On the back of Russia and Saudi ramping production to flood the market with oil supply, and coupled with Covid-19 further wreaking global demand, oil markets are currently facing huge disruptions, resulting in one of its biggest plunges in recent history. The excess oil production coupled with diminished demand has led to an oversupply, resulting in a shortage of storage spaces globally. Our findings suggest that current oil prices are oversold on a longer-term view, as production of oil at current oil prices will not be able to meet global demands by 2023. However, we believe that this low price environment could persist for the coming months while the market goes through some rebalancing. According to EIA forecasts, an oversupply state is expected throughout 2020, with rebalancing only to occur in 2021. We retain our average Brent crude price assumption of USD40/barrel for 2020. Globally, we are witnessing a trend of announced capex reduction and deferment of any nonessential greenfield investments among oil producers. As such, we would also not be surprised should Petronas take a similar stance, with cost optimisation remaining a high priority. As for stocks, players with greenfield exposure may see slower new contracts flow, while equipment and services contractors may face even greater margins pressure. That said, with the sector already facing a heavy sell-down in recent weeks, agile traders may look towards trading opportunities in names with value emerging, namely ARMADA, DAYANG and UZMA which are now trading below 5x forward PER, while SAPNRG is trading close to liquidation valuation of merely 0.1x PBV. Nonetheless, given the high uncertainty of the current market conditions, we would still advocate investors to trade with caution. Should one require exposure in the sector, we would favour proven resilient names with low balance sheet risks and an ability to continue delivering earnings growth despite the challenging environment – DIALOG, MISC, YINSON and SERBADK comes to mind. Maintain NEUTRAL on the sector.

Oil markets facing huge disruptions. Global oil markets are currently facing huge disruptions. This was first sparked by Russia pulling out of production cut agreements with OPEC in early March, thereby ending the OPEC-Russia coalition, while weak demand and oversupply issues are currently further exacerbated by the increasing spread of the Covid-19 coronavirus. As a result, Brent crude prices suffered one of its biggest plunge in recent history, dropping >50% YTD to breach below the USD30/barrel mark.

How long can oil prices stay low? With Russia and Saudi, as well as many other oil production nations flooding the market with supply, we have reached a point whereby storage spaces are starting to run out globally, as reported in recent news updates. According to EIA forecasted numbers, global oil markets are expected to continue to be in a state of oversupply throughout 2020, before rebalancing happens in 2021. Meanwhile, should oil prices continue to remain at current levels, production of

Slowdown in global activities. Amidst the weak oil prices, a slew of oil producers globally have announced reduction in capital expenditure, as well as delaying greenfield projects. This is another indication that oil majors globally are gradually preparing themselves for an extended period of low oil prices. As such, locally, we would not be surprised if Petronas adopts a similar approach in slashing its capex budget and deferring any non-essential greenfield projects. While production levels are unlikely to be cut back, costs optimisation would be given high priority for continuing brownfields.

Impacts throughout the entire value-chain. As for our local stocks, naturally, companies with exploration and production exposure (e.g. HIBISCS, SAPNRG) would be the first casualties during low oil prices. Beneficiaries of capex, such as fabricators (e.g. SAPNRG, MHB), pipe-players (e.g. PANTECH, WASEONG) and FPSO providers (e.g. MISC, YINSON, ARMADA) would also possibly see slower contract flows moving this period. Meanwhile, equipment and services contractors, such as drillers (e.g. VELESTO), EPCC and maintenance players (e.g. DIALOG, SERBADK, DAYANG, CARIMIN), and vessel providers (e.g. ALAM, COASTAL, ICON, PERDANA) could all face margins pressures as clients are now much more incentivised to heavily prioritise cost optimisation.

Are rebound plays still possible? With the sector already heavily bashed down in recent weeks, agile traders may look towards some sold-down names where value has started to emerge, namely ARMADA, DAYANG and UZMA which are now trading below 5x forward PER, while SAPNRG is currently trading near liquidation valuation of merely 0.1x PBV. Nonetheless, given the uncertainty in the recovery timeline and market volatility, we recommend fundamentally-centric investors to still stick to names with proven resilience: DIALOG, YINSON, SERBADK and MISC. They face very little balance sheet risk, and have proven over time to be able to deliver earnings growth despite difficult macroeconomic environments.

Maintain NEUTRAL, but with no outright stock picks. While we are still advocating investors to err towards the side of caution when investing in the sector, the aforementioned proven resilient names (DIALOG, YINSON, SERBADK and MISC) may provide some recourse should one require sector exposure. Ultimately, while we acknowledge some names have been bashed down beyond fundamentals, we believe continued macro-environment uncertainties may continue to spur volatilities in the stock market. As such, we would thus favour a “bottom-up” approach for our stock picks, favouring names with low balance sheet risks, coupled with a proven track record to be able to withstand challenging times to continue delivering earnings growth.

Source: Kenanga Research - 2 Apr 2020