Highlights

• Roller-coaster ride for oil prices… Volatile period for crude oil whereby prices plunged to a low of US$26/bbl and have rebounded to >US$40/bbl w ithin the span of 4 months despite largely unchanged oil market fundamentals. Oil surplus of close to 2m bbls/day is still ant icipated for 2016. Recent surge in oil prices seemed to have priced in potent ial production control to be agreed upon betw een OPEC and non-OPEC countries in the Doha meet ing on 17th Apr il 2016, of w hich its outcome w ould be the key driver of oil price movements going ahead.
• Near term still bearish… We maintain our bearish view for 2016 on the oil price as (i) oversupply is still expected to persist and (ii) oil inventory is still at all-t ime high despite recent inventory draw . Target for this year remains at US$30-35/bbl w hile 2017 target for Brent w ould be US$45-50/bbl. Premature recovery in the oil prices, in our opinion, w ould stif le the long term recovery of the industry. The market is able to reverse back to its oversupplied level sw if tly f rom restarts of US shale drilling.
• More impairment needed for fundamental shift… In 2015, w e have seen RM3.6bn w orth of impairments done by local asset players. How ever, w e believe it is not suf f icient given charter rates have plunged 30-40% w ith some assets being completely unut ilized. For readjustment to the new rate norm, cash cost savings (staf f costs, contractor costs) are not suf f icient for the group to maintain P&L pos itive. Asset players need to impair their assets to a greater extent to br ing dow n their overall cost structure through lesser depreciation. Asset value are, in our opinion, expected to stay in the level low er than seen before during US$100/bbl oil era as oversupply situation is still present.
• Pay attention to cash… Overall, the local O&G companies still look rather healthy f rom the cash f low perspective w ith operat ing cash f low /sales more than 20% on average w hile operat ing cash f low / interest remains healthy at more than 3x. Dayang is singledout as the ideal long-term pic k w ith high cash generation coupled w ith balanced bus iness mix. Investors are advocated to buy on weakness of its share price in the coming quarters as w eaker earnings are posted. ICON and MHB also appears to have strong cash posit ion rendering them more stable than the others amid industry headw inds.
• Near term volatile & trading oriented… The O&G sector remains primarily as a trading sector for shorter -term traders due high volatility in share pr ices and oil pr ices. SKPETRO remains as the best trading stoc k w ith volatile share prices correlated to oil prices but investor have to take note that near term share pr ice overhang remains given the r isk of it being taken of f as a KLCI constituent in the upcoming review . 2016 w ould be even tougher for O&G counters w ith full-blow n impact of dow nturn on earnings to be ref lected. Longer term investors could buy strong cash generat ive companies on w eakness throughout the year to position for industry recovery in 2017.

Rating

NEUTRAL

• Posit ives: Capex cuts are in place w hich points to drops in oil production in the long run to balance the demand and supply imbalance.
• Negat ives: Premature recovery in oil prices could af fect long term recovery for the industry

Valuation

Overall, we remain NEUTRAL on the sector given that the fundamental shif t in the sector is not imminent to a PER rerat ing in the meantime.

Source: Hong Leong Investment Bank Research - 14 Apr 2016