Given the volatile oil prices and demand and supply outlook, we continue to remain cautious on the Malaysia O&G sector, and maintain our Underweight stance. We see a risk of Petronas cutting capex in a prolonged low oil price environment. We expect Brent oil prices to trade in the range of US$45-50/bbl in 2H20 (averaging US$45/bbl for full-year 2020 on the assumption that oil trades at US$30/bbl in 2Q20) and US$50- 55/bbl in 2021. We reiterate our Sell call on MISC, Petronas Gas and Petronas Dagangan on our cautious global outlook. We downgrade Bumi to a Hold and prefer MMHE (upgrade to Buy) as current net cash position is greater than current market cap. Dialog and Serba Dinamik are our sector picks.

Most Players Will Not be Spared From Low Oil Prices

Based on our recent channel checks with industry players, there are not many signs of Petronas delaying its 2020 work programme. However, we gather that downward revision in capex spending, rates, and work activities tend to have a 6-month lag. If the low oil price environment prolongs, offshore support vessels (OSV) and jack up players are both at risk in terms of their daily charter rates (DCR). Most of the OSV players (about 70% of their respective fleets) have locked in a long-term ILCT contract with DCR lower than current market rate. The DCR should have been renewed early 2020, but was postponed further to Apr-20, which we believe could see further deferment. Likewise for the jack ups, Velesto’s 4 rigs with Petronas is set to expire by 2H20 and was expected to be renewed closer to market rate (current firm contract DCR is about US$10,000 lower than spot rate at US$80,000).

Contracts Could See Slower Roll Out, Though No Signs of Slowdown Yet

The oil market has had its worst luck in 1Q20 on softer oil demand due to the recent virus outbreak, compounded by OPEC and Russia failing to reach an agreement on potential supply cuts. With no signs of a compromise possibly until June-20, we see risk of a slower contract roll out, even for potential beneficiaries from Petronas’ Activity Outlook.

Cutting target prices for PCHEM, Serba, Velesto, Bumi, MMHE, Sapura and Kelington – reflecting trough valuation and business downside

During a down cycle, we expect small-mid cap companies to trade in the range of 6-8x one year forward PER, while mid cap spaces would trade closer to 10-12x forward PER. We lower our earnings forecasts for PCHEM (lower petrochemical product ASP), Serba Dinamik (on possible delay in construction progress), Velesto Energy and Bumi Armada (lower renewal DCRs). With the exception of PCHEM, we lower our valuation multiple for all companies, mostly at -1SD level of its long-term mean.

Underweight; Top Picks: Dialog and Serba Dinamik

With global factors not favouring higher oil prices, we remain Underweight on the sector. We reiterate our Sell call on MISC, Petronas Gas and Petronas Dagangan, while maintaining a Hold on PCHEM. We also downgrade Bumi to a Hold (from Buy). For sector exposure, we see Dialog as a low oil price beneficiary, given its exposure to the storage tank business. Serba Dinamik also stands to benefit from the ramp up in Middle East production. We recommend a switch to MMHE (upgrade to Buy from Hold) from Bumi Armada, as we see value in its net cash RM0.31/share and RM3bn orderbook.

1Q20 Saw Fewer Big Contracts…

Total contract value announced in 1Q20 (cut-off date 20 March 2020) was only RM3.6bn, inclusive of RM2.2bn DP2 Shuttle Tankers awarded to MISC by Petrobras. Stripping that, contract values came in lower at RM1.5bn as compared to RM3.2bn in 1Q19. Notably in 1Q19, we saw a higher number of contracts being awarded (-35% yoy) and with Serba Dinamik, Sapura Energy and Scomi Energy securing some big contracts.

…but Actual Amount Could be Higher Including Call Outs

1Q20 saw multiple call out contracts (no contract value in nature) being awarded. Dayang secured iHUC and modification umbrella contracts from Petronas Carigali and Carigali-PTTEP, with T7 Global also securing a MCM contract from Repsol. Based on our rough estimates, including the value for these contracts could see 1Q20 numbers comparable to 1Q19 level.

Risk of Slowdown in New Contracts, and Maybe Work Activities

Based on earlier indications from Petronas’ Activity Outlook report, 2020 was supposed to see a doubling in wellhead platform (5-6 in 2019 to estimated 10- 13) and 38 additional AHTS vessels (from 111 units in 2019 to an estimated 149 units) to be awarded. We believe this could see a delay as Petronas puts a hold on new exploration activities. Nevertheless, based on our channel checks, companies across the value chain have yet to see any postponement in previously approved work programme. The bidding of the 4 fields under discovered resource opportunities (DSO) would likely see a delay as well.

Source: Affin Hwang Research - 24 Mar 2020