A read-through of Petronas’ 3QFY20 results – despite the reported headline losses, Petronas actually recorded a core net profit of RM1.5b during the quarter (after excluding net impairments). This is a turnaround from losses last quarter, thanks to higher sales volume, following the easing of lockdowns worldwide. Notably, Petronas’ net-cash position had shrunk a further 17% during the quarter down to RM61b, and 25% YTD from end-FY19. This is mildly alarming, especially considering Petronas’ commitment of an additional RM10b special dividends to the Federal government to combat the Covid-19 pandemic, bringing full-year committed dividends to RM34b (RM24b ordinary + RM10b special). To-date, RM26b has been paid, with the remainder RM8b to be paid in 4QFY20. Meanwhile, YTD capex incurred is 22% lower YoY at RM22.5b, with upstream being the group’s highest investment. This is roughly in-line with Petronas’ earlier guidance of lowered capex. Gas and new energy is the second largest area of investment for the group, as the group is gradually embarking on its long-term sustainability targets. Overall, given the combination of Petronas’ mildly deteriorating balance sheet, earnings, and increased dividend commitment, we strongly believe Petronas will be increasingly prudent in spending moving forward. This would lead to lower activity levels, impacting local-centric contractors whom derive most of their earnings in Malaysia (e.g. DAYANG, UZMA, and VELESTO). We believe that continued commitment of higher dividends could hamper recovery of the sector locally, especially at a time when other oil majors are cutting dividends globally. Maintain NEUTRAL on the segment – while recovery trajectory is underway, it will be slow and gradual as fundamentals still remain weak. In the meantime, we advocate a trading approach to the sector (in contrast of a fundamentally-based investment strategy), taking advantage of short-term gains amidst recent vaccine development news flow to boost market sentiment.

Petronas sees sequential recovery. Despite the reported headline losses in 3QFY20, Petronas Group actually recorded a core net profit of RM1,546m, after excluding net-impairments, bringing 9MFY20 core net profit to RM10,282m. Sequentially, 3QFY20 managed to bounce back into the black QoQ, from core net loss of RM689m in 2QFY20, following the easing of lockdowns worldwide, resulting in higher sales volume particularly for petroleum products, LNG and processed gas. However, on a YoYbasis, 3QFY20 headline is still 82% poorer, dragged by lower realised product prices, in line with the declining benchmark prices. Similarly, for 9MFY20, YTD core earnings is also down by 69% YoY on the back of lower realised product prices and lower sales volumes, amidst the Covid-19 pandemic outbreak.

Declining net-cash on top of increased dividend commitments. More notably, Petronas’ net-cash position has shrunk 17% QoQ down to RM61b in 3QFY20. YTD, the group’s net-cash position has shrunk a total of 25% since end-FY19. This is slightly alarming, especially considering that earlier this month it was announced that Petronas is set to pay an additional RM10b special dividend to the Federal government, on top the ordinary dividends of RM24b, in efforts to combat the challenges caused by the Covid-19 pandemic. YTD, Petronas had already fully paid the ordinary dividends of RM24b, and RM2b of the RM10b special dividend. The remainder RM8b is expected to be paid in 4QFY20. This marks the second consecutive year that Petronas was asked to pay special dividends (recall that Petronas had paid a special dividend of RM30b in FY19, totalling that year’s dividends to RM54b).

Weaker YTD capex spending. Meanwhile, Petronas’ YTD-capex spending came in at RM22.5b, declining 22% YoY from 9MFY19. This is largely in line with the group’s earlier guidance of lowered budgeted capex in FY20. Most of the capex were incurred upstream and local investments. Also notably, gas and new energy is Petronas’ second largest area of investment, taking up 22% of the group’s capex, possibly signalling the group’s acknowledgement of the energy transition trend. In fact, the group has announced its target to achieve net zero carbon emissions by 2050 as a stronger commitment to sustainability.

Supressed spending to impact local players. Overall, given the combination of Petronas’ mildly declining balance sheet, earnings, as well as increased commitment to dividend payments, we believe it is highly likely for Petronas to increase prudency in spending going forward. This would lead to lower activity levels, and will be most impactful to local-centric contractors whom derive most of its earnings in Malaysia – e.g. DAYANG, UZMA, and VELESTO. Nonetheless, we also acknowledge that fundamentals for the global oil market is still weak at the moment, and internationally exposed players are also expected to see overall weaker activities for the time being. However, we believe that continued commitment to higher dividends may hamper the recovery of the sector locally, especially considering the global trend of lowering dividends among other international oil majors.

Maintain NEUTRAL. Although in a recovery trajectory, the pace of recovery is expected to largely be slow and gradual as fundamentals of the sector are still weak. As such, we do not expect to see activity levels returning to 2019-level at least until 2023. That said, we recommend keen investors to adopt a trading approach towards the sector (in contrast to a fundamentallydriven investment strategy), favouring names with historically high standard deviations to capitalise on the current sentiment boost following positive news flow of Covid-19 vaccine development recently. Our trading picks include UZMA, DAYANG, and MHB, with a stance to taking profit on any sizable gains within the next 2-3 months’ window.

Source: Kenanga Research - 30 Nov 2020