In the recently concluded 2QCY17 result season, we saw a lower number of outperformers, at only 4 companies from 9 in the previous quarter while the disappointment ratio stayed flattish at 27% in 2Q17. Within the upstream space, earnings disappointment largely came from offshore services players such as MHB, UZMA, WASEONG and DAYANG, dragged by lower-than-expected work orders and delay of contract award by oil majors. Meanwhile, FPSO players continued to deliver positive set of results driven by incoming and existing long-term FPSO charters. Moving forward, we expect better contract flow in 2H17 following few months of contract delay as a result of pullback in capex and opex spending that was disrupted by the volatility of oil prices in 2Q17, paving for better earnings outlook in 2018. On 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 resilient earnings counters 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.

Lower number of outperformers. In the recently concluded 2QCY17 result season, we saw lower number of outperformers, at only 4 companies from 9 in the previous quarter. Note that these four counters, namely COASTAL, (MP; TP: RM1.25), DIALOG (OP; TP: RM2.30), PANTECH (OP; TP: RM0.75), and YINSON (OP; TP: RM4.05) had registered positive earnings surprises for at least the consecutive two quarters. On the flipside, the disappointment ratio stayed flattish at 27% in 2Q17, whereby within the upstream space, these disappointments largely came from offshore services players such as MHB (UP; TP: RM0.65), UZMA (OP; TP: RM1.65), WASEONG (OP; TP: RM1.10) and DAYANG (OP; TP: RM1.10), dragged by lower-than-expected work orders and delay of contract award by oil majors. Following that, we cut our two-year forward earnings by 24%/3% given our less optimistic view on 2H17’s earnings outlook. Having said that, we upgrade PANTECH and DIALOG to OP call as we see stronger earnings prospects largely backed by robust development of RAPID in Pengerang as well as their decent valuations.

Challenging operating environment. In 2Q17, Despite recording 16% QoQ growth due to seasonality, the aggregate revenue from upstream space deteriorated 11% YoY (cumulative 1H17 aggregate revenue dropped 26%) across most sub-segments. Asset-heavy players such as drillers managed to narrow their operating losses helped by higher rig utilisation resulting from a higher number of short-term contracts and lower depreciation post impairment while OSV charterers widened their operating losses dragged by poor vessel utilisation with no reprieve in charter rates despite spot charter space still active. What caught us by surprise was the aggregate earnings for oilfield services players falling 67% QoQ even though the aggregate revenue improved by 16% QoQ. On a closer look, the poorer performance is marred by BARAKAH (Not-Rated) which sank into massive operating losses of RM77m in 2Q17 as a result of project cost overrun. We understand that this is because the oil major has become more stringent in terms of claiming variation orders suggesting that service providers/ contractors are exposed to higher operating risk going forward.

Expecting better contract flow in 2H17. Within the local scene, the recent portfolio reshuffling by Petronas 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 pullback 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 were initially anticipated in 2Q17. Based on our channel check, the estimated RM4-6b 5-year maintenance, construction and modification (MCM) tender has been extended to October. Besides this, OSV players are also expecting the integrated logistic contract (ILC) award by end of the year. Recall that the tender entails 25 packages with variations of firm and call-out contracts with the option of 3+2 year tenure and 5+2 year tenure. The contract is potentially valued up to RM4.0b and expected to commence next year. We believe DAYANG and PENERGY (Not-Rated) stand good chance to win MCM contracts while the listed OSV players such as ALAM (UP; TP: RM0.08) and ICON (Not-Rated) are in favour to win the ILC. Thus, we expect better contract flow in 2H17, paving for better earnings outlook in 2018.

Retain NEUTRAL. 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 push-up for higher oil prices. We are still maintaining our 2017E 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 resilient earnings counters 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 - 5 Sept 2017