Investment Highlights

• Mixed 3Q2017 report card. The 3Q2017 results for the 8 stocks under our coverage were mixed as 3 companies had outperformed expectations, 4 in line vs. 1 underperformer in 3QFY17. The companies that registered stronger-than-expected earnings were Yinson, MISC and UMW Oil & Gas. Higher-than-expected margins drove Yinson’s bottom line due to its Ghana-based FPSO, MISC benefited from its LNG charters while UMW Oil & Gas profited from higher rig charter utilisation. However, low rig utilisation led to Sapura Energy’s sharp earnings cut.

• Flat QoQ sector core net profit as the improved margins from UMW Oil & Gas and Yinson, together with Malaysia Marine and Heavy Engineering Holdings’s (MMHE) lumpy change order recognitions were offset by the absence of one-off compensation claims for MISC’s LNG charter termination and Bumi Armada’s past Lukoil construction works.

• Persistent low charter rates despite improved asset utilisation levels as Petronas maintains a cautious approach to upstream exploration and development expenditures. For 3Q2017 to date, contract awards have plunged by 68% QoQ to RM689mil due to the lumpy RM1bil Bokor central processing platform in 2Q2017. The overall trend is also dismal as the contract awards dived 45% YoY to RM4.9bil in 9M2017. For Malaysian operators which operate wholly offshore, these weak capex rollout prospects forebode that the worst can stretch for quite a while, especially for those struggling with high gearing such as Bumi Armada, Alam Maritim and UMW Oil & Gas.

• Supply-demand imbalance persists. Barring a shift in geopolitical tensions, we do not expect any further significant uptrend in crude oil prices given the persistent supply-demand imbalance. Even with the extension of OPEC production quotas until the end of 2018, US crude oil production stubbornly continues to rise, up 15% since the year-low in mid-October to 9.7mil barrels/day. This is supported by higher US rig counts, which added 31 rigs or 3% since the end of last month to 929 rigs, up 2.3x from the May 2016 low of 404, with the trajectory remaining upwards as this is less than half of the 2011 peak of 2,026.

• Slightly higher price outlook for 2018. As Brent crude oil spot has averaged at US$53/barrel since the beginning of this year, we maintain our 2017 projection at US$50-55/barrel. For 2018, we have raised our crude oil projection by US$5/barrel to US$55/barrel-US$60/barrel following increased optimism post-continuation of OPEC’s production quota. 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.

• Multiple push and pull factors. The price trend clarity is muddled by: 1) the ability of OPEC to ensure quota compliance as prices stabilise; 2) significant capex reductions which signal under-investment for future needs; 3) increasing proportion of renewable sources for electricity generation and growing adoption of fuel-efficient-cum-electric vehicles 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) commitment by major countries, excluding the US, towards the Paris climate agreement.

• Possibility that ESG-compliant global funds may avoid oil & gas stocks. The recent decision to exclude oil and gas stocks from Norway-based Norges Bank Investment Management’s US$1tril funds may be an indicator of trends for other global funds amid their commitment towards compliance on environment, social and corporate governance policies.

• Maintain NEUTRAL stance as the prospects of the sector over the next 12 months are muted given that offshore development prospects remain slow even though crude oil prices have risen above US$60/barrel given Petronas’ unchanged view that the longer term for 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. 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. We have upgraded Petronas Gas from a SELL to HOLD as its share price has fallen to our fair value. We were earlier bearish on Petronas Gas due to the upcoming implementation of the incentive-based regulatory tariff setting mechanism in January next year. Our other HOLD calls are for Sapura Energy, MISC, Bumi Armada and UMW Oil & Gas.

Source: AmInvest Research - 5 Dec 2017