· Oil refiner and distributor, the bright spot among O&G counters. Amid the sharp downturn in oil prices, O&G upstream services players are hit with industry-wide cut and slowdown in contracts, thereby making investors’ appetite for the sector subdued. However, oil refiner Petron Refining & Marketing Bhd (PETRONM) could be worth a second look given the current favourable movement in the oil price. In 1H15 alone, the group swung to a net profit of RM130.2m from a loss of RM8.2m despite flattish barrels of oil products sold. This was mainly due to the sharp drop in crude oil prices, which led to sharply lower cost of sales YoY, further helped by slower drop in selling price per bbl. We expect the trend to continue for the rest of the year albeit at a weaker rate as selling price normalises and results in lower gross margin.

· Oil refiner and crude product distributor. PETRONM has its roots in the Philippines as its parent company, Petron Corporation is the largest oil refining and distribution company there, which supplies nearly 40% of the country’s oil requirements. In 2011, it penetrated into the Malaysian market through the acquisition of Exxonmobil’s downstream subsidiaries, which was then renamed PETRONM. PETRONM owns and operates the Petron Port Dickson Refinery (PDR), which has a rated capacity of 88,000 bbls/day, providing a wide range of products, including gasoline, diesel, lubricant, liquefied petroleum gas (LPG) and industrial and commercial fuels.

· Cost savings to be achieved with KVDT connection. PETRONM is joining the industry bandwagon upon the completion of its pipeline connection to the Klang Valley Distribution Terminal (KVDT). Currently th this is based from its Port Dickson Refinery. Located in Dengkil, Selangor, the new KVDT which stores petroleum products to be distributed in the Klang Valley will results in a more efficient petroleum product distribution for the group. It houses a storage and distribution terminal capable of storing up to 140,000 cubic metres of hydrocarbon products. The facility is located on a site covering more than 60 acres in the Klang Valley corridor between Kuala Lumpur and the West Coast of Malaysia, where the demand for petroleum products is the highest and most concentrated. Before this, gasoline and diesel products from Petronas and Shell refineries at Melaka and Port Dickson will arrive at the terminal via a multi-product pipeline.

· Earnings to recover significantly. We project its earnings to recover to RM217.3m in FY15 from a loss of RM64.5m in FY14 on the back of: (i) higher gross profit per bbl of RM20.8/bbl compared to RM4.4/bbl as we forecasted a 29% drop in the selling price/bbl against 34% drop in cost of sales, and (ii) 3% growth in bbls sold, which is roughly in line with the local economy’s GDP growth expectation. Moving forward, we projected lower profit of RM95.1m in FY16E on the back of: (i) slightly lower gross profit/bbl of RM15.4/bbl on the expectations of normalisation in crude product distribution margin as the oil price movement turns less volatile, and (ii) 3% volume growth on petroleum products sold.

· Not-Rated with FV of RM3.17/share. By pegging FY16E EPS to target PER of 9x (which is higher than 8x ascribed to our Small-Mid Cap O&G stocks under the current oil price scenario due to its exposure to downstream refining and retailing segment), we arrived at a fair value of RM3.17/share. Although we do not deny that oil refiners and retailers have done well recently due to the sharp drop in crude oil prices resulting in significantly lower cost of sales in contrast to stickier selling price adjustment, we believe that the gross margin of crude products will normalise in the long run, thereby putting downward pressure on its current strong earnings streak as the crude oil price movement stabilises. Therefore, we have a Not-Rated call on the stock.

Source: Kenanga Research - 10 Sep 2015