Highlights

• Dominated by disappointments. Out of 9 results announced for company under coverage, 6 came below our expectations (mainly comprising of upstream services players). Meanwhile, 2 came within expectations and only 1 came above (PetDag) due to slightly better petroleum product margins.

• Underperformance caused by both weak activities and margins. Out of the 6 results which underperformed, 4 were due to weaker than expected work orders and margin contraction. On the other hand, the other 2 were caused by company–specific issues: Armada (due to non-utilisation of old FPSO assets) and KNM (higher than expected logistics costs due to project cost overrun).

• Petroleum product retailer flourishes. PetDag enjoyed higher than expected product margins in 4Q16 mainly due to improvement in MOPS pricing movements. This development points to resilience of the retail industry while sales volume is inelastic (i.e. not affected by rising fuel retail prices).

• Worst is over... 2016 could be the worst year seen in the O&G sector as oil prices have since recovered to US$55/bbl to-date from average of US$43.7/bbl in 2016. 2017 would be a better year for O&G with most asset impairments completed and OPEX cut done in a year before.

• ... but earnings recovery priced in. All of the O&G companies under our coverage except for UMWOG are projected to return to profits (some to recover from loss position in 2016). Overall, we had trimmed our earnings forecasts for companies in our universe of coverage by 2%/1% for FY17/18. Implied FY17 PER of the sector is still pricey at 18.3x (higher than average of 10-12x for the sector at the current oil price scenario).

• More downside than upside. We believe that given oil prices held steady at US$50-60/bbl range, the possibility of negative surprise in earnings is higher (than positive surprises) in 2017. Primary reasons include: (i) production cut by OPEC and Russia has been known and adherence has been reflected in oil price, and (ii) potential upside in US oil production as rig counts have been climbing since late 2016.

Risks

• Further plunge in oil prices.

• Slower than expected recovery in O&G activities.

Rating

NEUTRAL ( ↔ )

• Uninspiring results for FY16 but it would well be the worst year for the sector. Nevertheless, most of the recovery prospect has been priced in, in our opinion, and we still suggest investors to stay on the side-line for now.

• Our top pick is REACH (BUY; TP: RM0.83) – owing to it being the pure proxy for oil price recovery.

Source: Hong Leong Investment Bank Research - 8 Mar 2017