Highlights

• 2Q16 down but still manageable … Petronas reported 2Q16 core net profit (excluding net impairments mainly on the upstream assets) of RM9.4bn, bringing its 1H16 core net profit to RM17.7bn, down 27.3% YoY.

• Upstream: Upstream earnings suffered in tandem with weaker oil production margin after registering lower revenue YoY. However, production volume was up both YoY and QoQ caused by higher Peninsular Malaysia gas production to support shortfall in imported gas and higher facility uptime in Malaysia and Canada, defying the negative trend caused by natural production decline rate. LNG edged up YoY underpinned by new volumes from Gladstone.

• Downstream: Uninspiring PAT trend continued into 2Q16 from 1Q16 for its downstream segment due to lower prices of crude; petroleum & petrochemical products as well as lower refining margin and petrochemical product spreads. Volume of petrochemical products was higher both YoY and QoQ due to better plant operating performance.

• CAPEX to-date totalled RM25.2bn… Petronas group has spent RM25.2bn to date mainly on RAPID and upstream projects. This is broadly in line with the targeted CAPEX of RM52.5bn by the group. However, any potential further cut in CAPEX would result in a lower-than-expected spending, resulting in lower cash shortfall to be financed from outside of its operating cash flow.

• Operating cash covering CAPEX, what about dividends? We took comfort from the fact that its 1H16 operating cash flow of RM25.6bn is sufficient to cover for its CAPEX commitments. However, the group is still required to pay RM16bn worth of dividends for its shareholders. With RM6bn already paid, the group may opt to draw from its huge cash coffer of RM112bn as of the last reporting date to fulfil the additional RM10bn worth of dividend payments, still a manageable level for the group given its strong net cash position. However, we opine that this could only be sustained for another 4-5 years before its cash balances dwindle to a more worrying position.

• Numbers improved, what this means to service providers? The resilient numbers posted by Petronas would no doubt provide a positive sentimental lift in the stock market. However, we believe that the service players (especially asset players i.e. OSV and rigs) would not see a significant pick up in activities as we expect Petronas to maintain its current activity level to conserve its cash. OSV and rig players are still in the oversupply situation (particularly higher-end OSV and jack-up rig segment) with significantly more than enough capacity to cater for the demand at this juncture.

Rating

NEUTRAL

• Positives: Earlier than expected oil price recovery, higher than expected cash cost savings.

• Negatives: Delay in contract rollout, low oil price environment lead to competition and margin compression for contractors.

Valuation

Maintain Neutral on the sector. We still advocate to avoid asset-heavy players whereby the current oil prices would not solve the oversupply issue in that space. Investors should stay on the sidelines but look out for pick up in activities for maintenance-type players i.e. UZMA (HOLD; TP: RM1.72) to capitalize on potential improvement in activities in the near term.

Source: Hong Leong Investment Bank Research - 23 Aug 2016