Petronas’s 9M16 report card remains unexciting due to lower YoY core PAT and deteriorating operating cash flows. Going forward, we expect its net cash position to weaken further as the operating cash flow generated in 9M16 is merely sufficient to cover its committed capex while the remaining committed dividend payment of RM4.0b is due in 4Q16. Thus, we continue to hold the view that capex and opex allocations will be rather selective. New round of contract awards from Petronas such as Pan Malaysia T&I contract and topside maintenance job are likely to materialise in the nearterm and potential beneficiaries are SKPETRO, DAYANG and BARAKAH. While flattish oil prices will cap the sectors’ valuation, we advocate investors to avoid highly leveraged stocks and look out for those with strong contract flows as firm earnings recovery indicator. In all, YINSON (OP, TP: RM3.92) remains our preferred pick within the upstream segment on its resilient earnings outlook. SKPETRO, 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.

9M16 core PAT down 19% YoY. Petronas’s core profit after tax and identified items, which mainly comprises net impairment of assets in 3Q16 dropped by 24% QoQ to RM7.0b from RM9.4b in 2Q16, largely attributable to weaker contribution (-17% QoQ) from downstream segment as a result of lower crude and petroleum products sales volume. On a YoY basis, despite revenue falling 19% YoY led by lower average realised prices recorded across all products (-9% YoY Dated Brent prices) and lower crude oil and condensate sales volume, Petronas’s core PAT was up 12% YoY from RM6.3b due to lower product and production cost and favourable forex exchange rate. Cumulatively, Petronas’s core PAT weakened 19% YoY to RM24.8b in 9M16 from RM30.8b in 9M15, in line with 22% lower top line, on similar reasons as mentioned above but was partially offset by the cost saving impact arising from continuous cost optimisation measures.

Weaker QoQ cash flow from operations. Petronas recorded lower EBITDA (-14% QoQ) due to one-off payment for the FPSO facility for the early termination of RSC. The company’s operating cash flow (OCF) in 3Q16 continued to weaken (-34% QoQ? -37% YoY), resulting in its cumulative OCF to drop 29% YoY to RM36.1b in 9M16 in tandem with lower revenue. Meanwhile, Petronas recorded capex of RM10.7b in 3Q16 (-23% QoQ, -40% YoY), bringing its YTD capex to RM35.9b (-28% YoY). The investment made is mainly attributable to RAPID project in Pengerang, other domestic upstream projects and SAMUR project in Sabah. Basically, the local oil major’s performance is largely within expectations as operating cash flow remains in downtrend despite moderation in capex and opex.

Net cash position expected to weaken further. Petronas’s balance sheet remained firm with net cash position of RM51.9b even though it has deteriorated from RM66.8b in 4Q15. Going forward, we expect its net cash position to further weaken as the operating cash flow generated in 9M16 is merely sufficient to cover its committed capex. Note that PETRONAS is committed to pay RM16.0b dividend this year, RM10.0b lower than a year ago. Petronas has paid RM12.0b worth of dividend in 9M16 and is expected to pay the outstanding RM4.0b in 4Q16. Therefore, Petronas will continue to prioritise cash flow management amidst tight capex spending. We continue to hold the view that capex and opex allocations will be rather selective. New round of contract awards from Petronas such as Pan Malaysia T&I contract, topside maintenance job and IRM Peninsular Malaysia are likely to materialise in the near-term and potential beneficiaries are SKPETRO, DAYANG and BARAKAH.

OPEC Yes or No? Crude prices have been very volatile, responding to OPEC-related news. Despite being sceptical over the possibility of a successful outcome in the coming meeting at the end of the month, we reckon OPEC will strive to make more progress to avoid losing credibility after multiple discussions. That said, we believe oil prices outlook will be capped when the market refocuses back on revival of US shale gas production. Recent news report quoted Scott Sheffield, CEO of Permian basin-based company Pioneer Natural Resources who said that the region is likely to be comparable with the conventional production from the Middle East at breakeven price of USD30/bbl following service cost rationalisation and productivity gain. He also estimated that Permian basin which contributed almost a quarter of US production to hit 5m bbl/day in 10 years’ time from current production of 2m bbl/day.

Retain NEUTRAL. Overall, Petronas’s weakening net cash position is no surprise to us amidst challenging operating environment. In view of flattish oil prices (maintaining our forecast 2016-17 average Brent crude price at USD47-51/bbl), the sector will remain unexciting with limited catalysts. We advocate investors to avoid highly leveraged stocks and look out for strong contract flow as firm earnings recovery indicator. In all, YINSON (OP, TP: RM3.92) remains our preferred pick within the upstream segment on its resilient earnings outlook. SKPETRO, 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.

Source: Kenanga Research - 17 Nov 2016