Petronas recorded 9M18 core PATAMI jumping 52% YoY, thanks to better revenue from higher average realised prices (average Brent crude prices +38% YoY) coupled with recognition of non-FID costs for Pacific Northwest LNG project in Canada in 2017. The group has reiterated its dedication for higher dividend payments, having declared total dividends of RM26b YTD (versus 2017 total dividends of RM16b). This includes a RM2b special dividend, on top of its dividend commitment of RM24b. Additionally, another RM30b special dividend is also expected in 2019 – bringing next years’ expected dividends to a total of RM54b. Meanwhile, YoY-YTD capex has also dwindled by 22%, although the group guided for higher capex in 4Q18 driven by Pengerang, LNG Canada and increased drilling activities. On the back of cost-optimisation and capex tightening landscape, we see more potential for job flows in the brownfield space, as opposed to greenfield space. This could play out for players with high local brownfield exposure (e.g. DAYANG, UZMA), while local downstream players (e.g. SERBADK, DIALOG) should mostly remain unaffected. We remain NEUTRAL on the sector, still seeing a need to be selective, as we favour names with more stable earnings delivery, e.g. SERBADK, YINSON, DIALOG, on top of the staple Petronas names.

Healthy 9M18 Petronas earnings. Petronas recorded 9M18 core PATAMI of RM34.5b (arrived after stripping-off impairments of RM1.1b), representing an impressive YoY jump of 52%, thanks to (i) improved revenue by 12% due to higher average realised prices (average Brent crude prices for 9M18 at USD72.74/barrel, up from USD52.53/barrel in 9M17), masking effects of the strengthening Ringgit, coupled with (ii) non-FID costs for Pacific Northwest LNG project in Canada which was recognised in 2017. For the individual quarter of 3Q18, core PATAMI leapt 61% YoY to RM12.7b, from increased revenue due to higher average realised prices offsetting the strengthening Ringgit and lower LNG sales volume. Sequentially, core PATAMI improved 11% QoQ, driven by revenue growth of 8% coupled with a lower effective tax rate of 24% vs. 29%.

Higher Petronas dividends. Moving forward, Petronas has repeatedly emphasized its dedication of higher dividend payments to contribute to the government’s coffers, especially given healthy profit numbers during the year. YTD, Petronas has declared total dividends of RM26b (of which RM17b has already been paid). This includes an additional RM2b special dividend declared, on top of its RM24b dividend commitment for the year (which was revised higher once before in 3Q18 from RM19b), and represented a massive jump of 63% from RM16b dividends paid in 2017. Additionally, 2019 will also see a one-off special dividend of RM30b, on top of its regular dividend payment of RM24b – summing to a total expected pay-out of RM54b. While Petronas definitely does have the capabilities to meet the targeted one-off commitment, this would no doubt come at a great expense of its net-cash pile, currently at RM106b, which has improved significantly from end-2017 of RM64b. And despite the greatly improved profit figures, YTD operating cash flow had only improved 3% YoY. Thus, in order to facilitate higher dividend payments, we notice that Petronas have undergone (i) cost-cutting measures, resulting in 6% cut in fixed overheads YoY-YTD, and (ii) lowering of capex by 22% YoY-YTD, although the group have guided for higher capex in 4Q18 driven by Pengerang Integrated Complex (currently at 95% progression – on track for start-up in 2019), LNG Canada as well as increased drilling activities in both domestic and abroad.

Possible value-chains to keep a look-out. With Petronas’ tightening its capex spend and continued cost optimisation efforts, we see more potential of higher jobs flow in the brownfield space, as opposed to the greenfield space. With prudent financial management in mind to facilitate higher dividend commitments, we reckon that Petronas is more likely to ramp up production on existing fields to drive output, rather than sanctioning high capex investments and multi-year timelines for new oil fields investments. As such, we see this landscape to play out better for players with a high local exposure and brownfield-dependent nature, such as DAYANG or UZMA, while local downstream players such as SERBADK or DIALOG would also mostly remain unaffected by Petronas’ capex cuts.

Maintain NEUTRAL. Overall, with many of the names within the oil and gas sector still plagued by balance sheet concerns or earnings instability, we still find the need to be selective for stock picks. As such, we still favour counters with a more resilient nature coupled with visible earnings delivery, such as DIALOG, SERBADK, YINSON, on top of the Petronas’ staple names. Among them, we pick out SERBADK as our sector top-pick for its commendable earnings delivery coupled with superior ROE against its peers. Meanwhile, while oil prices have recovered relatively significantly since its low back in 2016, price movements these couple of months still clearly show volatility swings, affected by macroeconomic and geopolitical developments. From here, we look forward towards OPEC’s meeting in December for any clear indications towards its commitments to output cuts.

Source: Kenanga Research - 28 Nov 2018