We are positive on the OPEC meeting’s outcome given that OPEC and non-OPEC member, Russia, finally arrived at an agreement to cut production totalling 1.8m bbl/day. This will boost the near-term sentiment, serving a fresh catalyst to the local O&G sector after a disappointing 3QCY16 results season with disappointment ratio increasing to 56% from 50% compared to the last quarter. However, note that actual execution of the agreement is the key to sustainability of oil prices, which will eventually translate into a meaningful recovery of the sector in terms of higher spending and investments. Furthermore, we do not discount the possibility that market could refocus back on a revival of US shale gas production, evident by the continuous rebound of US rig counts. Overall, we expect the local oil and gas stocks to see an uplift with oil producers such as SKPETRO and HIBISCS being the key earnings beneficiaries. Reiterate NEUTRAL with positive bias as production cut will boost oil majors’ confidence to commit to new projects and hence shortening the time lag of 6 to 12 months for new investment cycle to pick up.

OPEC cutting production! OPEC announced that it had reached an agreement to cut production by 1.2m bbl/day (c. 1.3% of global production) to bring down its ceiling to 32.5m bbl/day, effective 1st Jan 2017. Meanwhile, non-OPEC member, Russia will also join the effort by lowering 600k bbl/day of production. The agreement will be a six-month accord, extendable by another six months, monitored by a committee. While we are positive on the outcome as it will boost the near-term sentiment, the actual deal execution is the key to sustainability of oil prices, which eventually translates into meaningful recovery of the sector in terms of higher spending and investments. Furthermore, we do not discount the possibility that the market could refocus back on revival of US shale gas production, evident by continuous rebound of US rig counts. Overall, we expect the local oil and gas stocks to see an uplift with oil producers such as SKPETRO and HIBISCS being the key earnings beneficiaries. Reiterate NEUTRAL with positive bias as a production cut will boost oil majors’ confidence on oil prices outlook and hence shortening the lag of 6 to 12 months for new investment cycle to pick up.

Another disappointing quarter. In the recently concluded 3QCY16 results reporting season, 9 out of 16 results within our coverage falling below expectations, widening to 56% disappointment ratio from 50% last quarter which led to further cut in average FY16-17E earnings by 12-27%. This is largely due to slower-than-expected pick-up in the upstream activities and stubbornly high fixed costs corroding margins. We upgraded UZMA and DAYANG to MP coupled with stronger quarterly results rendering less downside risk following share price weaknesses. On the other hand, we downgraded PCHEM and PETGAS to MP and UP, respectively, as near-term positives are already priced in. Meanwhile, in view of the absence of catalysts, continuous lacklustre performance, high financial risk as well as the lack of investment interests, we have dropped PERISAI from our core coverage.

Upstream services players still in the red. In 3Q16, drillers widened their aggregate losses from previous quarter as a result of lower vessel utilisation as contracts expired without being renewals coupled with weakening daily charter rates. Meanwhile, we observed that OSV players’ aggregate losses narrowed marginally thanks to stronger top line backed by better vessel utilisation and better cost efficiency post aggressive cost rationalisation. 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. FPSO players have mixed bags of performance whereby ARMADA’s earnings were bogged down by prolonged non-performing vessels and tail-end of FPSO conversion projects while YINSON continued to deliver steady earnings from its financially sound clients. Lastly, downstream players posted earnings improvement (+8% YoY; +2% YoY) buoyed by higher sales volume and plant utilisation.

Deteriorating fundamentals. The local oil and gas sector continued to underperform the FBMKLCI in the past three months with a quarterly performance of -18.5% vs. FBMKLCI’s -3.5%, led by PERISAI (-72.7%), ALAM (-33.3%) and ARMADA (-31.5%) despite crude oil prices surging up by 4.3%. On the flipside, the only performers were downstream related players, DIALOG (+3.9%) and PCHEM (+2.1%). Valuation-wise, the average sector implied Fwd. PBV continued to deteriorate to 0.5x as of end-November from 0.6x three months ago. We attribute such weakness to (i) poorer earnings outlook, (ii) higher impairment risk and (iii) heightening financial risk, especially after both Swiber and PERISAI’s debt defaults. Impairment quantum moderated QoQ, but we expect kitchen sinking to pick up again in 4Q16 in view of weaker asset utilisation and flattish oil prices. Companies with relatively high impairment risk include ALAM, UMWOG, WASEONG and ARMADA.

Source: Kenanga Research - 1 Dec 2016