Petronas Recorded 3Q20 Core Profit of RM1.5bn (QoQ: -RM0.7bn, YoY: -84%) Bringing 9M20 Core Profit to RM9.3bn (-76% YoY) on Lower Demand and Price of Crude Oil and LNG. 3Q20 Capex Spending of RM7.8bn (+25% QoQ, -31% YoY) Brought 9M20 Capex Spending to RM22.5bn (-17% YoY), Constituting Just 57% of Its Planned Capex Spending of C.RM40bn in FY20. Reiterate NEUTRAL View on the Sector, We Are Negative on Companies Which Are Heavily Reliant on Petronas’ Capex Spending Despite Higher Average Oil Prices of Late, While We Are Selectively Positive on Those Which Are More Insulated From the Volatility in Oil Prices. Our Top Pick for the Sector Is Armada (TP: RM0.65, BUY) as Its FPSO Earnings Are Expected to Remain Strong Amidst the Volatility in the Oil Market.

QoQ. Revenue increased by 21% QoQ to RM41.1bn from the impact of higher sales volume and ASP for crude oil, condensates and LNG as nations adjusts to the new normal globally. Subsequently, the aforementioned factors resulted in Petronas recording an improvement in its core profit to RM1.5bn (QoQ: -RM0.7bn).

YoY. Revenue declined by 25% YoY due to lower ASP for crude oil, condensates and LNG. Subsequently, the Company recorded a core net profit of RM1.5bn (-84% YoY).

YTD. Overall 9M20 core earnings declined to RM9.3bn (-76% YoY) on average lower averaged realised prices for Brent of USD43.3/bbl (-30% YoY) mitigated by marginally higher sales volume of 1% for its petroleum products due to higher trading activities despite lower marketing sales volume of 2% caused by Covid-19. 9M20 core earnings were derived after adjusting for impairments amounting to RM31.2bn.

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 9M20 capex spending of RM22.5bn (-17% YoY; 47% international, 53% domestic) was within our expectations of RM35bn capex in FY20 as we believe Petronas will fall slightly short of its c.RM40bn of its initial planned capex due to significantly weaker operating cash flow despite the recovery in crude oil prices. 9M20 operating cash flow of RM32.6bn (-42% YoY) is still at its weakest level in more than 5 years and we believe that Petronas would try to partially recoup some declines in its operating cash flow in FY21 by cutting capex despite the recent bullishness in oil prices. 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 RM10bn in 3Q20 bringing 9M20 dividends to RM26bn (-43% YoY) from RM46bn in 9M20. We believe that this move is quite strenuous for its cash flow as cash dividends declined by RM20bn YoY whilst, core net profit has declined by RM29.3bn YoY. Petronas’ net cash balance has also declined by RM65.2bn YoY to RM18.2bn (-72% QoQ, -78% YoY), signifying its weakening financial position due to weaker overall sales volumes and prices.

Maintain NEUTRAL. While we believe that the fundamentals of the O&G sector is becoming more positive, our tepid view on capex spending in FY21 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. Although we view that Petronas is likely to spend more on its capex at higher oil prices, we opine that Petronas would choose to be more prudent based on its current financial position. We are selectively positive on O&G players which are relatively insulated from the volatility in oil prices like Bumi Armada and Serba. Our top pick for the sector is Bumi Armada (BUY; TP:RM0.65) due to its consistently performing FPSO segment and undemanding valuations. Bumi Armada’s share price has appreciated by 34% since our upgrade and it is still trading at an FY20/21f PE of 4.5/4.4x.

Source: Hong Leong Investment Bank Research - 30 Nov 2020