Approaching price ceiling? The recent rally in oil prices which approached the USD60/bbl level, in our view, might be capped despite slightly better oil fundamentals in 2H17 as it could trigger resurgence of shale oil production, especially in the Permian Basin. Besides, the perception of oil market poised toward a rebalancing could suggest that OPEC and non-OPEC countries are stopping their production cut plan beyond March next year, serving another resistance to the uptrend. This is likely to be concluded by the next OPEC meeting in Vienna in November. Without further extension of production cut, we believe the global oil inventories will accumulate in 2018 and this will pressurise prices. Nonetheless, any escalation of geopolitical tension from issues such as the independence referendum in Iraqi Kurdistan and USNorth Korea quarrel would serve as wildcards to lift oil prices one notch higher. In all, we maintain our forecast for average FY17-18 Brent crude price at USD51-55/bbl.

Anticipating better work orders in FY18. Despite oil prices recovering 17% in 3Q17, the local O&G stocks only inched up by 1.4%. We attributed such weak correlation to the relatively disappointing 2Q17 results which was dragged by lower-thanexpected work orders and delay of contract award by oil majors. Having said that, following the stabilisation of oil prices above USD50/level in 3Q17, oil majors are gradually reviewing projects in hand which may potentially lead to better contract flows in the next 6-12 months. Within the local scene, despite the upstream space not given much attention, we opine that the rollout of different opex-related contracts such as the widely reported RM6.0b MCM contracts and potential RM4.0b ILC contracts will help to provide order-book replenishment opportunities for selected services contractors. Given rigorous cost optimisation over these few years, margins may not stay as attractive as it used to be during good times and contractors have to be as efficient as possible to avoid project cost overrun.

Getting ready for RAPID. We foresee muted impact from any initiatives proposed in the coming Budget 2018 while the downstream segment which is largely led by the RAPID project is expected to receive the final investment allocation before the slated commencement in 2019. As PIC is currently at 70% completion, the peaking of PVF demand would benefit players such as PANTECH (OP; TP: RM0.75). Meanwhile, based on our channel check, Petronas has sent out bid invitations for the maintenance contract for RAPID. We reckon that services players such as DIALOG and SERBADK are potential candidates for these plant turnaround and maintenance opportunities beyond 2019. Note that we have recently added SERBADK into our coverage universe with an OUTPERFORM call and target price of RM2.75 pegged to 12.0x FY18 PER. We like this established MRO service provider with: (i) superior 20% ROEs vs industry average of 11%, (ii) FY17E-18E CNP growth of +15%-+10% backed by RM4.7b order-book and modest RM2b annual replenishments, (iii) decent dividend yield of 2.8-3.1% assuming 30% pay-out.

Reiterate NEUTRAL when earnings still matter ultimately. We believe most negatives have been priced in after massive derating since the plunge of oil prices back in 2014. Therefore, we see some selective recovery YTD, outperforming the industry peers (+7.0%) as well as the broader benchmark, FBMKLCI (+7.9%), namely PANTECH (+43.8%), DIALOG (+29.9%), ARMADA (+24.0%), WASEONG (23.2%) and YINSON (23.0%). These strong share price performances are mostly backed by the anticipation of strong earnings recovery/delivery amidst volatile oil prices. The upstream space could still stay unexciting in view of flattish oil prices outlook in the near future and oil prices fluctuation will provide little room for short-term trading on upstream services providers. However, we believe the sector is still relevant as far as investment portfolio consideration is concerned. We have to be rather selective and earnings resiliency is still what we seek for within the sector with DIALOG and WASEONG being our preferred picks.

DIALOG & WASEONG - our preferred picks.

Potential formalisation of Pengerang Phase 3 (up to 5m m³) has emerged as the re-rating catalyst for DIALOG following the announcement of Phase 1 expansion by its JV partner, Vopak. In view of stronger prospect anchored by robust EPCC works and rising associates, we maintain OUTPERFORM call on the stock with SoP-driven TP of RM2.42/share (implying 33.3x CY18E PER which is at +0.5S.D. to its 5-year mean and 4.0x P/BV) imputing: (i) Phase 1 expansion of entire 1m m³ capacity (RM0.12/share), and (ii) indicative valuation of Phase 3 expansion assuming first 2m m³ to be developed by 2020 (RM0.17/share). Premium valuations vs. average O&G peers of 19x CY18 PER appear justifiable given its: (i) appealing longterm stable earnings profile amidst unexciting oil price outlook, (ii) lean capital structure (net cash position as at 4Q17) allowing further tank terminal expansion, and (iii) solid ROE of 11%-12%.

Backed by RM3.7b order-book providing 2-year earnings visibility, we believe WASEONG is poised to turn around strongly in FY17 and further register earnings growth of 27% in FY18 (vs. industry average of 20%). Key re-rating catalyst is QoQ earnings improvement arising from EUR600m Nord Stream 2 pipe-coating project, which provides fixed profit margin followed by potential additional performance bonus upon excellent execution. Currently, WASEONG trades at undemanding valuation of 9x FY18E PER (vs. small cap O&G counter average of 10-11x and industry average of 19x) and 0.7x FY18E PBV. Thus, we maintain OUTPERFORM call on the stock with TP of RM1.10 pegged to 0.8x FY18E PBV.

Source: Kenanga Research - 5 Oct 2017