Investment Highlights

• 2Q2017 report card in line. The 2Q2017 results for the 8 stocks under our coverage was largely in line as 5 were within expectations vs. 2 underperformers and an outperformer. Only UMW Oil & Gas outperformed with a lower than expected loss as higher rig utilisation temporarily spurred revenues. The underperformers were Sapura Energy, which suffered from higher effective tax rates as tax liabilities from its profitable operations were unable to be offset against other subsidiary losses, while MMHE’s order book dwindled from lack of new jobs.

• Sequentially, sector revenue contracted 7% while core net profit rose 6% from the a one-off compensation claim and contingency write-back from Bumi Armada’s LukOil project in the Caspian Sea, supported by the full quarterly recognition of its wholly-owned FPSO Olembendo. This was partly offset by the absence of MISC’s one-off gain of US$65mil from its adjudication victory against Sabah Shell Petroleum Company Limited for additional works undertaken by the group on the Gumusut Kakap semi-submersible floating production platform back in 1Q2017.

• YoY, core net profit rose 18% YoY largely from MISC’s early termination compensation for LNG vessel Tenaga Lima, reversal of provision for liner hire and Benchamas 2 construction recognition and Bumi Armada’s LukOil compensation claims. This was partly offset by Sapura Energy’s higher effective tax charges.

• Persistent low asset utilisation levels expected for the medium term 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 mean 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.

• Most of Petronas’ capex spent on RAPID. Petronas’ 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. For the sector, 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. stronger-than-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.

• 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, 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 - 30 Aug 2017