There was no positive surprise from the recent 2QCY16 O&G corporate report cards with the disappointment ratio maintained at 50% compared to the previous quarter. We see some seasonality improvements in operations, but overall activities remained sluggish. Going forward, we expect fiercer competition among services players arising from price slashing for cash flow and collaboration with other players for new type of jobs, which potentially reduce profitability. On the other hand, oil prices are likely to be capped below USD55/bbl due to overbuilding of oil inventories and revival of rigs count. The OPEC meeting in Algiers later this month could be a potential game changer, but we foresee no favourable outcome on production rationalisation in view of the on-going tussle for market share. All in, while another round of kitchen sinking could happen in 2H16, stay selective on financially healthy companies and watch out for strong contract flow as firm earnings recovery indicator. YINSON remains our preferred pick in the upstream segment for its resilient earnings outlook and we also like downstream players like PCHEM for its long-term growth story anchored by the RAPID project. Reiterate NEUTRAL call.

Still underwhelming. 2QCY16 report cards for the local oil and gas sector remained unexciting with half of the 16 results falling below expectations. This is largely attributable to lower-than-expected pick up in oil and gas offshore activities post monsoon season coupled with weaker margins. The sole outperformer beating expectation was DIALOG, helped by higher realised forex gains. On the flipside, we downgraded PERISAI and UZMA to UP on higher financial risk and weaker earnings prospect, respectively, in view of the prolonged downturn coupled with persistent margin compression pressure.

Mix bags of performance. In 2Q16, OSV players and drillers managed to narrow their aggregate losses from previous quarter as a result of better vessel utilisation due to seasonality. However, we gather that the daily charter rates (DCR) have not bottomed given that the price slashing has intensified arising from more desperate players trying to recoup cash to service their loan repayment and operating cost. Meanwhile, other sub-segments such as fabricators and oil-field services players also demonstrated softer earnings owing to lack of order book replenishment post project completion and continuous margin compression despite marginal increase in oil field activities. Besides, FPSO resilient earnings were challenged as operators faced collection issues from clients who are in stretched cash flows position.

Limited jobs but more desperate players. As a result of oil prices plunging for close to two years now, many services players have encountered common problems: lesser jobs, tight cash flows, unutilised vessels and ballooning debt obligations. While we believe the industry is undergoing restructuring, which allows the fittest to survive, we observed some players have collaborated to tender for jobs beyond their core competence. Thus, we expect more bidders for on the same job with some quoting significant lower prices in order to bag the contract. Following that, oil majors are more inclined to dish out contract on a lump sum basis instead of on per vessel basis, pushing the cost management obligation towards services players. In short, service players are going to face fiercer competitions and cost efficiency is the key to sail through the rough seas.

Minimal expectations on OPEC meeting. Oil prices will be capped below USD55/bbl, in our view due to over-building of oil inventories and revival of rigs count. The OPEC meeting in Algiers this month could be a potential game changer, but we remain sceptical on the outcome even though the dynamics of relationship between OPEC members have improved from the first discussion in April this year with Iran’s oil minister Bijan Zanganeh agreeing to attend the meeting. We reckon that OPEC needs to come out with a better proposal rather than merely freezing their output at their respective record high level if they want to change the fundamental of supply-demand balance. That said, any fruitful outcome will serve as a short-term catalyst to oil prices underpinned by improved trading sentiment. Maintain forecast of 2016 year-end Brent crude price at USD47/bbl.

Reiterate NEUTRAL call. Following Petronas making RM7.6b impairment on its oil assets, we do not discount the possibility of another round of kitchen sinking in 2H16 in view of weaker asset utilisation and flattish oil prices, but we opine the quantum to be smaller compared to a year ago. Industry’s average net gearing level increased slightly QoQ to 0.55x from 0.53x in 1Q16. While flattish oil prices will cap the sectors’ valuation, we advocate investors to be nimble and selective and look out for strong contract flow as firm earnings recovery indicator. In all, YINSON (OP; TP: RM3.90) remains our preferred pick within the upstream segment for its resilient earnings outlook while we like PCHEM (OP; TP: RM7.18) for its long-term growth story anchored by the RAPID project. SKPETRO (MP; TP: RM1.48), in our view, remains the best proxy to trade the volatility in oil prices given its oil production profile, which will directly benefit from stronger oil prices. Retain NEUTRAL call on the sector while awaiting for re-rating catalysts.

Source: Kenanga Research - 2 Sep 2016