Oil price is down 16% YTD, retesting the low of USD44/bbl level on persistent oversupply concerns from rising US production and record-high production in Nigeria and Libya. While fundamentals are far from rosy, we expect oil prices to recover from the low in 2H17 with higher magnitude of inventory draw-down and higher crude consumption and also do not discount the possibility of deeper production cut from OPEC if prices continue to fall. The rig count in US is expected to continue its uptrend but the pace of increase is seen moderating in the near term. In all, we still cut FY17 average Brent crude price assumption to USD51/bbl from USD55/bbl previously following a sharp correction in oil prices in the past few months. For 3Q17, our preference is still on resilient earnings counters backed by firm contracts but do keep an eye on SENERGY ((MP; TP: RM1.80), a sector proxy for potential rebound in oil prices with our preferred entry level at RM1.50. Keep NEUTRAL view on the sector with positive bias with WASEONG (OP; TP: RM1.10) as our top pick for the quarter.

Slightly better oil fundamentals in 2H17. Following the sharp correction in oil prices bogged down by fear of persistent oversupply resulting from US production and uptick of production from Nigeria and Libya, we reckon the recent low of USD44/bbl could be oversold in the near term amidst such bearish sentiment. We believe oil fundamentals will recover from low in 2H17 premised on higher magnitude of inventory draw-down and higher crude consumption while do not discount the possibility of deeper production cut from OPEC if prices continue to fall. The rig count in US is expected to continue its uptrend but the pace of increase to moderate in the near term. Recall that OPEC and non-OPEC members agreed to extend production cut at similar quantum for another 9 months till end of March next year. In all, we lowered our forecast for average FY17 Brent crude price to USD51/bbl from USD55/bbl.

Looking for sentiment-driven trading opportunities. In tandem with oil prices falling by 20% from its YTD high, as of our report cut-off date of 23 June 2017, the local O&G stocks have retraced by an average 14% from its YTD high as well. Although this has yet to hit the low in 2016, which is also the all-time low for most of the O&G counters in end-October last year when global markets remained uncertain ahead of US election, we reckon such retracement present “sentiment-driven trading” opportunity for traders to buy on weakness and sell on strength. The degree of correlation of a particular stock towards oil prices basically depend on the extent of oil prices affecting the bottom-line. For instance, companies with oil field exposure, such as SENERGY (MP; TP: RM1.80) and HIBISCS (Not-Rated), are often regarded as the closest proxy to oil prices given that every dollar change in crude prices will have direct impact on the earnings performance. This is often followed by services players which are dependent on capex spending from oil majors such as fabricators MHB (UP; TP: RM0.80), drillers UMWOG (NotRated) as well as OSV players ALAM (UP; TP: RM0.15), ICON (Not-Rated). Based on our analysis, SENERGY has the highest correlation to oil prices over the past one year at 0.65, followed by ICON and HIBISCS at 0.64x and 0.60, respectively.

Earnings resiliency play in WASEONG, YINSON and ARMADA. In a longer run, other investment strategy available is to look out for counters which demonstrate earnings resiliency backed by firm contracts. These companies’ earnings are less susceptible to fluctuation in oil prices in the near term and thus, the level of retracement is also relatively lower when oil prices turn south. Within our coverage, we have identified ARMADA (OP; TP: RM0.90), YINSON (OP; RM4.05) and WASEONG (OP; TP: RM1.10) as candidates. ARMADA and YINSON are both FPSO players with successful delivery of new projects this year. Thus, we expect earnings to improve QoQ with the recognition of charter income from these new projects. Meanwhile, WASEONG is also expected to register better profit in the coming quarters with the ramping up of pipe coating activities backed by on-going mega project, Nord Stream 2.

Reiterate NEUTRAL. If the recent weakness in oil prices were to persist, this would lead to further tightening of oil majors’ spending. Petronas has earmarked 10-15 greenfield projects and 20-25 brownfield projects in 2017-19. In our view, brownfield projects will remain intact as their feasibilities are less sensitive to oil prices opex-rated jobs in shallow water region will be prioritized to reap the low hanging fruits. In the 2Q17, we saw stronger contracts flows (+1.5x QoQ; 11.6x YoY) for the two consecutive quarters and the strong uptick in contract flow is skewed by the USD1.0b FPSO job for Ca Rong Do field secured by YINSON. Moving forward, apart from the widely discussed maintenance, construction and modification job estimated at RM4.0-6.0b where potential winners are DAYANG and PENERGY, based on our channel checks, Petronas has opened the integrated logistic tender to support production operations for all Petroleum Arrangement Contractors (PAC). The 3-5 year contracts are split into 25 packages, estimated to be worth up to RM4.0b. We believe most listed OSV players stand a chance to share the pie. With the lower oil prices assumption, we lower our valuation multiples on fabricators and oil producers in view of potential delay in roll-out of new greenfield projects and higher impairment risk from oil and gas assets, respectively. Thus, we lower SENERGY and MHB’s target prices but maintain their MP/UP calls.

Source: Kenanga Research - 6 Jul 2017