We foresee divided straits for the sector in the coming quarter, drawing a distinctive line between upstream and downstream prospects. Despite the muted near-term news flow, we still think that the upstream segment remains exciting as it is just a matter of time before fresh contracts are dished out. However, things are different for the downstream segment as it is weighed down by the delay in Petronas’ Refinery and Petrochemicals Integrated Development (RAPID) project, which dampens near-term prospects of onshore oil and gas players. Our Top Pick is still Sapurakencana Petroleum Bhd (SKPETRO, OP; TP: RM4.72) given its status as Malaysia’s sole integrated oil and gas service provider. It is also currently trading at an unjustified discount to its large-cap peers (i.e. MMHE; Bumi Armada) which makes it an attractive investment proposition. The small-to-mid-cap (<RM2.0b) upstream plays also look favourable at this juncture, as most of their valuations have retraced post Aug-13 on share price corrections. We believe the Upstream prospects will outweigh the negative aspects of the downstream sector. As such we maintain our OVERWEIGHT call for the sector.

Contract awards expected to pick up near end-13. Domestic contract awards totalled RM1.4b in 3Q13 (lower than the RM7.6b and RM9.2b booked in 1H13 by oil and gas companies in our coverage). We are unfazed by the quarterly lull as we believe that it is just a matter of time before contract awards return given: (i) Petronas’ serious bid to stem reserves and production decline and (ii) expectations that Brent crude oil prices are unlikely to fall below USD80-90/bbl (the crucial price level where projects might be shelved). Near-term awards will mainly be for the OSV market, but nearing end-CY13, we believe that one or two fabrication and RSC contracts could be awarded. We also do not discount jack-up rig contract awards, coinciding with the listing of UMW O&G in Nov-13.

UMW O&G listing could reset drilling peers’ valuations. Based on the indicative IPO price of RM2.80/share, we postulate a market cap of RM6b and the stock to be listed at a CY14 PER of 17-18x. Response for the IPO is purportedly overwhelming; hence we expect to the stock to perform well. We believe the listing could lead to an industrial wide re-rating for its peers such as Perisai Petroleum (OP; TP: RM1.42) and Coastal Contract (OP; TP: RM3.87) that currently only trade at CY14 PER multiples of 9-12.7x, respectively.

Small-to-mid-market cap stocks trading at attractive valuations. We note that the forward trading PERs for small-to-mid caps (<RM2.0b) are still attractive at an average of 11x (below the average PER multiples of 13-14x that we have ascribed, and also below peak valuations of 12.8-15x for some stocks). Amongst them, we favour Coastal Contracts (COASTAL, OP; TP: RM3.87) and Alam Maritim Resources Bhd (OP; TP: RM1.91) which trade at CY14 PER of 9x and 10.8x respectively. We like COASTAL as it is one of the cheapest drilling rig players for now; whilst ALAM seems to be the best beneficiary for incoming third-party OSV charters. It also has exposure to the installation, repair and maintenance (IRM) and Pan-Malaysian T&I projects.

Downstream segment in the doldrums for now. Petronas’ delay in the commissioning of the RAPID project has a significant negative impact to the onshore oil and gas providers. For now, we understand the Final Investment Decision (FID) will only take place in 1Q14, the RAPID refinery is scheduled to be ready for start-up in Q4 2017 and the remaining plants within the complex is scheduled to be commissioned in 2018. This will dampen prospects for the onshore oil and gas players which were eyeing projects in Pengeran. Also, as the downstream segment was the main beneficiary in the last Budget 2013; unless there is further positive development for the RAPID project, we foresee a muted impact to the sector even if initiatives are mentioned for RAPID in the Budget 2014 (expected to be on 25th Oct 2013).

Reiterate OVERWEIGHT. Our TOP PICK is SKPETRO (OP; TP: RM4.72). We also maintain our Outperform call on: : ALAM (OP;TP: RM1.91), COASTAL (OP; TP: RM3.87), DAYANG (OP; TP:RM6.06), DIALOG (OP; TP: RM3.28), PANTECH (OP; TP: RM1.28), PCHEM (OP; TP: RM6.97), PERDANA (OP; TP: RM2.40), PERISAI (OP; TP: RM1.42), SKPETRO (OP; TP: RM4.72), SEB (OP; TP: RM0.78), UZMA (OP; TP: RM4.57) and YINSON (OP; TP: RM5.58). We are Neutral and Underperform for GASMSIA (MP; TP: RM3.41), PETGAS (MP; TP: RM20.77), MHB (UP; TP: RM3.39) and WASEONG (UP; TP: RM1.57).

UPSTREAM SEGMENT

Slight lull in contract flows in 3Q13. Domestic contract awards came in at RM1.4b for 3Q13. This was lower than the RM7.6b and RM9.2b contract wins booked in for 1H13 by the oil and gas companies that we track. Inclusive of international wins for 3Q13, contract wins were RM2b (versus RM18.1b and RM10.8b in 1Q13 and 2Q13). Main winners of the international contracts in 3Q13 were: (i) Bumi Armada (BAB, Not Rated) for the Engineering, Pocurement, Installation and Precommissioning of subsea in-field and inter-field pipelines for the Filanovsky field in the Russian sector of the Caspian Sea; and (ii) Daya Materials (TB ; TP: RM0.40) which won bareboat charter Norwegian contracts from Technip.

Plenty of contracts still to be awarded. Based on our channel checks, near-term awards will mainly be for the OSV market where we understand outstanding requirements exist for: (i) 10k brakehorsepower (BHP) vessels to support the upcoming drilling contracts, (ii) platform supply vessels (PSVs), and (iii) accommodation (barge and boat) vessels. In the fabrication space, channel checks suggest there could be one of two contracts awarded being the Block SK316 EPCIC and Samarang contracts. We also hope to finally hear of at least one Risk-Service-Contract (RSC) within the year. Newspaper reports have tipped that SKPETRO is tying up with Vestigo for the Bubu RSC, and Vestigo will go ahead with the Tembikai and Cenang RSC. We also do not discount the possibility of jack-up rig contract awards to coincide with the listing of UMW O&G from Nov-13 onwards. This would raise the profile of the segment in the coming months. (Refer to next page for a list of segments and their potential incoming contracts/prospects) Pan Malaysia T&I contract set to dominate news flows in early-14. In 2014, we believe one of the most awaited contracts; besides the outcome for delayed EPCIC contract (there is estimated to be around 8 or more contracts pending), would be the Pan Malaysia T&I contracts. Estimated to be worth around c.RM15-20b for all 5 packages, we believe this will be an interesting time as there seems to be a fair bit of competitors for each package. For now, we understand that there are no expected delays to the contract roll-outs (expected in early-14 for contract start-ups by Mar-14).

UMW O&G listing likely to be well-received. Response for the IPO is purportedly overwhelming given UMW’s: (i) niche market status as the first domestic jack-up rig player, (ii) its sweet spot considering the ample drilling contracts that are expiring in 2013-2014 in Malaysia and SEA region, and (iii) the cyclical uptrend in jack-up rig charter rates. Based on the indicative IPO price of RM2.80/share, we postulate a market capitalisation of RM6b at a CY14 PER of 17-18x. We suspect the listing could rerate the benchmark valuations for drilling peers like COASTAL and PERISAI that currently trades at CY14 PERs of 9-12.7x, respectively. Other potential entrants to the drilling rig market would be Tanjung Offshore (Not Rated) which is currently ongoing fund-raising exercises in its bid to acquire drilling assets, but we are not surprised should more companies are lured into this segment.

DOWNSTREAM SEGMENT

Downstream segment in the doldrums for now. Petronas’ statement in Aug-13 that it will delay the commissioning of the Refinery and Petrochemicals Integrated Development (RAPID) project to end-17 will mean delays in contract roll-outs to downstream oil and gas players, including Muhibbah Engineering (M) Bhd (OP; TP: RM3.00) and Pantech Group Holdings Bhd (OP; TP: RM1.28). Hence, in the short-term, we foresee muted activity for the contractors in the Pengerang space. Previously, we mentioned that potential beneficiaries are:

1) Onshore oil & gas constructors - such as Dialog (OP; TP: 3.28); SapuraKencana Petroleum Bhd (OP; TP: RM4.72); Muhibbah (OP; TP: RM3.00); MMC Corporation Bhd (MP; TP: RM2.67); and East Malaysia-based Naim Holdings (OP; TP: RM4.45); and, Suria Capital (NOT RATED); and

2) Process equipment & fixtures players – such as KNM Group Bhd (NOT RATED); and Pantech (OP; TP: RM1.28)

3) Civil engineering constructors like WCT Bhd (MP; TP: RM2.50) is the purported beneficiary of the earthworks in RAPID, while Benalec Holdings Bhd (OP; TP: RM1.94) could be a beneficiary for land reclamation works.

Budget 2014 potentially a non-event for the sector. The downstream segment was the main beneficiary in the previous Budget 2013. However, given the turn of events, unless there are further positive updates for the project, we foresee muted impact from any initiatives proposed in the coming Budget 2014 (expected to be on 25th Oct 2013). Previously there were 2 initiatives proposed.

Source: Kenanga