Highlights

Recapping 2013… Oil and Gas sector has outperformed FBM KLCI index strongly in 2013 driven by around RM40bn worth of contract awarded. Large cap O&G has outperformed FBM KLCI by 11% while small cap O&G has outperformed by 60%.

Our favourable micro themes…We advise investors to focus on the micro themes in the O&G industry for alpha generation after strong share price performance in 2013. Our favourable micro themes are risk services contract (RSC), drilling-related stocks, fabrication jobs, and Pengerang play.

RSCs to award in Jan 2014... From our channel checks, Petronas is likely to award some RSC contracts in 1Q2014. We understand some of the marginal field award might be smaller than previous which required less capex (US$100-300m vs. US$900m of previous round). Potential winners are Scomi Energy (BUY, TP:1.02), Uzma (BUY, TP:6.16), SapuraKencana (Buy: TP:4.93) and Bumi Armada (Buy, TP:4.87).

Rigs localisation provides ample opportunity… There are 14 foreign jacks up rig contracts are expects to expire within 1-2 years with 3 in 2H2013, 4 in 1H2014, 5 in 2H2014 and 2 in 2015. UMW O&G is the best proxy (HOLD, TP:3.92). Alternative drilling related stocks stand to benefit from massive drilling activities are Perisai (BUY, TP:1.93), Scomi Energy and Destini (Non-Rated).

Increasing fabrication job orders… We estimated more than RM10bn worth of potential contract to be awarded. Smaller players like THHeavy (Non-Rated), BHIC (Buy, TP:3.39) and KKB Engineering (Non-Rated) are likely to share a portion of the cake.

RM60bn Rapid project... We expect Petronas to proceed with the project as it is one of the key projects established to address the country’s downstream solution but timing is the uncertain risk. Beneficiaries are onshore fabricators/process equipment providers (Muhibbah, MMHE, Pantech) and downstream players (Dialog, Petronas Chemical and Petronas Gas).

Catalysts

Upgrades: New Discoveries, marginal field contract awards, M&A. Downgrades: Sharp plunge in oil prices.

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

Post earnings forecasts revision and rolling forward our valuation base year from CY2014 to CY2015, our target prices were also revised by -8% to +18%. Except for SapuraKencana (which was upgraded to BUY), recommendation for all others stocks remains unchanged.

Top picks: Big Cap: Bumi Armada Mid to Small cap: Scomi Energy, Uzma and Perisai.

Source: Hong Leong Investment Bank Research - 9 Jan 2014