Investment Highlights

• Petronas’ 2Q2018 core net profit rose 10% QoQ. Petroliam Nasional’s (Petronas) 2Q2018 core net profit (excluding one-off impairments) rose 10% QoQ to RM11bil from higher crude oil prices as Brent climbed 11% to US$74/barrel while the ringgit depreciated by 1%; partly offset by a lower production of crude oil and gas.

• Production down 6% QoQ. Petronas’ upstream revenue fell 10% QoQ to RM25bil, causing EBIT to drop by 14% as production output slid by 6%, with gas production contracting by 10% to 1.3mil barrels/day while crude oil decreased by 1% to 982K barrels/day due to statutory plant turnaround activities.

• Total capex spending decreased 34% QoQ. Petronas’ 2Q2018 capital expenditure shrank 34% QoQ to RM7.9bil, as spending halved to RM2bil for the US$27bil Pengerang Integrated Complex (PIC) in Pengerang Johor, which has reached a progress stage of 92% with completion still targeted in stages from mid-2019. This is not a surprise as the proportion of capex spent on PIC has declined from 59% in 1H2017 to 26% in 2Q2018. The overall spending contraction was also contributed by capex for other operations, which dropped 41% QoQ to RM3.4bil as progress on the Pengerang FLNG (PFLNG) 2 has reached a completion stage of 88%. Domestic projects, which accounted for 66% of 1H2018 capex, is likely to remain Petronas’ priority despite its recent acquisition of a 25% equity stake in the C$40bil LNG Canada project in Kitimat, British Columbia.

• Overall capex spending may miss target this year, but E&P reaffirmed. While Petronas’ president/CEO Tan Sri Wan Zulkiflee Wan Ariffin had earlier indicated that its capex could increase by 24% YoY to RM55bil for 2018 amid higher crude oil prices and cost reduction initiatives, there is a possibility that the group could miss its target given that spending has only reached 36% in 1H2018 notwithstanding a ramp-up in construction progress towards the end of the year. Despite the lower spending on PIC and other projects, the group’s commitment to exploration and production (E&P) is reaffirmed by its 2Q2018 capex increase of 28% QoQ and 9% YoY to RM2.4bil.

• Likely E&P refocus for Petronas under Pakatan government. Given the nation’s huge debt of RM1tril, we maintain our view that one of the Pakatan government’s options to raise revenue will be to ramp up Petronas’ production against the backdrop of improving crude prices. This will mean a substantive refocus in spending for E&P activities despite Wan Zulkiflee earlier saying that the group will invest in downstream operations such as speciality chemicals and renewable energy solutions, including solar. Hence, we expect the asset utilisation rates for local service companies to improve in the medium to longer term, even though charter rates could remain unexciting in the light of excess capacity globally.

• 2Q2018 contract awards declined but uptrend remains intact. Malaysia’s 2Q2018 contract awards slumped 33% QoQ to RM2.5bil as 1QFY18 benefited from Sapura Energy’s huge but lumpy EPCIC work for the Pegaga central processing platform. Nevertheless, the rollout of projects still appears to be ongoing as 1H2018 awards rose 33% YoY to RM6.2bil and the pipeline of overseas jobs was still slow last year. Going forward, we expect the rising momentum of fresh awards to gain traction, partly driven by Petronas’ downstream focus on PIC Johor, together with the resumption of massive offshore developments in Brazil and West Africa.

• Maintain 2018-2019 price 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$72/barrel and Petronas’ unchanged US$52/barrel for 2018. For 2019, the EIA is forecasting Brent at US$71/barrel against a projected 11% YoY increase in US daily production to 11.9mil barrels. The OPEC production quotas that were initiated in the beginning of last year have suppressed US oil inventories, which have fallen to 408mil barrels, down 5% since the beginning of the year and 23% from the 534mil peak in March 2017. Although US daily crude production has expanded by 12.5% since the beginning of the year to 11mil barrels, this has been mitigated by declining Venezuelan output and potential resumption of US sanctions on Iran.

• Maintain OVERWEIGHT view on the sector given the stabilising crude oil prices above US$75/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 FPSO charters are secured by strong client/operators together with a proven track record of savvy management/execution capabilities. We are UNDERWEIGHT on Petronas Gas due to the Energy Commission’s upcoming announcement of the transportation tariff setting mechanism, which we expect to be valueeroding due to an expected lower targeted rate of return on asset values.

Source: AmInvest Research - 30 Aug 2018