Malaysian Agreement 1963, Petronas sought orders to cancel notices of assessment for an amount of over RM1.3bil issued by Sarawak's Comptroller of State Sales Tax, and declarations that the Sarawak government is not entitled to impose state sales tax on petroleum products. Otherwise, the authority of the Petroleum Development Act (PDA) 1974, which grants exclusive ownership of Malaysia’s petroleum resources to Petronas, would effectively be rendered as non-absolute. Currently, Petronas already pays a royalty tax of 5% to the East Malaysian states.

Rising tax liabilities amid political tensions. As Petronas did not pay the tax, Sarawak filed a RM1.3bil civil suit against the national oil firm. Subsequently, Petronas’ president and group CEO Tan Sri Wan Zulkiflee Wan Ariffin stepped down on 1 July this year, and was replaced by its chief financial officer, Tengku Muhammad Taufik Tengku Aziz. Back then, Petronas viewed that the sales tax was not valid under the Federal List and should not be double-taxed as the group already bears a petroleum income tax of 38%. Additionally, the sales tax also appears to overlap with the PDA 1974, which states that Petronas is the regulator of all oil and gas assets in Malaysia.

With the withdrawal of its appeal against the Sarawak state government, Petronas has set a precedent for Sabah, which joined Malaysia in 1963 together with Sarawak. However, we do not think that other states in Peninsular Malaysia will follow suit, as the National Land Code allows the compulsory acquisition of land by the federal government.

Petronas already cutting capex. Based on the RM500mil being sought since April last year by the Sabah state, which has lower producing fields compared to Sarawak, we estimate that Petronas may have to bear up to RM2.5bil additional tax annually from East Malaysia, which will vary based on crude oil and natural gas prices. This represents 6% of Petronas’ FY19 core earnings and 3% of net cash of RM88bil (including fund investments).

Petronas, which had earlier indicated its intention to maintain domestic capex, has already announced cuts of 21% for capital and 12% operating expenditure this year due to the current Covid-19-impacted cyclical downturn, exacerbated by the SaudiRussian price war earlier this year. Based on Petronas’ FY19 capex of RM47.8bil, the additional sales tax that could be imposed by the East Malaysian states translate to 7% of FY20F capex of RM38bil.

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. So far, 20% to 30% capex reductions for 2020 have been announced by Exxon Mobil, Royal Dutch Shell, Saudi Aramco and Petrobras. In 1H2020, new contract awards to Malaysian operators dropped 62% YoY to RM2.2bil, with the worst fallout yet to come in 2H2020 onwards.

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.

Source: AmInvest Research - 4 Aug 2020