After bottoming out in April 2020, oil prices are expected to hover within a recovery trajectory, on easing of global lockdowns coupled with compliance in OPEC+’s historical production cuts. Global consumption and production surplus levels may have significantly improved post-April 2020, but positive effects could still be delayed as crude inventory remains near record-high levels. Overall, we raised our 2020 average Brent price assumption to USD45/barrel (from USD40), and introduce 2021 average assumption of USD50/barrel. Nonetheless, global trend of capex and opex cuts are still expected to lead to slower activities for the year. On average, global oil majors have announced capex cut of 24%, while shale producers are far worse at 36%. Petronas has also committed to a 21% cut in capex, and 12% cut in opex budgets. While tender book values still relatively unchanged, we believe potential job awards being pushed back could possibly lead to near-term order-book replenishment risks. Additionally, we believe a broad based bottom-fishing strategy on the sector would generally be unviable at the moment, as valuations are already trading ahead of fundamentals, despite the current challenging climate. The KL Energy Index is currently trading at a forward PER of 25x – at a premium against average of 21.7x. Going into 2H 2020, while earnings recovery is widely expected, we also strongly believe that asset impairments are likely, in tandem with the lower activities throughout the year. Investors should thus be wary of names with weak balance sheets. We may also possibly see some M&A activities, especially within the OSV space. Maintain NEUTRAL, with no outright picks, although we have identified PCHEM and HIBISCS as good trading proxies for oil prices. Investors requiring sector exposure would still advised to stick to proven resilient names – e.g. DIALOG, YINSON and SERBADK.

Oil prices in recovery mode. With oil prices plunging to a bottom in April 2020, with WTI even dipping into an unprecedented negative territory, oil prices have seemingly been on a recovery trajectory since then. This was helped mainly by: (i) gradual recovery in global oil demand, as global lockdowns following the Covid-19 pandemic ease up, as well as (ii) OPEC+’s agreed record-high production cuts until end of the year. According to industry data, global oil consumption and production surplus have seen a sharp recovery post-April 2020, and expected to remain level at least until end of the year, with OPEC in compliance with its record production cuts. However, this could be slightly offset as crude inventory levels still remain near record-highs currently. Overall, we raised our 2020 average Brent price assumption to USD45/barrel, from USD40/barrel previously (versus 1H 2020 average of USD42/barrel), as well as introduce 2021 average Brent price assumption of USD50/barrel.

Expect weaker activity levels. Nonetheless, oil prices are still considerably weak against 2019 levels (end-2019 of USD66/barrel), and as such, oil majors globally have embarked on a trend of budget cuts in capex and opex spending. On average, global oil majors have undertaken a 24% cut in capex, while shale producers have been worse hit, taking a 36% cut. Petronas has also committed to a 21% cut in capex and 12% cut in opex budgets, although citing priority in retaining local investments to the best of its ability. This is expected to result in an overall reduction of activity levels across the entire oil and gas value chains, with non-essential greenfield investments expected to face the most deferments. While our channel checks with various individual companies have shown that tender-book values have thus far remained unchanged, the expected pushing back of job awards, some even indefinitely, result in order-book replenishment risks to many of the players within our coverage universe.

Is bargain hunting a viable strategy? While possible, it is certainly not a strategy that we would strongly advocate, not especially for longer-term investors. Despite the current climate, the KL Energy Index is currently trading at a forward PER of 25x – close to +1SD premium against its average of 21.7x. This was mainly caused by the massive cut in earnings expectations, in contrasts against recent share price rebounds, and thus, could possibly suggest that the rebounds may still be a little premature, and that corrections could still occur before underlying fundamental s catch up to valuations. Based on our study, we have identified several names which are still trading at steep discounts (table below), although one thing to note is that these names are generally plagued by either one or few of the various factors, such as: (i) weak balance sheet, as indicated by their high gearing levels, (ii) lack of earnings visibility, or (iii) smaller market cap, implying lower trading liquidity

Source: Kenanga Research - 9 Jul 2020