Investment Highlights

• Petronas’ 2Q2017 core net profit down on lower prices. Petroliam Nasional’s (Petronas) 2Q2017 core net profit (excluding one-off impairments of RM2.8bil) slipped 7% QoQ to RM9.8bil due to a 4% crude production decline, lower realised product prices as average Brent crude oil prices shed 7% to US$50/barrel as the ringgit strengthened 3%, partly supported by a 16% reduction in operating costs. The group’s asset impairments of RM2.8bil represent 14% of its C$6bil (RM20bil) capex which has already been spent for Pacific NorthWest liquefied natural gas (LNG) project in western Canada.

• But higher 1H2017 core earnings. For 1H2017, Petronas’ core net profit, excluding impairments, rose 12% YoY to RM20.3bil from higher products prices with Brent up 30% and the 7% appreciation of the dollar vs. ringgit, which more than offset the crude production decline of 2%. Petronas’ 1HFY17 controllable costs decreased by 3% to RM22.1bil to RM49.1bil while dividends paid to the government was RM6.5bil, half of the guidance of RM13bil this year, which represents a 19% YoY decline.

• Most of capex spent on RAPID. The group’s capex declined 21% QoQ to RM9.4bil in 2Q2017, which led to a decrease of 15% YoY to RM21.3bil in 1H2017, of which 59% was spent on the US$27bil Refinery and Petrochemical Integrated Development (RAPID). RAPID has reached a completion stage of 70%, compared to only 20% for exploration and development. So far, the 1H2017 capex spending accounts for only 35% of the RM60bil guided by Petronas for this year with average Brent crude oil prices assumed at US$45/barrel.

• Supply-demand imbalance persists. We do not expect any immediate rebound in crude oil prices given the persistent supply-demand imbalance. As at 18 August, US crude oil production stubbornly continues to rise, up 8% since the beginning of the year to 9.5mil barrels/day, largely offsetting the 13.5% decline in commercial crude inventories since 31 March this year to 463mil. US rig count has dropped by 12 rigs since the end of last month to 946 rigs, up 2.3x from the May 2016 low of 404, with the trajectory remaining upwards as this is still half of the 2011 peak of 2,026.

• Flat oil price forecast for 2017-2018. As Brent crude oil spot has averaged at US$53/barrel since the beginning of this year, we maintain our 2017-2018 projection at US$50-55/barrel. As a comparison, Petronas is projecting an average of US$45/barrel for 2017 while the EIA forecasts US$52.60/barrel for 2017 and US$57/barrel for 2018. We remain cautious on the sector given the unabated increase in shale oil production highlighted by the rising US rig count, which has surged 2.2x since the all-time low in May 2016 to 908. The capacity for fleet expansion is still significant as this US rig count accounts for less than half of the 30-year high of 2,031 back in 2008.

• Multiple push and pull factors. The price trend clarity is muddled by: 1) the decline of “price-sensitive barrels” vs. strongerthan-anticipated growth in “political barrels” which could prolong uncertainties; 2) significant capex reductions which signal under-investment for future needs; 3) increasing proportion of renewable sources for electricity generation which could reduce liquid consumption and lead to “peak oil demand”; 4) pace of US deregulation under the Trump administration that could further accelerate crude output growth; and 5) decoupling of global economic growth from carbon dioxide emissions since 2000 in tandem with the shift towards gas and other energy alternatives together with fuel-efficient hybrid automobiles.

• Persistent low asset utilisation levels as we do not expect any significant change in Petronas’ cautious approach to upstream exploration and development expenditures. For 2Q2017 to date, contract awards have risen by 15% QoQ RM2.2bil largely due to the lumpy award of the RM1bil Bokor central processing platform project to MMHE. For Malaysian operators, which operate wholly offshore, weak capex rollout prospects forebode that the worst can stretch for quite a while for those struggling with high gearing such as Bumi Armada and UMW Oil & Gas. Locally based companies such as Perisai Petroleum Teknologi, Alam Maritim and Nam Cheong Group are currently in financial distress.

• Maintain NEUTRAL stance as the prospects of the sector over the next 12 months are muted given that the direction for crude oil price appears to be “lower for longer”. Our top picks are companies with stable and recurring earnings such as Dialog Group and Yinson Holdings. Dialog’s earnings visibility is secured largely by the Pengerang Deepwater Terminal project with its enlarged buffer zone while Yinson’s Ghana floating production, storage and offloading vessel project will provide the earnings momentum over the next 2 years. Our HOLD calls are for Sapura Energy (with a lowered fair value of RM1.54/share based on a 30% discount to FY18F book value), MISC, MMHE, Bumi Armada and UMW Oil & Gas while Petronas Gas is a SELL due to the upcoming implementation of the incentive-based regulatory tariff setting mechanism.

Source: AmInvest Research - 25 Aug 2017