Investment Highlights

• Petronas’ 1Q2018 core net profit decreased 33% QoQ. Petroliam Nasional’s (Petronas) 1Q2018 core net profit (excluding one-off impairments) fell 33% QoQ to RM11.9bil due to lower sales volume of petroleum products (-7% QoQ), crude oil and condensate (-5% QoQ) together with the 6% ringgit appreciation and additional forex loss of RM1bil. This was partly offset by a 2% decline in operating costs.

• However, production was up 3% both QoQ and YoY. Even though Petronas recorded lower sales volume with downstream revenue falling by 15% QoQ, its daily output had instead risen 3% both QoQ and YoY to 2.5mil barrels which led to an upstream revenue increase of 5% QoQ.

• Total capex spending rose 12% QoQ on other operations. Petronas’ 1Q2018 capital expenditure climbed 12% QoQ to RM12bil, driven by spending on businesses other than the US$27bil Refinery and Petrochemical Integrated Development (RAPID) in Pengerang Johor and exploration and production (E&P). We note that spending on RAPID shrank by 14% to RM4bil, accounting for only 36% of group capex, down from 62% in 1QFY17. E&P spending declined further by 32% QoQ to RM2bil, which accounts for only 16% vs. 26% in 4QFY17.

• Still in tandem with higher capex target this year. While 1Q capex spending does not reflect the full-year programme, it is still in line with Petronas’ plan to increase by 24% YoY to RM55bil for 2018 amid higher crude oil prices and cost reduction initiatives. However, we expect a re-intensification of spending on RAPID, which remains Petronas’ priority at a progress stage of 89% as at 31 March 2018, and is scheduled for completion in 2019.

• Raised 2018-2019 price forecast to US$70-75/barrel. We have raised our 2018-2019 Brent crude oil projection to US$70- 75/barrel from US$60/barrel-US$65/barrel vs. the EIA’s Brent crude oil prices at US$71/barrel and Petronas’ unchanged US$52/barrel for 2018. For 2019, the EIA is forecasting Brent at US$66/barrel, dampened by a projected 11% YoY increase in US daily production to11.9mil barrels. The OPEC production quotas that were initiated in the beginning of last year appeared to have suppressed US oil inventories, which have fallen by 15% YoY to 438mil barrels. However, US crude inventory has risen by 6% since mid-January as US daily oil production has reached above 10mil barrels, and expected to reach 11mil barrels by the end of this year.

• Possible E&P refocus for Petronas under new government. Following the revelation of the nation’s debt at RM1tril, we view that one of the new Pakatan government’s options to raise revenue will be to ramp up Petronas’ production against the backdrop of improved crude prices. This will mean a substantive refocus in spending for E&P activities, even though Petronas’ president/CEO Tan Sri Wan Zulkiflee Wan Ariffin had earlier said that the group will be investing in further downstream operations such as speciality chemicals and renewable energy solutions, including solar. As such, we expect the asset utilisation rates for local service companies to improve significantly in the medium to longer term, even though charter rates could remain unexciting in the light of excess capacity globally.

• Rising contract awards. Malaysia’s1Q2018 contract awards jumped 68% QoQ and 36% YoY to RM2.7bil due to Sapura Energy securing the EPCIC work for the Pegaga CPP and Serba Dinamik’s EPC and O&M jobs. Although the Pegaga EPCIC job is lumpy, 1Q2018 order increase augurs a reversal from the 2017 order decline of 15% given Petronas’ downstream focus, particularly on RAPID in Pengerang, Johor. We note that Petronas’ Integrated Logistics Control Tower project, which was expected to be awarded late last year for 110 vessels under 23 packages on a three-plus-two-year basis, has yet to be announced.

• Maintain OVERWEIGHT view on the sector given the stabilising crude oil prices around US$76/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 have also upgraded MISC to a BUY as its share price has fallen significantly to below our revised fair value of RM6.95 while its bids for offshore projects could catalyse a valuation re-rating. Our other BUYs are 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, which we expect to be value-eroding due to an expected lower targeted rate of return on asset values.

Source: AmInvest Research - 31 May 2018