Investment Highlights

• 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 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 exceeded 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. Petronas has recently launched the engineering, procurement, construction, installation and commissioning project for the over US$1bil central processing platform of the giant gas field Kasawari in SK316 off Sarawak, underpinning the rising offshore rollouts in the region. 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. 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. Order flows in 2Q2018 are likely to be steady with Sapura Energy recently securing RM1.8bil of fresh contracts comprising EPCIC and rig charters. Additionally, Upstream has reported Sapura Energy and MMHE (via a JV with UK-based Technip-FMC) are bidding to be included as Saudi Aramco’s preferred long-term agreements’ contractors for offshore engineering, procurement, construction and installation work, as the country has over US$300bil of offshore upstream projects over the next 10 years. Up to US$4bil worth of Saudi projects are presently under tendering while the huge Marjan expansion project alone is expected reach over US$10bil. 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 while Saudi Aramco’s listing remains in the pipeline. 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, 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 from rising shale production and resolution of transport bottlenecks; 2) slower-than-expected global economic growth against the backdrop of Trump-initiated trade wars; 3) accelerated adoption of fuel-efficient-cum-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. 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 - 25 Jun 2018