Petronas’ 2Q20 core loss stood at-RM0.7bn (1Q20: +RM8.5bn, 2Q19: +RM14.5bn), brought 1H20 core profit to RM7.8bn (-73% YoY). The weak results were primarily due to lower crude oil prices. 1H20 capex spending of RM14.8bn only constituted 37% of its planned capex target of c.RM40bn in FY20. While Brent crude and LNG prices have recovered from its lows, demand for crude and LNG is still severely impacted by Covid-19. We believe that Brent Crude prices would need to average above USD55 for at least 1 year in order for Petronas to revert to its pre -Covid-19 capex spending level of about c.RM50bn. Reiterate NEUTRAL view on the sector, our top pick for the sector is Armada (BUY; TP: RM0.60) as its FPSO earnings are expected to remain strong, while its current valuations are still undemanding. We are keeping our average oil prices forecast unchanged at USD44/bbl in 2020.

QoQ: Revenues declined by 43% to RM34.0bn from the impact of lower sales volume and ASP for crude oil, condensates and LNG due to the demand erosion caused by Covid-19. Subsequently, the significant dip in revenue resulted in the company recording a core loss of -RM0.7bn (1Q20: RM8.5bn).

YoY: Revenue declined by 42% due to the same reasons mentioned above. Subsequently, the company recorded a core net loss of -RM0.7bn (2Q19: RM14.5bn).

YTD: Overall 1H20 core earnings declined to RM7.8bn (-73%) on average lower realised prices for Brent (-36%), mitigated by marginally higher sales volume of 3% for its petroleum products due to higher trading activities despite lower marketing sales volume of 2%.

Capex and OCF. Recall that Petronas’ has pledged to cut about 21% of its capex and 12% of its opex spending for FY20 due to the onset of the Covid-19 pandemic. We believe that 1H20 capex spending of RM14.8bn (-7% YoY; 45% international, 55% domestic) was within our expectations (c.RM35bn) as we believe that Petronas will fall slightly short of its c.RM40bn initial planned capex due to significantly weaker operating cashflow despite the recovery in crude oil prices. 1H20 operating cashflow of RM26.3bn (-41% YoY) is at its weakest level in more than past 5 years and we believe that Petronas would try to partially recoup some declines in its operating cashflow in 2H20 by cutting capex below its initial target. We believe that oil prices would need to stabilise above USD55 for a year at least in order for Petronas to gain the confidence required for it to elevate its capex spending above pre-Covid-19 levels of c.RM50bn.

Dividend. Despite its significantly weaker results and volatile market environment, Petronas has declared a dividend of RM16bn in 2Q20 bringing 1H20 dividends to RM16bn (-38% YoY; no dividends declared in 1Q20) from RM26bn in 1H19?. We believe that this move would be quite strenuous for its cashflow as cash dividends have only declined by RM10bn YoY whilst, core net profit has declined by RM20.9bn YoY. Petronas’ net cash balance has also declined by RM28.3bn YoY to RM64.3bn (-31% YoY), signifying its weakening financial position due to weaker operational performance and dividend commitments.

Maintain NEUTRAL. While there are positive developments since the peak of movement control orders globally due the recovery in Brent crude prices from its lows of USD19/bbl to an average of above USD40/bbl, our tepid view on capex spending in 2H20 remains due to Petronas’ weakening financial position from the Covid -19 pandemic and its dividend commitments. We believe that Petronas’ lower capex spending would continue to plague upstream services players, particularly companies involved in exploration activities. We are selectively positive on companies which are relatively insulated from the volatility in oil prices like Bumi Armada and Dialog. Our top  pick for the sector is Bumi Armada (BUY; TP: RM0.60) due to its consistently performing FPSO segment and undemanding valuations. Bumi Armada’s share price has appreciated by more than 30% since our upgrade and it is still trading at an FY20/21f PE of 5.2/5.0x which is less than a third of Yinson’s F20/21F P/E of 18/17x. However, we have also downgraded Sapura Energy from a HOLD to a SELL at an unchanged TP of RM0.09 based on 0.2x FY20 P/B in view of the recent rally in its share price. We believe that the prospects of Sapura remains subdued due to major capex cuts from oil majors around the world and its share price has ran above its fundamentals.

Source: Hong Leong Investment Bank Research - 7 Sept 2020