Investment Highlights

• Mixed 2QFY20 report card. The 2QFY20 results of the 9 companies under our coverage were mixed with 2 coming in above expectations and 2 underperformers. Bumi Armada registered stronger-than-expected results mainly from a steady revenue contribution from the group’s floating production, storage and offloading vessel Armada Kraken which had been operating sub-optimally over the past 2 years. Sapura Energy also surprisingly outperformed with an unusual margin surge in its engineering and construction division together with higher asset utilisation.
  
  The underperformers were Velesto Energy, which suffered lower rig utilisation and higher Covid-19 safety expenses, and Petronas Chemicals Group registering sharply lower product prices due to the low crude oil price regime.

• Core 2QFY20 net profit rose 19% QoQ to RM1.6bil largely due to Sapura Energy’s surprising turnaround from a sharp loss in the previous quarter to a slight profit, which may not be sustainable in the following quarters. This was slightly supported by Bumi Armada, Yinson, Dialog Group and Petronas Gas. However, by excluding Sapura Energy’s results alone, the sector’s core earnings would have decreased by 31% QoQ instead. This stemmed from MISC’s lower petroleum tanker rates and reduced Petronas Chemical’s average product prices.

• Still on a capex trough. Petronas, which will be releasing its 2QFY20 results later today, has already announced cuts of 21% for capital and 12% operating expenditure this year due to the current Covid-19-impacted cyclical downturn which was exacerbated by the Saudi-Russian price war earlier this year. 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.

• Remain cautious 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. As there is a risk that Velesto could reverse to a loss in 2HFY20 due to lower rig utilisation, balance sheet risks may re-emerge next year. However, the rest of the players are relatively comfortable at this juncture with Serba Dinamik recently raising a 10% equity placement while Bumi Armada has reclassified a RM1.3bil shortterm debt to long term due to higher asset utilisation.

• 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$42/barrel with spot prices at US$43/barrel currently from the year-low of US$14/barrel on 22 April 2020. This is supported by US crude oil inventories declining by 6% to 508mil barrels currently from the all-time high of 541mil barrels in June this year. Hence, 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$41/barrel for 2020 and US$50/barrel for 2021.

• Upgrade sector to OVERWEIGHT. Following our upgrades to BUY for Petronas Gas and Bumi Armada, we now have 5 BUY calls vs. only 2 SELLs and 1 HOLD. Hence, we have upgraded our call on the sector to OVERWEIGHT from NEUTRAL despite the ongoing volatility of crude oil prices as the down cycle may have reached a bottom with the worst experienced in April this year when Brent spot prices temporarily fell to a low of US$14/barrel while futures inverted to an abnormal negative US$38/barrel due to a lack of storage capacity.
  
  We like Petronas Gas, as the group’s optimal capital structure strategy and resilient earnings base translates to highly compelling dividend yields. We also recommend Dialog Group and Serba Dinamik Holdings due to their resilient noncyclical tank terminal and maintenance-based operations while Petronas Chemicals Group has a high correlation to the recent oil price upturn. Even though Bumi Armada is still likely to experience asset impairments towards the end of the year, the company has shown stabilising core profitability from improved operating performance of its floating production, storage and offloading vessel, Armada Kraken together with a stronger balance sheet.

Source: AmInvest Research - 4 Sept 2020