1Q17 core PAT up 25% YoY. Petronas’ core earnings in 1Q17 improved by 25% YoY to RM10.5b from RM8.4b in 1Q16, thanks to higher average realised prices recorded (Brent prices +59% YoY, JCC prices +32%), strengthening of USD against Ringgit (+6% YoY) as well as higher gas sales volume (+2% YoY). Note that downstream segmental earnings also jumped by 1.6x underpinned by higher average selling prices and better margins as a result of improved plant utilisation to 86% from 83% in 1Q16. (PAT margins of 10.6% vs 5.3% in 1Q16). Sequentially, Petronas’ core PAT was down 15% from RM12.3b in 4Q16 despite revenue growing 5% largely bogged down by higher amortisation of oil & gas properties and higher tax expense (+19% QoQ) and higher net forex loss.

Higher EBITDA both QoQ and YoY. Petronas recorded higher EBITDA (+12% QoQ, +58% YoY) in line with better average realised prices. Apart from higher top-line, based on our channel checks, Petronas has requested for further rates cut on services cost in the beginning of the year. Thus, we saw its controllable opex cost down by 3% YoY and operating cash flow (OCF) in 1Q17 strengthened (+2% QoQ? +86% YoY), in tandem with higher EBITDA. Meanwhile, Petronas spent RM11.9b on capex in 1Q17 (-18% QoQ, +6% YoY), of which 92% are attributable to local investment. We reckon the bulk of it was attributable to committed investment in Pengerang Integrated Complex project, which was at 63% completion as of Mar 2017. Moving forward, Petronas will continue to embark on cost optimisation measures to lower its cost base. Petronas had spent an average capex of RM36b/annum in the past five years with c.60% allocated to upstream segment. Capex-wise, we believe higher priority will be given to downstream segment, particularly on RAPID project in the near term.

Committed to pay RM13.0b dividend this year. No dividend was paid in 1Q17 as expected. In FY17, we believe Petronas’ OCF at most is sufficient to cover its committed capex of RM60.0b but might not be 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 RM59.2b as of 1Q17, improving from RM53.9b in 4Q16.

Potential deeper production cut? The decision of OPEC and non-OPEC members agreeing to extend production cut for 9 months was slightly disappointing as some parties were expecting deeper production cuts. With this outcome, we expect oil prices to trade at a lower range of USDS48-52/bbl in the near term vs. USD53-57/bbl during the initial cut in Dec 2016. However, better oil prices could be seen in 2H17 banking on stronger demand and potential further price propping actions led by Saudi ahead of valuations for Saudi Aramco’s IPO. Recently, news reported that OPEC could revisit the proposal for a further cut of up to 300k bbl/day from existing 1.2m bbl/day cut. However, such proposal is very much dependent on the reaction of other OPEC producers as well as non-OPEC countries. All in, we retain our in-house Brent oil forecast of USD55/bbl in 2017.

Retain NEUTRAL. Within the local scene, as higher priority is given by Petronas to downstream and most of them are considered commitment investment, it is unlikely to see further adjustment to it at the expense of upstream segment should Petronas decide to trim down its capex budget. Hence, any cut from upstream space will be dependent on the degree of project maturity and certainty of requirement. Petronas has earmarked 10-15 greenfield projects and 20-25 brownfield projects for 2017- 2019. The long-awaited MCM contract amounting to RM5b is likely to be out in 2Q17. All in, we reiterate our NEUTRAL call on the sector but remain bullish on FPSO players such as ARMADA (OP; TP: RM0.90) and YINSON (OP; TP: RM3.73) and services players like DAYANG (OP; TP: RM1.30) and UZMA (OP; RM2.05) which are potential beneficiaries from new round of contract award within the opex space.

Source: Kenanga Research - 5 Jun 2017