We have rolled forward our valuation base to CY14 and upgraded the target PERs of our stocks by around 1-2x following our Strategy report post GE13 on 06 May-12. Our bullish outlook for the companies is premised on clearer contract flows as the sector goes on full throttle on the back of: 1) Petronas’ continued aggressive capex spending; and 2) Government’s resumption of plans under the ETP to encourage domestic economic activities. Our Top Pick continues to be Sapurakencana Petroleum Bhd (“SKPETRO”, OP; TP: RM4.57) due to its breadth of service offerings across the value chain that will benefit it during contract bids. For the small-to-mid-cap (<RM1.5b) plays, we favour Alam Maritim Resources Bhd (“ALAM”, OP; TP: RM1.39); given vessel utilisation and the prospects for the other divisions look like they are improving. However, we highlight that in the current bull market, laggards seem to be the likes of Coastal Contracts Bhd (“COASTAL”, OP; TP: RM2.90); and Pantech Group Holding Bhd (“PANTECH”, OP; TP: RM1.18).

Contract rollout risk reduced. Despite a marked slowdown in 2Q13 due to the GE factor, we estimate that at least around RM12.4b worth of contracts have been awarded to Malaysian players YTD. We believe that the contract flows will start to pick up again in 2H13 most notably in the hook-up and commissioning and topside maintenance and the inspection, repair and maintenance sub-sectors given that the respective contracts seemed to have been delayed due to the previous political uncertainties. Other sub-sectors to look out for in 2H13 are the Enhanced Oil Recovery (similar to Dialog’s joint-venture with Halliburton for the Bayan field), drilling and Risk-Service Contracts (which are rumoured to be opened for tender again). The only sector that has disappointed us thus far is the fabrication sub-sector, which may continue to see award-delays moving ahead. An exception to this seems to be the Samarang CPP job that is purportedly likely to be awarded to SKPETRO.

Herald the bull-cycle. In early-2013, we had re-rated the offshore support vessel and hook-up and commissioning and topside maintenance companies under our coverage (ALAM, PERDANA and DAYANG) due to the aggressive positive newsflows in the market and obvious contract flows. With the positive turnout of the GE, we now foresee the bullish sentiment to finally spread towards the rest of the sector as the risk for future contract rollouts has been minimized. We also believe that the sector is now entering a bull-cycle, similar to that 2007-2008, owing to strong contract flows and excess liquidity condition in the domestic financial markets.

Oil and Gas stocks have rallied but there is still more room for re-ratings. Several of the stocks under our coverage have already rallied in price since 7 May. However, if we look back to the forward trading PERs in 2007-2008, we note that in a short span of time (6-10 months) the small to mid-cap stocks actually re-rated up by around 4-7x PER multiples (i.e. ALAM, COASTAL, PERISAI, WASEONG) from the start of the up-cycle (Jan-2007) to its peak valuations, while the larger cap stocks (DIALOG and Sapuracrest) rerated up by as much as 10-20x PER multiples. We do not expect the current PER multiple re-ratings to trade up to the levels that the larger cap stocks saw, as mentioned above, as there is now a larger number of oil and gas stocks to choose from and the sector seems to be on a consolidation or diversification mode (companies have started to move into more sub-sectors to enhance their earnings growth and opportunities). On the YTD, we believe the stocks have thus far re-rated up by about 3.2x PER multiples, and projecting a modest average 5x PER multiple expansion for the overall sector, implies that there is more share price upside to go, especially for the laggard stocks.

Rolling forward our earnings valuation base and increasing the target PERs. Given that we are already approaching mid-year, we have rolled-forward our earnings valuation base to CY14 we are also applying around 1-2.0x PER expansions to our PER based valuations and have reduced the risk premium for DIALOG’s Pengerang tank terminal project as the outcome of the GE implies lesser uncertainties moving ahead. Exceptions to our target PER revisions are MHB (UP; TP: RM3.39); and WASEONG (OP; TP: RM2.01) which we do not foresee will have much near term catalysts for a significant change in business operations, hence their earnings estimates are likely to trend as per consensus expectations.

Source: Kenanga