We are positive on the 9-month production cut extension by OPEC and non-OPEC members as this will boost near-term sentiment, which may eventually translate into meaningful recovery of the sector in terms of higher spending and investments. However, we do not discount the possibility that the market could refocus on the revival of US shale gas production. On the other hand, the recently concluded 3QCY17 results season also demonstrated somewhat better performance with higher number of outperformers and lower disappointment ratio of 25% from 27% in 2Q17. Interestingly, we observed a 41% QoQ increase in Petronas’ capex spending on exploration and development coupled with two greenfield projects being brought on-stream in 3Q17. This could probably be an early sign of recovery in the upstream space. Overall, we expect the local oil and gas stocks to get an uplift with oil producers such as SAPNRG (MP; TP: RM1.55) and HIBISCS (Not-Rated) being the key earnings beneficiaries. While keeping our preference to earnings resilient counters such as SERBADK (OP; TP: RM2.65) and WASEONG (OP; TP: RM1.40), watch out for bombed-out counters such as UMWOG (Not-Rated) and ICON (Not-Rated) as valuation catchup plays should exploration activities pick up. Keep NEUTRAL view with positive bias on the sector as we are turning more bullish on the upstream space albeit with gradual improvement.

Higher number of outperformers. In the recently concluded 3QCY17 result season, we saw a higher number of outperformers with 5 counters, i.e., MHB, (UP; TP: RM0.65), PCHEM (OP; TP: RM8.10), PETDAG (OP; TP: RM25.20), SERBADK (OP; TP: RM2.65) and WASEONG (OP; TP: RM1.40) recording positive earnings surprises. On the flipside, the disappointment ratio improved slightly to 25% from 27% in 2Q17. These disappointments largely came from offshore services players such as ALAM (UP; TP: RM0.07), UZMA (MP; TP: RM1.65), and DAYANG (OP; TP: RM0.73), dragged by lowerthan-expected work orders and delay of contract award by oil majors. Following that, we trim our two-year forward earnings by 2%/8% on lower services/charter rates. Lastly, we upgraded GASMSIA to OP on recent price weakness backed by decent yield of >3% and downgraded UZMA to MP call after its disappointing results in view of limited re-rating catalyst and unexciting outlook.

Fairly good quarter. In 3Q17, almost all the sub-segments posted improving set of results. Fabricators booked higher earnings helped by variation orders while FPSO players remained on their growth trajectory, driven by incoming and existing long-term FPSO charters. Asset-heavy players such as OSV charterers managed to narrow their operating losses helped by higher vessel utilisation. Backed by stronger rig utilisation and lower operating cost, the local driller, UMWOG (Not-Rated) managed to return to the black this quarter after more than two years of losses. The management also guided an improving outlook with higher tender activities despite charter rates remaining sluggish. Petronas-linked counters continued to deliver commendable results (+3% QoQ, +3% YoY), recording stronger 9M17 (+20%), backed by higher realised average product prices and higher plant utilisation.

Production cut extended for another 9 months. OPEC had agreed to extend its production cut agreement together with nonOPEC members for another nine months till end of 2018. Recall that the deal was initially arrived end of last year for OPEC to trim production by 1.2m bbl/day to its ceiling to 32.5m bbl/day. Meanwhile, key non-OPEC countries, including Russia also joined the effort by cutting 600k bbl/day of production. Subsequently, it was extended for another nine months in May this year. We are positive on the outcome as it will boost the near-term sentiment, which eventually translates into meaningful recovery of the sector in terms of higher spending and investments. However, we do not discount the possibility that the market could refocus on revival of US shale gas production. All in, we maintain our conservative average FY18 forecast of USD55/bbl capped by continuous growth in US production.

Turning more bullish. Within the local scene, Petronas’ 9M17 core earnings improved by 20% YoY on the back of better performance from both upstream and downstream segments. Interestingly, we observed a 41% QoQ increase in capex spending on exploration and development coupled with two greenfield projects being brought on-stream in 3Q17. This could probably be an early sign of a recovery in the upstream space. Overall, we expect the local oil and gas stocks to see an uplift with oil producers such as SAPNRG (MP; TP: RM1.55) and HIBISCS (Not-Rated) being the key earnings beneficiaries. While keeping our preference to earnings resilient counters such as SERBADK and WASEONG, watch out for bombed-out counters such as UMWOG and ICON (Not-Rated) as valuation catch-up plays should exploration activities pick up. Keep NEUTRAL view with positive bias on the sector as we are turning more bullish on the upstream space albeit with gradual improvement.

Source: Kenanga Research - 4 Dec 2017