We take the recent run-up in Sapura Kencana's ('SKPETRO') share price as a sign that investors view the company as the main beneficiary for domestic contract awards that are rumoured to be up for tender in the coming months. In our view, the positive interest will continue given that the stock could likely enter the FBMKLCI index by early Dec. As such, while we are maintaining our FY13-14 earnings estimates (as we await the company's 2QFY12 results for a better visibility of its merger synergies), we have tactically increased our PER target for the stock to 20x (from 18x previously), lifting our fair value for the stock to RM2.79 (previously RM2.51). We believe the revised PER is not a stretch for SKPETRO, given that some domestic oil and gas counters have historically been able to reach trading PERs of 30-40x. We continue to favour the company for its scale and existing global track record, which will enhance its competitive edge during new contract bids.

Contract awards could be incoming. Recently, there been a slew of news that several domestic projects are tipped for tenders in 2H12 to earlyCY13. For example, they are the:  1) North Malay Basin development; 2) Malikai platform fabrication project; 3) EPCIC for Dulang and Samarang oil fields; 4) fabrication for the Bokor redevelopment; 5) the front-end engineering and design tenders for Block SK 316 in Sarawak; and 6) the potential third marginal field award to Coastal Energy. Such news have been a positive booster for the sector, which had remained relatively quiet (in regards to contract awards) in 1H12.

Main contender for domestic contracts. While not all projects are at the fabrication and installation stages yet (where SKPETRO holds market dominance); after the merger, we believe that investors view it as one of the main domestic beneficiaries given its extensive scale and service capabilities that cater throughout  the whole Engineering, Procurement, Construction, Installation and Commissioning (EPCIC) value chain.

Drivers of share price gains.  The above factors have been the main drivers for the steady gain in SKPETRO's share price (+8.1%) in the past two weeks. We expect the positive  share price trend to continue as SKPETRO will very likely be included in the FBMKLCI index by early Dec.  Possible inclusion in FBMKLCI by early Dec. We had highlighted in our 3Q12 House Strategy that SKPETRO will  very likely be included in the FBMKLCI index in its next round of evaluation in early-December given its significant market capitalisation ('market cap'). The stock's market cap is currently  larger  than  both  Bumi  Armada  ('BAB',  market  cap  of  RM11.6b) and Malaysia Marine and Heavy Engineering Holdings ('MMHE', market cap of RM8.6b), the two lower weighted oil and gas stocks in the index. Other stocks in the index carrying higher weightings are Petronas Chemicals (OP; TP: RM7.46), Petronas Gas (NON-RATED) and Petronas Dagangan (NONRATED).

Stock rerating after FBMKLCI inclusion? We note that both BAB (NON RATED) and MMHE (UP; TP: RM4.65) are currently trading at forward PERs of 19.0x and 22.6x respectively. This  is above the 17.0x that SKPETRO is presently trading at for its CY13 earnings. Given the PER differential, we believe that SKPETRO will see a rerating as it approaches December. The inclusion of SKPETRO could also lead to a de-rating for MMHE, on the other hand, given the stock's current low index weighting (0.48%).

Source: Kenanga