Share price skyrocketed thanks to strong earnings. Recall that we issued a report on oil refiner Petron Refining & Marketing Bhd (PETRONM) in September last year, Since then, the share price has rallied 144% underpinned by stellar earnings performance benefiting largely from low crude oil prices. In 9M15, PETRONM recorded a net profit of RM204.4m from a loss of RM16.9m last year, mainly driven by: (i) steady growth in sales volume, (ii) lower crude and petroleum prices which resulted in higher gross profit margin but partially offset by stockholding losses, and (iii) better operating efficiencies. This accounted for 94% of our projected net profit of RM217.3m where we conservatively assumed a weaker 2H15.

Are such earnings sustainable? The earnings going forward could be volatile depending on its main profit drivers, crude and petroleum product prices. In 9M15, PETRONM enjoyed much wider gross margin of 7.3% vs 1.2% a year ago as raw materials prices have fallen more than refined product, buoyed by increasing consumption. Such margins might be reversed under two scenarios; (i) recovery of crude prices which will increase cost of sales but likely to be offset by stockholding gains, and (ii) oversupply in refined products driving down selling prices. Premising on a gradual recovery in crude prices to average at USD47/bbl in FY16 and stay flattish at USD51/bbl in FY17, we project the gross refining margin to normalise to 7.6/6.3% in FY16/17E.

Remains hungry on network expansion. We believe total sales volume will continue to grow in the short-to-medium-term owing to lower fuel prices boosting consumption and aggressive expansion plans to grab market share. In FY15, PETRONM incurred capex to open 27 new service stations and 11 of them have already commenced operations. The company is also looking to widen its distribution footprint especially in rural areas by targeting 60 to 80 new service stations within the next two years. This allows PETRONM to improve its current market share of 16% against its main competitors Shell and Petronas.

Better efficiencies in logistic and distribution facilities. The additional storage capacity tanks at Port Dickson Refinery (PDR) was ready end of last year, allowing PETRONM to lower vessel delivery turnaround times and result in better loading efficiency. Furthermore, PETRON also completed its multi-product pipeline connection from PDR to the Klang Valley Distribution Terminal (KVDT). We estimate this supply chain enhancement will reduce the cost of delivery of refined products by USD0.30/bbl.

Higher earnings projection in FY16. All in, we raised our FY16E earnings projections by 147% to RM234.8m, on the back of higher gross profit/bbl of RM28.70, respectively, and higher growth assumption of 5% in total sales volume from previous estimate of 3%. Furthermore, FY17E is projected to drop 14% to RM202.8m based on: (i) lower gross profit per bbl of RM16.80, and (ii) 5% growth in bbl sold.

Current valuation appears fair. Post earnings adjustment, our revised FV now is RM7.50/share by pegging rollover targeted FY17E PER of 10x (which is our ascribed mid Cap O&G stocks’ valuation of 10.0x under the current oil price scenario). Following the strong share price performance over the past few months, current valuation for PETRONM appears fair and warrants limited upside potential. Therefore, we still have a Not- Rated call on the stock. However, we do not discount that share price might consolidate in the near term which would offer trading opportunities. 

Source: Kenanga Research - 24 Feb 2016