For 3QCY14, we downgrade our sector call to NEUTRAL (from Overweight) largely due to Kenanga’s cautious outlook on market conditions (due to several negative factors) which could affect sentiment of high-beta sectors including oil and gas. Moreover, we believe new headline contract awards could only emerge towards 4QCY14, keeping the newsflow trend muted in the short-run. Ongoing OSV, jack-up rig and fabrication contracts might emerge; but we believe this has been largely priced-in thus far. On the back of our cautious outlook, we advocate investors to continue being stockselective and focus on laggards that have strong order-books to back-up forward earnings visibility. Our Top Picks continued to be Sapurakencana Petroleum (SKPETRO, OP, TP: RM5.57) for the large-cap space and Coastal Contracts (COASTAL, OP; TP: RM5.94) for the small-mid-cap space.
2QCY14 largely within expectations. 2QCY14 turned out within our expectations with (i) 1Q14 results being seasonally weaker due to the monsoon season and (ii) domestic contract awards including those for the offshore support vessel (OSV), jack-up rig and Risk Service Contract (RSC) players.
Unsurprisingly weak 1Q14 results. As expected, stocks under our coverage reported weak 1Q14 earnings; especially for offshore asset owners which were hit by the monsoon season. Only MHB came in below our expectations at 14% of both our and consensus estimates on the back of slower-than-expected milestone completion for new projects (projects must reach a certain construction milestone for profit recognition). We expect to see better 2Q14 earnings as offshore companies kick-start their new offshore campaigns (which were awarded in 2H13) from Mar/Apr-14 onwards. The exception will still be PERISAI, which continues to see no pipelay barge and mobile offshore production unit (MOPU) utilisations.
International awards bump up contract count in 2QCY14. Cumulative wins by domestic companies hit RM18.5bn but this was mainly fuelled by large lumpy international contracts which we estimated made up at least 75% (c. RM14.1b) of the total sum. ARMADA won the largest contract via a Letter Of Intent (LOI) from ENI for a project offshore of Angola with a contract worth c.RM9.4b. The remaining RM3-4b went to SKPETRO for various tender-drilling, fabrication and subsea jobs. Within the domestic scene; besides the OSV and rig contracts that made up 50% of the contract awards value, the other major contributor was a FPSO contract (c.RM1.2bn) by JX Nippon Oil and Gas for the Layang project that went to TH-Heavy (NOT RATED).
Cautious Kenanga 3QCY14 Market Outlook. In our Market Strategy report, whilst we believe it is still a liquidity driven market, a few negative factors could cap the market’s upside. These negative factors include: (i) indecisive interest direction, (ii) less attractive regional valuations, (iii) historical low volatility, (vi) stretched valuation (as per the historical PER Band and discount between FBMKLCI and its consensus), and (vii) a seasonally weaker quarter. With that in mind, we believe that the cautious market sentiment will have a spillover effect especially on the high-beta segments like the oil and gas segment that has been posting significant gains to-date. Moreover, we suspect there might not be the benefit of strong contract newsflows in the short-run.
New contracts only in 4QCY14? A significant amount of long awaited contracts have been awarded as at 1HCY14 (these include: (i) PERISAI’s first jack-up rig contract, (ii) SKPETRO’s slew of drilling and fabrication contracts, and (iii) RSCs to UZMA (Tanjung Baram) and SCOMI (Ophir)) and moving forward there could be a possible slowdown in awards for 3QCY14, before another pick-up approaching 4QCY14. This is especially for fabrication and Chemical Enhance Oil Recovery (CEOR) contracts. Interestingly, we note that 3QCY13, was the slowest quarter in terms of contract awards for the 2013, with a pick-up in 4QCY13 as the year wound down. A similar trend could emerge this year.
Ongoing awards in 3QCY14, which we suspect, have been largely priced in. Key contracts we mentioned previouslywhich could still emerge in 3Q14 include those in these segments:
(i) Offshore support vessel (OSV) - ie Inspection, Repair and Maintenance (IRM) contracts; platform supply vessel (PSV) and accommodation workbarge/boat contracts ;
(ii) Offshore construction assets - ie. Mobile Offshore Production Unit (MOPU); pipelay barge); and
(iii) fabrication projects
(iv) RAPID packages ie. infrastructure/ process-equipment
But we believe such projects have been somewhat priced-in by investors judging from the price gains and/or price stickiness for some of the stocks in the quarter. Examples are:
(i) Alam Maritim (ALAM; OP; TP: RM1.86) gained 11.3% possibly due to investors factoring in Inspection, Repair, Maintenance (IRM) wins post its Diving Support Vessel (DSV) acquisition;
(ii) Perisai Petroleum (PERISAI; OP;TP: RM2.22) saw a gain of 1.9% despite weak 1Q14 results likely due to investors factoring in forward drilling; MOPU and pipelay barge contract wins; and
(iii) MMHE (MHB; UP; TP:RM3.60) saw minimal share price reaction despite weak 1Q14 results, again likely due to investors factoring in forward fabrication contracts.
Non-stop Exploration & Production M&As ahead. We were pleasantly surprised by DIALOG’s (MP; TP: RM3.92) recent announcement that it had entered into a Letter Of Intent (LOI) to farm into 20% of ROC’s participating interest in the Production Sharing Contract for the three fields D35, D21 and J4 (Fields), located offshore Sarawak, Malaysia (PSC). No purchase price has been revealed as yet but we will not be surprised if the consideration mirrors ROC oil’s farm-in terms (USD25m plus a carry with a 50% participating interest of USD80m for the project spread over Phases 1 and 2). The move by Dialog is viewed as its bid to move up the oil and gas value chain; much like its other large counterparty SKPETRO which bought outgoing Newfield assets in early-CY14. We foresee such trends to continue; especially for those that are involved in RSCs as it is a natural progression of skill sets for oil and gas companies. Market talk has it that: (i) Sona is looking to acquire 40% in Salamander’s B8/38 concession; and (ii) Enquest has agreed to take over Exxonmobil’s interest in the brownfield assets - Seligi oilfield and PM8. Talisman is purportedly looking at the sale of all or part of its Asian portfolio (which includes Malaysia) and we wouldn’t be surprised if that gets snapped up as well.
Downgrading sector call to NEUTRAL (from OVERWEIGHT). Whilst the longer term prospects of the sector are still positive given Petronas’ macro targets (i) 3-3.5% production growth per annum, (ii) reserve replacement ratio of >1.1, and (iii) ROACE of 15-20%; via (a) sweating its assets (enhanced oil recovery), (b) developing marginal/idle fields, and (c) aggressive new field exploration) we believe the coming months will be relatively quiet for the sector based on the reasons stated above. Moreover, looking at the stocks under our coverage, we note that our total weighted average upside is only 5.5% at this juncture, as the larger-cap O&G stocks under coverage have limited upsides at this juncture.
Stay picky!! Given our cautious outlook, we believe investors should be stay stock-selective and focus on companies that have significant order-book (on the premise of earnings visibility) and/or are laggards. Our Top Picks are SKPETRO and COASTAL.
SKPETRO is our large cap top pick… We like SKPETRO as it is Malaysia’s largest non-Petronas integrated oil and gas company (from exploration to fabrication and installation) which means it will be able to capture opportunities along the whole oil and gas value chain. It has also established itself in Brazil - via its pipelay barge contracts and is slowly making headway into West Africa via its drilling fleet. It currently boasts one of the largest order-books (c.RM30b) within the stocks in our coverage and is still trading an attractive CY14-15 PER of 19.9-16.9x (vis-à-vis other heavyweights such as UMW O&G that trades at CY14-15 PER of 32.7-21.7x).
COASTAL is our mid-cap pick. We favour COASTAL as it is currently a laggard in terms of valuations versus its small-to-mid-cap peers. It is currently trading at CY15 PER of 11.3x vis-a-vis YINSON that is trading at CY15 PER of 19.3x, and UZMA which is trading at CY15 PER of 13.3x. We believe the company is in the midst of a cyclical shipbuilding uptrend as evidenced by the significant RM1.2-1.3b order book. It has successfully landed a jack-up rig compression contract in Mexico and is currently searching work for their maiden jack up rig. A successful takeup will change the company's business model to asset ownership (from trading previously) which are rerating catalysts for the company.
Source: Kenanga
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