The reduced volatility in oil prices should help boost O&G capex, although near-term uncertainties in the local O&G landscape remain. After Petronas implemented systemic changes to contract rollouts, more upstream contracts are in store within a one-year horizon. These include large EPCIC projects (K5, Kasawari) and integrated maintenance contracts (ILCT, Pan Malaysia MCM). We maintain MARKET WEIGHT on the sector and prefer companies that are internationally competitive.

WHAT’S NEW

• Producers will maintain check and balance on supply-demand, based on the outcome of the Jun 18 OPEC meeting to increase production. This is against many supply shocks, such as Iran sanctions, Venezuela crisis, Libya attacks and poor Brazil production growth. However, oil demand has downside risks on reduced economic confidence (trade wars) and higher prices faced by consumers. If supply-demand continues to be well-contained, this should help support stable oil prices in the US$70-80/bbl range.
• Challenging year on cost control while ensuring volume growth. In tandem with our views, Petronas’ moves to spend on international projects (Mexico, Canada, Africa, India) are strong signals that the oil major has to maintain its international edge in the midst of the changing oil and LNG landscapes. Locally, the bulk of the capex spending remains on downstream (Pengerang). The limited upstream spending did not help to improve overall production, given that its net volume declined 7% yoy in 1Q18. While the sale of the Prince Court Medical Centre should help buffer Petronas’ cash position, the oil major continues to remain conservative in view of various business challenges.
• Petronas has implemented systemic changes in contract rollouts by focusing on economies of scale and cost efficiency. It appears to favour integrated umbrella contracts that combine a suite of offerings spread out across several work packages. This may be a “silent push” to encourage consolidation of service contractors. More integrated maintenance contracts may be rolled out by end-18. Since the rollout of Bokor and Pegaga, more of large EPCIC projects such as Kasawari and K5 are on the cards. While local contract newsflows will continue, these contracts are there to replenish orderbook and are only sufficient as significant catalysts to selected contractors’ earnings outlook.

ACTION

• MARKET WEIGHT. We advocate investing in strong international O&G players as they have visible earnings upgrades and do not depend on Petronas work orders. Our top BUY is Serba Dinamik (Target: RM4.30), which should see earnings re-rate from a growing orderbook to >RM7b. We like FPSO players such as Bumi Armada (Target: RM1.06) on earnings growth once Kraken final acceptance is concluded by 2H18, and Yinson Holdings (Target: RM5.30), given long-term earnings re-rating on new projects. We upgraded Deleum to HOLD as earnings risk vs its strong balance sheet and dividend payout is adequately factored in. Non-rated Velesto Energy (VEB MK) and Reach Energy (REB MK) have potential for earnings turnaround.

ESSENTIALS

• Political uncertainty takes time to settle. With the incorporation of Petros’ to control Sarawak upstream/downstream O&G operations from Jul 18, the political uncertainties on oil royalty entitlements and the question of regulatory control between Petronas and the states could complicate contract flows although the dust should eventually settle.
• Changes in Petronas’ management likely positive for the sector. There are rumours of Tan Sri Hassan Marican to rejoin Petronas as new Chairman, which if it materialises, is expected to be positive, in our view. Marican is known to be a hands-on CEO with prudency in financial management, and was credited for evolving the state-run oil major into the same leagues as BP, ExxonMobil and Shell (the Seven Sisters). Assuming this and along with Group CEO Datuk Wan Zulkiflee (whose term was extended until 2021), we believe this will rejuvenate the morale of the Petronas Group. His international prowess (as a long-time SembMarine Chairman) should help Petronas to rebalance its priorities between cost control and international growth. Hence, we do not expect huge favouritism for local contractors to return, unless they have proven track records to be highly capable in executing international projects.

Source: UOB Kay Hian Research - 17 Jul 2018