In line with the broader local bourse, the sector’s results disappointment ratio narrowed to 40% from 56% in 3Q16 with higher numbers of outperformers, which are mostly Petronas stocks in the recently concluded 4QCY16 result season. However, out of our total 15 core coverage stocks, five offshore services players (DAYANG, WASEONG, ALAM, MHB and ARMADA) ended FY16 with core losses largely marred by stubbornly high fixed cost amidst lower revenue. Meanwhile, another round of kitchen sinking on unutilised vessels and doubtful debts at bigger quantum were seen in 4QCY16. Greater compliance for OPEC and other producers, including Russia to curb production is positive to oil prices stabilisation but upside is limited on continuous oil inventories build-up and rebound in rigs count. In all, we are keeping our NEUTRAL call with positive bias in view of better contract flows from Petronas and other oil majors. Maintain SKPETRO (OP, TP: RM2.09) as our sector top pick, a good proxy to ride on the gradual recovery of the sector while YINSON (OP, TP: RM4.08) is our top pick for non-Shariah compliant investors looking for earnings resiliency within the upstream space.

Disappointment ratio narrowed. In line with the broader local bourse, we saw the results disappointment ratio narrowing to 40% from 56% in 3Q16 with higher numbers of outperformers, which are mostly Petronas stocks in the recently concluded 4QCY16 result season. GASMSIA (OP, TP: RM3.04) and PETDAG (OP, TP: RM26.63) beat expectations on better sales volume while PCHEM outperformed with better ASP and stronger USD. Following that, we upgraded PETGAS (TP: RM26.63) to MP following share price weaknesses coupled with decent yield of 3%. On the other hand, the underperformers were mainly marred by slower-than-expected pick-up in the upstream activities and stubbornly high fixed costs. We downgraded ALAM (TP: RM0.23) and MHB (TP: RM0.96) to UP as we expect the near-term outlook to remain challenging, dragged by falling vessel utilisation and depleting order-book. Overall, FY17E earnings estimates were trimmed down by average 11%, whereby the downgrade quantum was smaller than average 27% in the previous quarter.

Upstream services players still in red. In 4Q16, the aggregate revenue from upstream space deteriorated 40% YoY across all sub-segments leading to cumulative operating losses for the quarter. Sequentially, asset-heavy players such as drillers and OSV charterers widened their operating losses dragged by lower vessel utilisation with no reprieve in charter rates amidst the monsoon season. What caught us by surprise was the aggregate oilfield services revenue which improved by 6% QoQ helped by better work orders from companies such as BARAKAH, DELEUM and UZMA (MP, TP: RM1.81) despite weaker seasonality. However, on a full-year basis, out of our total 15 core coverage stocks, five offshore services players (DAYANG, WASEONG, ALAM, MHB and ARMADA) ended FY16 with core losses largely marred by stubbornly high fixed cost amidst lower revenue. On the flipside, downstream players posted strong earnings improvement (+13% QoQ; +7% YoY) in 4Q16 buoyed by higher sales volume, stronger USD against MYR and better plant utilisation, leading cumulative FY16 earnings higher by 7% amidst a 5% drop in the full-year aggregate revenue.

Another kitchen sinking quarter. Within the upstream space, the aggregate impairment in FY16 was 2.3x higher than what was impaired in FY15. This is largely attributable to ARMADA (MP, TP: RM0.73) which made a cumulative impairment amount of RM1.7b on its FPSOs, subsea vessels and OSVs. Besides that, we also see an increase in the provision of doubtful debts, suggesting that companies are encountering collection issues from selective clients. Meanwhile, average net gearing heightened to 0.8x from 0.7x in 3Q16 as a result of: (i) loan drawdown for new FPSOs, and (ii) reduction in equity value post impairment. Moving forward, we expect impairment to persist especially on the OSV segment in view of an oversupplied market.

Production curb near 100% compliance. As February data showed an increase in compliance to 100% from 90% in January to reduce output from the OPEC nations, we do not discount the possibility of an extension of the output cut after 6 months which will be decided in the next OPEC meeting in May. On the other hand, US rigs count and inventory also continued with its uptrend and new president, Trump’s protectionism policy is inclined to exacerbate the situation. Hence, we believe in the nearterm, oil prices outlook will be rather flattish unless more aggressive measures are proposed to curb production. All in, we retain our in-house Brent oil forecast of USD55/bbl in 2017. Domestically, better contract flow is seen in 1Q17 across different subsegments. YTD, we have seen contract flow being awarded for drilling, FPSO, oilfield services segments, although contract value are undetermined for certain contracts depending on actual work orders. Such trend is expected to continue and we foresee stronger earnings in 2H17 when these contracts start kicking in.

Keeping NEUTRAL call with positive bias in view of better contract flows from Petronas and other oil majors. All in, we maintain SKPETRO (OP, TP: RM2.09) as our sector top pick, a good proxy to ride on the gradual recovery of the sector while YINSON (OP, TP: RM3.79) is our top pick for non-Shariah compliant investors looking for earnings resiliency within the upstream space.

Source: Kenanga Research - 6 Mar 2017