A read-through of Petronas’ 1QFY20 results highlights an earnings slump, mainly dragged by lower average realised prices. The group acknowledges the challenging market conditions and plummeting oil prices, and hence, is now increasing efforts in costs compression and cash preservation. During the 1QFY20 quarter, the group incurred capex of RM8.5b, slightly up from RM8.3b in 1QFY19, primarily on local and upstream projects. However, moving forward, the group had announced reducing its budgeted capex by 21% (from ~RM50b) and opex by 12%, following the global trend. While inclined to protecting local investments, the group also warned of inevitable disruptions in the local supply chain. The group’s balance sheet still remains resilient, with net-cash position of RM77b, but there were no other dividend announcements beyond the ordinary dividends of RM24b already declared to be paid throughout the year (versus last year of RM30b special dividends on top of ordinary dividends of RM24b). Overall, we believe the cut in budgeted capex and opex could have a cascading effect across the entire value chain, impacting local-centric players. Lowered capex could translate to project deferments and slower contracting opportunities, impacting fabricators (e.g. SAPNRG, MHB), hook-up and commissioning work orders (e.g. DAYANG, CARIMIN), drilling activities (e.g. VELESTO) as well as FPSO bidding opportunities (e.g. YINSON, MISC). Meanwhile, reduction in opex could exert margins and pricing pressure on local services providers and contractors (e.g. UZMA, DAYANG). Maintain NEUTRAL on the sector. While expecting a gradual recovery of oil prices in 2HCY20, the effects of project delays, operational disruptions and margins squeeze could reverberate for several quarters. Stock preferences favours names with resilient earnings and balance sheet to provide a degree of defensiveness such as DIALOG and SERBADK. As for the nimble traders, ARMADA and UZMA are highlighted for potential bottom-fishing plays given their hugely discounted valuations.

Petronas Group posts weaker 1QFY20 results. Petronas posted 1QFY20 core PATAMI of RM8.4b (arrived after stripping-off net impairments), slumping 30% YoY, mainly due to the impact of lower average realised prices, partially offset by higher sales volume for petroleum products coupled with the weakening Ringgit. Sequentially, however, core PATAMI improved 20% QoQ, wholly attributable to lower tax expenses. In fact, at the core PBT level, results were actually poorer 15% QoQ, dragged similarly by lower average realised prices for major products, coupled with lower sales volume for crude oil and condensates.

Lowers budgeted capex and opex, anticipates constraints in supply chain locally. Against the challenging backdrop of low oil prices and Covid-19 outbreak, Petronas has declared that it is planning to reduce its capex by 21% and opex by 12% as compared to what was previously budgeted, following the global trend. Before this, Petronas had guided its year’s capex to be slightly below RM50b – flattish against 2019 capex spend of RM48b. During the 1QFY20 quarter, Petronas had incurred total capex of RM8.5b (slightly higher YoY from RM8.3b), with the biggest spending on upstream and local projects. With Petronas mostly inclined to protecting local investments, the forward capex cuts would thus primarily have to come from optimising its international investments. Nonetheless, the group also acknowledges that there will inevitably be constraints in the supply chain at the local front. Meanwhile, the group’s balance sheet still remains stable, with a net-cash position of RM77b, which should be sufficient for it to weather through the challenging period. That said, the group has not announced any additional dividends beyond the RM24b ordinary dividends to be paid throughout the year (last year, the group paid a special dividend of RM30b on top of its ordinary dividends of RM24b).

Impacts on the entire value chain. With Petronas announcing cuts in both capex and opex in its efforts for cost compression and cash preservation, we expect the effects to cascade down to all value chains across the sector, especially on local-centric players. Lowered capex would translate to greater job deferments and lesser contracting opportunities, impacting fabricators (e.g. SAPNRG, MHB), hook-up and commissioning works (e.g. DAYANG, CARIMIN), drilling activities (e.g. VELESTO), as well as FPSO activities (e.g. MISC, YINSON). Meanwhile, lowered opex could also exert margins and pricing pressures on local centric contractors and services providers (e.g. DAYANG, UZMA). The overall lowered offshore activities could also translate to slower OSV demands, impacting players such as PERDANA, ICON, and ALAM.

Maintain NEUTRAL on the sector. While oil prices are expected to stage a gradual recovery in 2HCY20 as economic activities progressively resume, we believe it is unlikely for Brent crude prices to revert to >USD60 levels for the time being (i.e. next 6-12 months) as the effects of project delays, operational disruptions and margins squeeze could reverberate throughout the sector over the next few quarters. Our in-house average Brent crude assumption of USD40/barrel for 2020 has already taken into account a slight recovery in 2HCY20. Meanwhile, our stock preferences would include names with resilient earnings and balance sheet to provide a degree of defensiveness – these include DIALOG and SERBADK. Meanwhile, we highlight ARMADA and UZMA as potential bottom-fishing plays (trading at discounted valuations of 4x and 7x PERs, respectively) for the nimble traders.

Source: Kenanga Research - 27 May 2020