Petronas’s 1Q16 core net profit dampened 63% YoY to RM3.6b in tandem with a 26% plunge in revenue dragged by lower averaged realised product prices and lower crude oil and condensates, processed gas and petroleum sales volume. We do not foresee an immediate recovery in upstream segment as Petronas will continue its significant cutback in capex even though oil prices have been stabilising above USD40/bbl, which is higher than Petronas’s internal oil prices benchmark of USD30/bbl upon project assessment. While the prolonged downturn and lacklustre outlook in the upstream segment is likely to persist, we like PCHEM (OP; TP: RM7.31) for its long-term growth story anchored by the RAPID project. FPSO players like YINSON (OP; TP: RM3.92) will continue to be resilient due to their robust recurring cash-flow generation. All in, reiterate NEUTRAL call on the sector in view of tougher operating environment and lack of re-rating catalyst.

Core net profit plunged 63% YoY. Petroliam Nasional’s (Petronas) 1Q16 PATAMI fell 71% YoY to RM2.6b in tandem with 26% drop revenue as a result of lower average realised prices recorded across all products and lower sales volumes of crude oil and condensates, processed gas and petroleum product. However, this was partially offset by a weaker ringgit and lower product and production cost. Stripping off asset impairment of RM924m, Petronas’s core net profit would have fallen 63% YoY to RM3.6b. Sequentially, Petronas managed to return to the black from a reported loss of RM4.7b in 4Q15 due to lower impairment charges. Excluding such one-off item, its CNP also fell 48% from RM6.9b, dragged by both weaker upstream and downstream performance.

Refining margins fallen. Downstream segment’s PAT was down by 42% YoY to RM1.1b in 1Q16 mainly marred by falling feedstock prices and weakening refining and marketing margins (5% net margin in 1Q16 vs 7% in 1Q15) despite higher sales in line with higher production on the back of improved feedstock supply. Investment wise, the Pengerang Integrated Complex (PIC) project is on schedule at 28% completion while the Sabah Amonia Urea (SAMUR) project is 99% completed and slated to start operation next month.

Weaker operating cash flow. In tandem with the decrease in lower revenue, Petronas’s operating cash flow has weakened by 44% to RM9.7b. In line with the company’s key priority to conserve cash, Petronas 1Q16 capital expenditure dropped 83% QoQ to RM11bil. It could also partly due to seasonality as we only saw a 7% decline in capex figure compared to a year ago. The capex spent was largely attributable to its on-going domestic Refinery and Petrochemical Integrated Development (RAPID) project in Johor as well as international upstream projects in Canada and Azerbaijian. We believe Petronas is unable to fund both its entire capex amount and dividend payment (committed at RM16b in 2016 vs RM26b in 2015), but it should not be a major concern given its net cash position of RM62b as of 1Q16.

Recovery in sight? In our view, we do not foresee an immediate recovery in upstream segment as Petronas will continue its significant cutback in capex even though oil prices have been stabilising above USD40/bbl, which is higher than Petronas’s internal oil prices benchmark of USD30/bbl upon project assessment. Having said that, in order to enhance cost efficiency within the industry, there is a possibility that Petronas would raise the criteria for job awards to competitive and financially sound players. It will probably fasten the consolidation pace among nonlisted O&G companies and this would benefit the listed players which have stronger financial muscles.

Maintain NEUTRAL. While the prolonged downturn and lacklustre outlook in the upstream segment is likely to persist, we like PCHEM (OP; TP: RM7.31) for its long-term growth story anchored by the RAPID project. FPSO players like YINSON (OP; TP: RM3.92) will continue to be resilient due to their robust recurring cash-flow generation. All in, reiterate NEUTRAL call on the sector in view of tougher operating environment and lack of rerating catalyst.

Source: Kenanga Research - 19 May 2016