Brent prices have been showing signs of stability, trading within the USD55-70/barrel range throughout most of the year. In recent weeks, drone strikes in Saudi Aramco which affected roughly half the country’s output ignited a sharp albeit temporary surge in crude prices, although a sooner-than-expected restoration of production put a firm halt on the surge. Continued production compliance from OPEC and Russia has helped eased supply-side worries, although the U.S.-China trade tensions are currently spurring some demand-side concerns. Overall, we maintain our projected 2019-2020 average Brent price of USD65/barrel, with oil majors comfortable at current levels for increasing investments. That said, with the stabilising of oil prices, we expect a gradual rise in global investments within the upstream space, with Petronas also guiding for increased focus in upstream despite being committed to pay higher dividends. Globally, thus far, we have noticed increased jobs in engineering/construction from the Middle-east and floaters from South America. Locally, players have also started to enjoy an uptick in contract flows for the past 4-5 quarters from various upstream value-chains (e.g. floaters, fabrication, maintenance and drilling). Nonetheless, while these are clear signs of a bottoming-out, we note that the recovery process could be long and gradual, with cost optimisation still key. For stock picks, consistently solid counters (e.g. YINSON, DIALOG, SERBADK) have continued to outperform benchmarks, although value-hunting investors could seek for heavily discounted counters with turnaround potential (e.g. MHB, SAPNRG, PANTECH). We continue to be selective, favouring defensive names with clear earnings outlook, with top picks for the quarter such as MISC and SERBADK. Maintain NEUTRAL on the sector, given limited upside from Petronas-related counters, although with increase sanguinity.

Brent crude stabilising at current price range. Brent prices have been trading within the USD55-70/barrel range throughout most of 2019, barring some occasional up and down spikes (YTD-average of USD65/barrel). In recent weeks, drone strikes in Saudi Aramco’s refineries affected about 5.7m barrels per day, which makes up roughly half of the country’s oil output, igniting a sharp albeit temporary surge in Brent crude prices to as high as USD69/barrel mid-last month. However, the quicker-than-expected restoration of production, on top of maintaining export volumes using spare inventories and production capacity quickly put a firm halt on the surge. That said, OPEC and Russia’s continued compliance towards self-imposed production cuts have helped eased supplyside worries, with the U.S.-China trade war tensions causing greater demandside concerns. Overall, we maintain our projected 2019-2020 average Brent price assumptions at USD65/barrel. We believe this price range to be relatively comfortable for oil majors to commit to higher investments.

Investments in upstream expected to recover. On the back of gradually steadying oil prices, we expect to see greater investments in the upstream space for the coming years. Locally, despite already committed to higher dividend pay-outs in 2019, Petronas has maintained its higher capex spending guidance, with increased focus on upstream. Globally, we have also witnessed increased flow of engineering/construction jobs from the Middle-east while floater demand has jumped rapidly from South America.

Improvement in local contract flow. Meanwhile, local players have also started to see uptick of contracts flow in the past 4-5 quarters. As expected, the newer jobs came mostly from the upstream space, such as floaters, fabrication, maintenance and drilling. While this can be seen as a clear sign of a bottoming-out, we note that the recovery process could be long and gradual, with many of the local players still plagued with earnings uncertainties and balance sheet constraints, all while cost optimisation still remains a key theme for new job tendering.

Disparity in valuations between gainers and losers. The Bursa Malaysia Energy Index (index of oil and gas counters, excluding Petronas-related names) managed YTD gains of 34%, far outperforming FBMKLCI at -6% returns. Biggest contributors of weighted gains were from YINSON, DIALOG and SERBADK – little surprise there, given their resilient record of superb growth and earnings delivery. As such, we are witnessing a disparity in valuations being formed between outstanding companies within the sector, as compared to the majority of lacklustre oil and gas names. In fact, barring a few names (DAYANG, DIALOG and YINSON), most of the counters within our coverage are currently trading at discounted valuations of -1SD or more below its mean valuations, and as such, some of our OUTPERFORM calls (e.g. MHB, SAPNRG, PANTECH) were selected given that the turnaround stories could not justify the discounted valuations.

Maintain NEUTRAL. Despite a slightly more optimistic tone, we continue to remain NEUTRAL towards the sector, given limited upside to Petronas-linked counters with the exception of MISC. Nonetheless, while traders could find some value in heavily discounted stocks within the upstream space (e.g. SAPNRG, MHB, PANTECH), we remain selective with our stock picks for a long-term investment approach, favouring more defensive names with stable dividend, clear earnings delivery coupled with a palatable balance sheet. Preferred picks for the quarter include MISC and SERBADK. Note our changes to our calls for DAYANG and UZMA (both to UP from MP), given recent strength in share price providing gain-realising opportunities.

Source: Kenanga Research - 3 Oct 2019