Highlights

Despite the recent run up in O&G stocks, we believe there is still ample upside to share prices as the sector is in the early stage of a cyclical upswing. Our base assumption that the Government is reliant on O&G revenue to finance the budget and drive the ETP is still valid. Hence, we expect contract flow aimed at resuscitating production and thus government revenue to continue to flow into the oderbooks of competent domestic companies.

Governments internationally and regionally are in a similar reliant situation. This means that contract flows for offshore O&G services companies is a global phenomenon.

Underlying this growth are compelling valuations, mostly for small caps. Despite recent run up in prices, the market has still not finished separating the wheat from the chaff. The market is taking a wait and see attitude while prices climb.

While the economics of new investment in Shale and oil sands at current prices is questionable, offshore production remains extremely viable and we expect capex investment to continue to grow. We do not think the positive outlook has been factored into forecasts of selected stocks.

The average peak P/E for 3 proxy small cap companies in the last upcycle was 23x and sentiment was euphoric. We are a long way from this level.

Catalysts

• Upgrades: HUC and marginal field contract awards, M&A.
• Downgrades: Sharp plunge in oil prices.

Risks

Global recession.

Rating

OVERWEIGHT

• Positives: We believe that the ETP driven RM300bn Capex spending to enhance exploration, EOR and Marginal fields will drive earnings in the sector.
• Negatives: execution risk, delay in contract rollout and investors’ perceptions on previous disappointments.

Valuation

Top picks in order of preference target prices raise mostly due to rolling valuations over to FY14.

• SapuraKencana (BUY RM4.40)
• Perisai (BUY, TP: RM1.58)
• Perdana Petroleum (BUY, TP RM1.83)
• Dayang (BUY, TP: RM4.00)
• Uzma (BUY TP: RM2.64)
• Bumi Armada (BUY TP: 4.88 BUY)
• Wah Seong (BUY TP: RM2.13).

Source: Hong Leong Investment Bank Research - 16 Apr 2013