Petronas’s 4Q16 core earnings recovered strongly by +113% QoQ and +79% YoY, helped by lower product and production costs. In 2017, we believe Petronas’s operating cash flow at most will be sufficient to cover its committed capex of RM60.0b and not able to fully fund its dividend commitment
of RM13.0b (vs RM16.0b in FY16). However, this is not alarming, in our view, as Petronas’ balance sheet remains healthy with net cash position of RM53.9b as of 4Q16 even though it has deteriorated from RM66.8b in 4Q15. Meanwhile, we believe the recent oil prices pull-back will not affect Petronas’ spending given that the local oil major has pegged its capex spending at average USD45/bbl, which is relatively conservative as compared to EIA forecast of USD54/bbl. 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: RM4.08) is our top pick for non-Shariah compliant investors looking for earnings resiliency within the upstream space. Reiterate NEUTRAL on the sector with positive bias in view of better contract flows from Petronas and other oil majors.

FY16 core PAT (excluding impairment) up 2% YoY. Petronas’ core earnings in 4Q16 jumped by 113% QoQ to RM15.1b from RM7.1b in 3Q16, thanks to stronger contribution (+52% QoQ) from downstream segment backed by better margins despite lower crude and petroleum products as well as petrochemical products sales volume. On a YoY basis, despite revenue declining by 3% YoY, led by lower processed gas and LNG prices (JCC price -20% YoY), Petronas’ core PAT surged 79% YoY from RM8.4b helped by lower product and production cost and favourable forex exchange rate. Cumulatively, Petronas’ core PAT inched 3% YoY to RM40.1b in FY16 from RM39.2b in FY15, despite 17% lower top-line, on similar reasons as mentioned above coupled with lower taxation (-36% YoY) but was partially offset by lower average realised prices (Brent prices -17% YoY, JCC prices -36%). Meanwhile, impairment quantum has eased by almost half to RM10b in FY16 following stabilisation of oil prices.

Stronger QoQ cash flow from operations. Petronas recorded higher EBITDA (+45% QoQ) in 4Q16 with the absence of oneoff payment for the FPSO facility for the early termination of RSC recorded in 3Q16. The company’s operating cash flow (OCF) in 4Q16 strengthened (+69% QoQ? -4% YoY), in tandem with higher EBITDA. However, cumulatively, FY16 OCF still declined by 23% YoY due to weaker performance in the previous quarters. Meanwhile, Petronas spent RM14.9b on capex in 4Q16 (+35% QoQ, -3% YoY), bringing its YTD capex to RM50.4b (-22% YoY). We reckon the increase in capex is attributable to the ramping up in Pengerang Integrated Complex project which is at 60% completion as of Feb 2017. Moving forward, as mentioned by Petronas president and CEO Datuk Wan Zulkiflee Wan Ariffin during a press briefing last month, Petronas is looking to commit capex of c.RM60b (+17% YoY) this year with Brent crude oil prices pegged at average of USD45/bbl.

Committed to pay RM13.0b dividend this year. In FY17, we believe Petronas’ OCF at most is sufficient to cover its committed capex of RM60.0b and not sufficient to fully fund its dividend commitment of RM13.0b (vs RM16.0b in FY16). However, this is not alarming, in our view, given that Petronas’ balance sheet remains healthy with net cash position of RM53.9b as of 4Q16 even though it has deteriorated from RM66.8b in 4Q15.

Short pull-back in oil prices. Oil prices have weakened 9% to USD51.4/bbl within a week after a few months of stabilisation largely due to reignited concerns on building oil stocks and revival of rigs count in US coupled with moderation of oil demand growth. This is not surprising to us as US shale producers were the biggest beneficiaries, evident by a 10% growth since the production cut announcement in December last year. While the positives from the production cut between OPEC and non-OPEC nations could have been priced in, we are still expecting consistent compliance from the OPEC nation and higher compliance from Russia from current level till end of June. Additionally, we reckon that the market is building in expectations for an extension after the six-month period which will be decided in the next OPEC meeting in May. All in, we retain our in-house Brent oil forecast of USD55/bbl in 2017.

Retain NEUTRAL. We believe the recent oil prices pull-back will not affect Petronas’ spending given that the local oil major has pegged its capex spending at average USD45/bbl, which is relatively conservative as compared to EIA forecast of USD54/bbl. However, capex and opex allocations will remain rather selective as Petronas will continue to prioritise cash flow management amidst tight capex spending. Following recent contract announcement of Pan Malaysia T&I contract to SKPETRO, we are expecting more contracts such as maintenance, construction and modification job and IRM Peninsular Malaysia to roll out in the next few months. Potential beneficiaries are SKPETRO, DAYANG, ALAM and BARAKAH. 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: RM4.08) is our top pick for non-Shariah compliant investors looking for earnings resiliency within the upstream space.

Source: Kenanga Research - 15 Mar 2017