Petronas’ 9M17 core earnings improved by 20% YoY on the back of better performance from both upstream and downstream segments. Furthermore, thanks to consistent cost optimisation, controllable opex cost softened by 7% YoY and operating cash flow (OCF) in 9M17 strengthened by 60%. RM7.5b dividend was paid in 3Q17, bringing YTD dividend to RM14.0b. We expect the remaining RM2.0b to be paid in the last quarter given that Petronas has committed to pay total dividends of RM16.0b this year. Interestingly, we observed a 41% QoQ increase in capex spending on exploration and development coupled with two greenfield projects – Kumang F12 and B15 being brought on-stream in 3Q17. This could probably be an early sign of recovery in upstream space. Meanwhile, despite Brent price (YTD average price at USD54/bbl) likely to surpass our FY17E forecast of USD51/bbl, we opt to maintain our forecast for average FY18 Brent crude price at USD55/bbl at the moment pending outcome from the upcoming OPEC meeting end of the month. In all, we keep our NEUTRAL view on the sector with positive bias.

9M17 core PAT increased by 20%. Sequentially, Petronas’ core PAT was down marginally by 1% to RM9.8b as a result of higher net product and production cost, weakening of USD against Ringgit (-2%) as well as higher tax expenses (+42%). This is cushioned by higher sales volume and higher average realised prices recorded (Brent prices +5% QoQ). YoY, core earnings improved by 37% thanks to higher average realised prices (Brent prices +13%; JCC prices +30%), strengthening of USD against Ringgit (+4%) offsetting higher tax expenses (+1.6x), higher product costs and higher amortisation of oil & gas properties. Cumulatively, 9M17 core earnings also improved by 20% to RM30.1b backed by 17% revenue growth due to higher average realised prices and lower well costs write off.

Balance sheet still firm. Overall, in tandem with 15% stronger revenue coupled with widening margins (+6 ppts), Petronas’ 9M17 EBITDA surged by 37% to RM66.7m. Furthermore, thanks to consistent cost optimisation, we saw its controllable opex cost softening by 7% YoY and operating cash flow (OCF) in 9M17 strengthening by 60%. On the other hand, Petronas spent RM12.5b on capex in 3Q17 (+32% QoQ, -16% YoY), bringing its 9M17 capex spending to RM33.8b (-6% YoY) of which 55% of it were attributable to committed investment in RAPID (at 81% completion as of November 2017). RM7.5b dividend was paid in 3Q17, bringing YTD dividend to RM14.0b. We expect the remaining RM2.0b to be paid in the last quarter given that Petronas has committed to pay total dividends of RM16.0b this year. Overall, net cash position has deteriorated slightly to RM61.4b from RM63.9b as of 2Q17 coupled with weaker OCF (-18%) narrowing its OCF to capex ratio to 1.4x from 2.3x as of 2Q17.

Both upstream and downstream segments improved in 9M17. Operationally, both upstream and downstream segments fared better in 9M17. Downstream earnings improved 63% underpinned by higher product prices and lower operating cost. Likewise, upstream segmental earnings jumped 16x mainly helped by cost re-basing and higher LNG sales volume from Train 9, Gladstone LNG and Egyptian LNG coupled with new volume from Petronas Floating LNG 1. Interestingly, we observed a 41% QoQ increase in capex spending on exploration and development coupled with two greenfield projects – Kumang F12 and B15 being brought on-stream in 3Q17. This could probably be an early sign of recovery in upstream activities.

Approaching two-year price ceiling. Oil prices have been hovering above USD60/bbl level, which is near its two-year high level helped by: (i) swelling market expectations of OPEC extending its production cut plan, and (ii) escalating tension in the Middle East, which could disrupt the crude supply. Despite Brent price (YTD average price at USD53.8/bbl) likely to surpass our forecast of USD51/bbl, we opt to maintain our forecast for average FY18 Brent crude price at USD55/bbl at the moment pending outcome from the upcoming OPEC meeting end of the month. This is because we see some pullback forces potentially dampening the recent price optimism, namely: (i) the resurgence of shale production, and (ii) weaker compliance as a result of favourable pricing among OPEC members. The US production, in our view, will continue its grow story due to high initial production rates and record high inventory of uncompleted wells. Nonetheless, any escalation of geopolitical tension would serve as wildcards to lift oil prices one notch higher.

Retain NEUTRAL with positive bias. Reading through Petronas’ results, it seems like the local oil giant is coping well in the challenging environment largely attributable to its successful cost cutting measures. Despite no clear indication that Petronas would increase its capex allocation to upstream segment, we are anticipating gradual recovery within the space and expecting more activities next year following stabilisation of oil prices above USD50/level. This includes rollout of different opex-related contracts such as the expiring HUC contracts and potential RM4.0b ILC contracts, providing 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. Contractors have to be as efficient as possible to avoid project cost overrun. In all, we are still NEUTRAL on the sector with positive bias.

Source: Kenanga Research - 24 Nov 2017