Petronas’s 1H17 core earnings improved by 12% YoY on the back of better performance from both upstream and downstream segments. Steady cash flow from operations with widening OCF to capex ratio and improving EBITDA also strengthened its net cash position to RM63.9b. The recent portfolio reshuffling may not be seen as beneficial to the local upstream space as not much attention is given as far as the local services players are concerned. This could be due to the pull-back in capex and opex spending that was disrupted by the volatility of oil prices in 2Q17, further delaying some of the contracts awards, including MCM, which was initially anticipated in 2Q17. Meanwhile, we believe the potential disruption leading to refineries, platforms and terminals shutdown in US caused by Hurricane Harvey is temporary and thus unable to sustain the run-up in oil prices. We are still maintaining our FY17E Brent crude forecast of USD51/bbl in view of limited re-rating catalyst to fundamentally lift oil prices to the USD60/bbl level. Likewise, the support for oil prices is buoyed by higher magnitude of inventory draw-down on healthy oil demand and consumption. All in, our preference is still on counters with resilient earnings backed by firm contracts. Keep NEUTRAL view on the sector with positive bias with WASEONG (OP; TP: RM1.10) as our top pick for the quarter.

2Q17 core PAT inched marginally YoY. Sequentially, Petronas’ core PAT was down 6% to RM9.8b from RM10.5b in 1Q17 in tandem with revenue falling by 16% as a result of lower realised prices (Brent prices -7% QoQ, JCC prices +15% YoY) and lower sales volume for oil & condensate and LNG. Petronas’ core earnings in 2Q17 improved by 2% YoY to RM9.8b from RM9.7b in 2Q16, thanks to higher average realised prices recorded (Brent prices +9% YoY, JCC prices +66% YoY), strengthening of USD against Ringgit (+8% YoY) offsetting lower sales volume for crude oil and condensate and petroleum products. Cumulatively, 1H17 core earnings also improved by 12% to RM20.2b backed by 18% revenue growth due to higher average realised prices masking steeper amortisation of oil & gas properties and tax expense.

Healthier balance sheet. Despite EBITDA falling 16% QoQ in tandem with weaker prices, the margins were sustained at 39.9% in 2Q17, improving from 37.8% in 2Q17 thanks to consistent cost optimisation. With that, cumulatively, we saw its controllable opex cost softening by 3% YoY and operating cash flow (OCF) in 1H17 strengthening by 56%. Meanwhile, Petronas spent RM9.4b on capex in 2Q17 (-21% QoQ, -32% YoY), bringing its 1H17 capex spending to RM21.2b (-16% YoY) of which the bulk of it was attributable to committed investment in RAPID (at 70% completion as of June 2017). Meanwhile, RM6.5b dividend was paid in 2Q17 as expected, but in line with better earnings, Petronas has increased its commitment by RM3.0b to pay total dividends of RM16.0b this year. Net cash position has improved to RM63.9b from RM59.2b as of 1Q17 coupled with stronger OCF widening its OCF to capex ratio to 2.3x from 1.5x as of 1Q17.

Both upstream and downstream segments improved in 1H17. Operationally, both upstream and downstream segments fared better in 1H17. Downstream earnings improved 46% underpinned by higher petrochemical sales (from SAMUR) despite lower crude and petroleum products sales while upstream segments returned to the black thanks to cost re-basing and increase in production in MLNG supply system offsetting lower Iraq production entitlement, lower activities in Canada and higher decline rate in Malaysia-Thai Joint Development AREA and Egypt. Moving forward, Petronas expects production cost per unit of USD6.8/bbl in FY17.

Portfolio reshuffling. Following the abandonment of the Pacific NorthWest LNG project at Port Edward in British Columbia, Canada, Petronas is exiting blocks 01 and 02 in the Cuu Long basin, Vietnam upon the expiry of PSC next month as well as Algeria, which are deemed to be less profitable ventures. Even so, being the third largest global LNG player, Petronas remains committed to developing its LNG business and growing its international businesses in a longer run amidst an unexciting oil price environment. Petronas has recently expanded its exploration portfolio with the award of shallow water Block 6 in the Gulf of Mexico’s Salina Basin in a 50:50 partnership with Ecopetrol, Colombia’s national oil company. We view this as a positive strategy for the oil major to continue its growth trajectory, but it may not be seen benefiting the local upstream space as not much attention is given as far as the local services players are concerned. This could be due to the pull-back in capex and opex spending that was disrupted by the volatility of oil prices in 2Q17, further delaying some of the contracts awards, including MCM, which was initially anticipated in 2Q17.

Retain NEUTRAL. We believe the potential disruption leading to refineries, platforms and terminals shutdown in US caused by Hurricane Harvey is temporary and thus is unable to sustain the run-up in oil prices. We are still maintaining our FY17E Brent crude forecast of USD51/bbl in view of limited re-rating catalyst to fundamentally lift oil prices to USD60/bbl level. Likewise, the support for oil prices is buoyed by higher magnitude of inventory draw-down on healthy oil demand and consumption. All in, our preference is still on counters with resilient earnings backed by firm contracts. Keep NEUTRAL view on the sector with positive bias with WASEONG (OP; TP: RM1.10) as our top pick for the quarter.

Source: Kenanga Research - 28 Aug 2017