Investment Highlights

• Fairly decent 1Q2018 report card. The 1Q2018 results for the 8 stocks under our coverage was fairly decent as 5 companies came in within expectations with 2 below. The only company that exceeded expectations was Dialog Group which was supported by its Middle East operations amid growing demand for specialist products/services together with rising activities for its 60% stake in Jubail Supply Base Phase 1, Saudi Arabia. The two weaker-than-expected performers were MISC, mauled by low petroleum tanker charter rates and decline in offshore margins, while Velesto Energy was dented by decreased rig utilisation rates.

• QoQ sector core net profit fell 13% largely from MISC’s weak performance, which was partly offset by a substantive fall in Sapura Energy’s losses. Excluding MISC’s results, the sector’s core net profit would instead have risen by 31% QoQ and 27% YoY from improved results of Sapura Energy and Bumi Armada.

• Maintain crude oil forecast at US$70-75/barrel. We maintain our 2018-2019 Brent crude oil projection at US$70-75/barrel vs. the EIA’s Brent crude oil prices at US$71/barrel for 2018 and a lower US$66/barrel for 2019, dampened by a projected 11% YoY increase in US daily production to11.9mil barrels. As a comparison, Petronas’ 2018 internal crude oil assumption is maintained at only US$52/barrel for project feasibility studies. 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 above US$75/barrel, underpinned by the resumption of nuclear sanctions on Iran and deterioration in Venezuela’s output. Notwithstanding Petronas’ cautious capex strategy, asset utilisation rates have begun to improve. Hence, 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. Our other BUYs are MMHE, MISC, 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.

• Watch out for multiple de-rating risks. We reiterate the multiple risks for the sector from: 1) resumption of US crude inventory expansion; 2) slower-than-expected global economic growth; 3) accelerated adoption of fuel-efficient-cumelectric 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. Recall the recent decision to exclude oil and gas stocks from Norway-based Norges Bank Investment Management’s US$1tril fund may be an indicator of trends for other global funds in their commitment towards compliance on environment, social and corporate governance (ESG) policies.

Source: AmInvest Research - 4 Jun 2018