Highlights

• YoY: Petronas group 4Q16 core net profit (excluding asset impairments) rose 79.4% YoY to RM15.1bn mainly attributed by (i) better Upstream performance on higher gas production (due to resumption of operations of Sabah-Sarawak Gas Pipeline (“SSGP”) and higher LNG sales (due to higher volume from Train 9 and Gladstone LNG) and (ii) better Downstream contribution on higher international refining and marketing margins.

• QoQ: Group core net profit more than doubled driven by (i) higher product prices for major products (ii) higher Upstream sales volume on higher LNG volume and gas production and (iii) higher favourable FOREX impact as reflected in higher Corporate & Others segment.

• FY16: Petronas core net profit was flattish YoY (-0.1%) despite 18.8% drop in top line. The improvement in margin was driven by (i) higher gas production from Malaysia, Indonesia and Canada (ii) lower OPEX due to cost cutting measures in the year and (iii) lower oil production costs.

• RM59.4bn spent. CAPEX amounting to RM59.4bn was spent in FY16 mainly for domestic upstream E&P projects, downstream RAPID (Johor) and SAMUR (Sabah) projects. However, the amount spent was down 22.1% YoY due to budget cut in domestic upstream CAPEX.

• 2016 proposed dividend down to RM13bn. For FY16, Petronas group has proposed RM13bn (FY15: RM16bn) worth of dividends to be paid in FY17 in instalments. We expect the dividend payment would be financed through gearing up its balance sheet or drawdown from its cash balance as its operating cash flow for FY16 only stood at RM53.8bn, of which RM50.3bn was utilised for CAPEX requirements. The group’s net cash as of end FY16 stood at RM53.9bn, signalling moderate buffer for further drawdown for dividend payment.

• Hands tied due to RAPID. At this juncture, the group is slightly over midway through the progress of US$29bn RAPID project with targeted operational start-up in 1Q19. Recent Saudi Aramco deal to inject US$7bn into the project would help to relieve Petronas’ cash flow commitments. Our back of the envelop calculations suggest that Petronas would only need to dish out RM16bn/year for the next 2 years for RAPID if the deal is finalized, which would open up more room for domestic upstream CAPEX.

• Benefit of the deal could be back loaded. While the Aramco deal would be indirectly beneficial for local upstream industry, it may not be realizable in 2017 as the details of the deal have yet to be firmed up. It is more than likely that Petronas would have to maintain its CAPEX level in RAPID in 2017 (lower cash flow available for upstream CAPEX) before the investments from Aramco kick in possibly in 2018 the earliest.

Rating

NEUTRAL ( ↔ )

• While improvement is expected in 2017 for O&G sector, we believe it has already been reflected in the market value of stocks under coverage. Meanwhile, we do not anticipate major CAPEX upcycle by Petronas in the year due to uncertainty in oil prices.

Valuation

• 2017 is expected to be a better year for O&G but moderate recovery in the sector seems to be priced in by the market at current level with average CY17 PER at 18x (higher than 10- 12x PER for current oil price scenario).

• Top Pick – REACH (BUY; TP: RM0.83) due to its pure-play exposure to E&P segment while being the direct beneficiary of gradual improvement in oil prices.

Source: Hong Leong Investment Bank Research - 15 Mar 2017