A read-through of Petronas’ 2QFY20 results - the group plunged into losses as a direct result of plummeting crude oil prices, leading to weaker realised product prices and lower sales volumes. The group recognised a net impairment charge of RM21b during the quarter, in line with many of its global peers, to address the downward revisions on crude oil price outlook, and also lowering assumptions for the future performances of its assets and wells. The group had also incurred a total capex of RM14.8b in 1HFY20, down from RM15.7b in 1HFY19, although discretionary opex spending still remain flattish. As such, we expect further cost saving measures as well as further lowered spending in 2HFY20 in order to meet its guidance of capex reduction by 21% and opex by 12%.

Moving forward, we also expect dividends in relation to FY20 to be likely lower than the RM24b declared for FY19, as the group continues its cash preservation efforts. With Petronas expected to stay cautious on spending, we expect a cascading-down effect to impact locally-centric players across all value chains. Meanwhile, while 2H 2020 will almost certainly see improved results over the 1H, helped by mild rebound in crude oil prices coupled with easing of lockdowns, we believe oil production and activity levels are still very unlikely to return to pre-pandemic levels at least for the next 12-18 months. Petronas is now seeing a long-term crude oil price of USD50-60/barrel (as opposed to USD60-70/barrel previously). As such, we still feel that further impairments, disposals, refinancing, restructuring and M&As are still possible within the sector moving forward as companies undergo cost saving measures in order to meet debt repayment obligations. Overall, we maintain NEUTRAL on the sector. Valuations in the sector are still not particularly attractive, and hence, we would prefer to wait for fundamentals to play catch-up before reconsidering entry opportunities.

Petronas Group plunged into losses. Petronas plunged into core loss of RM689m in 2QFY20 (after stripping-off net impairments), versus core PATAMI of RM12.7b in 2QFY19 and RM8.5b in 1QFY20. The group was severely impacted by the sharp fall in crude oil prices, resulting in lower average realised prices recorded for major products, coupled with lower sales volumes on petroleum products, LNG and processed gas. Cumulatively, 1HFY20 core PATAMI fell 65% YoY to RM8.7b, similarly dragged by lower average realised prices recorded for all projects, coupled with lower sales volume mainly for processed gas and LNG.

Buckling down. During the quarter, Petronas recognised a net impairment charge of RM21b, in line with many of its global peers, to address the downward revisions on crude oil price outlook, and also lowering assumptions for the future performance of its assets and wells. Petronas has very much acknowledged the current declining landscape for oil and gas with the growing pace of energy transition, and also cited that it will shift more attention to the new energy business, with the group expecting crude oil prices to hover between USD50-60/barrel in the long term. The company had incurred a total capex of RM14.8b in 1HFY20, down from RM15.7b in 1HFY19, with the bulk spent on local and upstream projects. This was also in line with the group’s guidance of lowered capex by 21% previously for FY20. However, the group’s discretionary opex spending has still yet to be significantly lowered from last year’s levels, and hence, we could expect further cost saving measures in 2HFY20 in order to meet the group’s guidance of 12% lowered opex for FY20. As for dividends, the group had paid RM16b during the quarter, with another RM8b payable in 3QFY20. This is in relation to the RM24b ordinary dividends declared with respect to FY19. Nonetheless, moving forward, we believe lowered dividend pay-outs will be very likely as the group seeks to conserve cash. Petronas had reiterated that it is “not compelled to pay dividends so far”, and hence, FY20 dividends will be “governed by affordability”.

Still in the woods. With Petronas being increasingly cautious on spending (both on the capex and opex front), we believe this will have a cascading-down effect to all value chains across the oil and gas sector, leading to lowered activity levels especially for local-centric players. Lowered capex would translate to greater job deferments across the board and less greenfield contracting opportunities, impacting fabricators (e.g. SAPNRG, MHB), hook-up and commissioning works outfits (e.g. DAYANG, CARIMIN), drilling rig providers (e.g. VELESTO) etc. Meanwhile, lowered opex could also possibly exert margin and pricing pressures on local-centric contractors and services providers (e.g. DAYANG, UZMA). Generally, lowered offshore activity levels could also translate into lower OSV utilisations, impacting players such as PERDANA and ICON.

Locally listed O&G players also posting disastrous results. Meanwhile, reviewing back our recently concluded corporate results season, locally listed oil and gas players have posted very poor results sector-wide, with half of our stock universe (7 out of 14 stocks) recording disappointing results all of which can be directly attributed to the MCO impacting operations, as well as effects of declining crude oil prices. Most notably, the two Petronas heavyweight subsidiaries (namely PCHEM and PETDAG) posted severely poorer results, in tandem with its parent company, as lower oil prices have suppressed product prices which led to poorer margins spread. Meanwhile, almost all equipment and services providers which mainly operate in upstream (e.g. DAYANG, MHB, UZMA, VELESTO, WASEONG) also reported poorer results, citing operational disruptions and project deferments.

More impairments and restructuring exercises still possible. Moving forward, while it is almost certain that 2HCY20 will see improved results in comparison to the 1H, helped by mild rebound in crude oil prices post-April 2020 and easing of MCO lockdowns, production and activity levels are still very unlikely to return to pre-pandemic levels at least for the next 12-18 months. As companies are now undergoing cost saving measures in order to meet debt repayment obligations, we are also expecting more impairments, disposals, refinancing and M&A activities within the sector moving forward.

Maintain NEUTRAL. Valuations for the sector as a whole are not particularly attractive – still trading at +2SD above mean forward PER, despite being in the midst of a down-cycle. Hence, we still do not think that pre-emptively buying into the sector to time a recovery is a viable investment strategy at this point in time (at least not on a broad-based approach). For now, we would still prefer to wait for fundamentals to catch up before reconsidering our entry positions. However, should one require exposure to the sector, we will opt to stick to proven resilient names e.g. SERBADK, YINSON, DIALOG.

Source: Kenanga Research - 7 Sept 2020