Investment Highlights

• Petronas’ 4Q2017 core net profit surges 81% QoQ. Petroliam Nasional’s (Petronas) 4Q2017 core net profit (excluding one-off impairments of RM303mil) surged 81% QoQ to RM17.7bil from an 18% increase in crude oil prices and 8% growth in crude production to 2.4mil barrels of oil equivalent. The group’s operating costs were flat QoQ against the backdrop of the group’s cost efficiency programmes.

• Total capex spending down 12%. Petronas’ 2017 capital expenditure slid 12% YoY to RM44.5bil as we had earlier guided. Spending for exploration and development (E&D) declined by 15% YoY to RM10bil but rose 38% for the US$27bil Refinery and Petrochemical Integrated Development (RAPID) in Pengerang Johor, which has reached a completion stage of 84%. Hence, RAPID accounted for 53% of 2017 capex vs. 34% in 2016.

• But higher capex target this year. Petronas is targeting a 24% capex escalation to RM55bil for 2018 following its FY17 core net profit increase of 27% to RM46.6bil amid higher crude oil prices and largely successful cost reduction initiatives. However, with 4QFY17 capex decreasing by 14% QoQ and 26% YoY to RM11bil, we highlight that the overall E&D spending trend is likely to be proportionately lower than for RAPID, which remains Petronas’ priority as its completion is scheduled in 1Q2019.

• No substantive boost for offshore sector from a focus on downstream and alternative energy. Petronas’ president/CEO Tan Sri Wan Zulkiflee Wan Ariffin said that the group is eyeing investments in further downstream operations such as speciality chemicals and renewable energy solutions, including solar. While companies operating in the Pengerang development such as Dialog Group, Petronas Chemicals Group and MMHE could secure fabrication jobs, plant expansion or off-take storage tankers contracts, the overall potential boost to the majority of the country’s domestic offshore operators will be minimal.

• Higher dividend expected this year. With improved crude oil prices, Petronas is now targeting a 19% growth in 2018 dividends to RM19bil, up from RM16bil both in 2016 and 2017. Late in 2016 when oil prices averaged US$44/barrel, Petronas had earlier planned to lower its 2017 dividend by RM3bil to RM13bil.

• Maintain 2018-2019 price at US$60-65/barrel. The OPEC production quotas that were initiated in the beginning of last year appears to have suppressed US oil inventories, which have fallen by 21% from March 2017 to 423.5mil barrels, despite US daily oil production reaching above 10mil barrels, and expected to reach 11mil barrels by the end of this year. Hence, we maintain our 2018-2019 Brent crude oil projection of US$60/barrel-US$65/barrel vs. the EIA’s WTI crude oil prices at US$58/barrel and Petronas’ internal target of US$52/barrel for 2018.

• Improved contract awards from 2018 Pan-Malaysian umbrella jobs. Contract awards have declined by 15% YoY to RM7.6bil in 2017, even though in 4Q2017 they rose 20% QoQ to RM1.6bil mainly from the 2018 Pan-Malaysian Transport & Installation/Maintenance, Construction & Modification jobs to Sapura Energy. This was a hefty surge of 14x YoY vs. only RM112mil in 4Q2016. As these Pan Malaysian umbrella scope of works are mainly determined on a call-up basis, we still expect Petronas to maintain a cautious approach to upstream exploration and development expenditures.

• Maintain OVERWEIGHT view on the sector given the stabilising crude oil prices above US$60/barrel notwithstanding Petronas’ cautious capex strategy. As asset utilisation rates have begun to improve, we expect charter rates to have bottomed out even in the absence of any upward trajectory at this juncture.

Our top picks are still 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 also have BUYs for MMHE, Sapura Energy and Bumi Armada, which are trading below their intrinsic values. We maintain a SELL for Petronas Gas due to the Energy Commission’s upcoming announcement of the transportation tariff setting mechanism next month, which we expect to be value-eroding due to an expected lower targeted rate of return on asset values.

• Watch out for multiple de-rating risks. We highlight that there are still multiple risks for the sector due to: 1) continuation of US crude inventory expansion; 2) slower-than-expected global economic growth; 3) accelerated adoption of fuel-efficientcum-electric vehicles that could reduce consumption and lead to “peak oil demand”; 4) non-compliance by OPEC members to their agreed quotas, which will again lead to aggressive measures to regain market shares; and 5) increasing exit from oil and gas stocks by ESG-compliant global funds.

Source: AmInvest Research - 6 Mar 2018