After crude oil price rebounded in the tumultuous year 2020, we see oil prices in need of a delicate balancing act to sustain the current uptrend. While oil demand is almost certain poised for a recovery, uncertainties still linger for the supply side. These include: (i) OPEC’s commitment to maintaining production cuts, (ii) resurgence of Libya oil, (iii) possible lifting of Iran’s sanctions under the Joe Biden administration, and (iv) possible resurgence of shale oil production, should oil prices breach past its breakeven point of ~USD55/barrel. All in, we opine that sustained OPEC production cuts are imperative to prolonging oil price’s stability, and if OPEC turns on the taps excessively, existing inventory overhang could linger until year-end even without any fresh surplus during the year. Overall, we retain our 2021 average Brent crude price assumption at USD50/barrel. The sector’s recovery trajectory is expected to be slow and gradual. From our recent read-through of Petronas’ Activity Outlook, activity levels are expected to remain stagnant for the next coming year. In fact, most of the value chains are expected to see flattish or lower activity levels in 2021, from 2020. This comes after Petronas’ increased prudency in spending, given its declining net-cash position coupled with higher tax and dividend commitments, and somewhat downplaying the possibility of a recovery to pre-pandemic activity levels during the year. While no particular value chain emerged as a clear winner, we highlight the brownfield space as a partial winner, given increased activity levels across various value chains. This would benefit contractors such as UZMA. Conversely, losers are value chains most exposed to greenfield projects (e.g. fabrication, jack-up rigs, hook-up and commissioning). Valuation-wise, the sector as a whole is rather fairly priced at the moment, trading close to mean valuation levels. Maintain NEUTRAL, as sector fundamentals still remain weak. We urge keen investors looking to enter the sector to be highly selective with their stock picks. UZMA (OP, TP: RM0.72) emerged as our top trading pick, while SERBADK (OP, TP: RM2.50) and DIALOG (OP, TP: RM4.35) remains our fundamentally-backed favourites.

Oil price in a balancing act. After the turmoil last year for oil prices, Brent crude prices have rebounded and are currently hovering at around the USD50/barrel mark. This was largely helped by the expected recovery in oil demand amidst vaccination programmes worldwide, coupled with OPEC’s continued efforts in limiting production output. Nonetheless, moving forward, we see oil prices to be in a delicate balancing act to sustain the current uptrend. While demand is almost certain to recover going into 2021, we still see many uncertainties surrounding the supply side of oil. These include: (i) the question of OPEC sustaining current production cuts, as it now practices a monthly review system amidst deep tensions and disagreements among member nations, (ii) the resurgence of Libya oil, which may add up to 1.3m barrels per day (bpd) of global oil output, (iii) a possible lifting of Iran sanctions under the Joe Biden administration, which may reintroduce another 1m bpd of oil exports, and (iv) a possible resurgence of shale oil production, should oil prices breach past its breakeven point of ~USD55/barrel. All in, we opine that sustained OPEC production cuts at current levels are imperative to prolonging the current stability in oil prices, although we suspect this to be highly unlikely throughout the course of the year. The IEA had also reiterated a similar view that existing inventory overhang could linger until the end of the year if OPEC turns on the tap, even without fresh surplus during the year. As such, we retain our 2021 average Brent crude price assumption of USD50/barrel.

Recovery to be slow and gradual. Overall, while a recovery is expected to be underway, we believe this recovery trajectory will slow and gradual. From our read-through of the recently-announced Petronas Activity Outlook 2021-2023, we gathered that overall activity levels are still expected to stagnate for the coming year, as most of the value chains are expected to see flattish or lower activity levels in 2021, from 2020. This somewhat downplays the possibility of a recovery to pre-pandemic activity levels during the year, amidst Petronas’ increased prudence in spending given its dwindling net-cash position, coupled with increased tax and dividend commitments. From Petronas’ activity outlook, while no particular sub-sector emerged as a clear winner, we see the brownfield space as a potential partial winner as it benefits from increased activities across various value-chain – e.g. increase in hydraulic workover unit demand, wells decommissioning and services. This is likely to benefit brownfield contractors such as UZMA. Conversely, losers would be value chains that are exposed to greenfield projects – e.g. fabricators (e.g. SAPNRG, MHB), hook-up and commissioning (e.g. DAYANG, CARIMIN) and jack-up rig providers (e.g. VELESTO). (Refer to our report dated 4th January 2021 for a more detailed takeaway from the Petronas Activity Outlook).

Are valuations fairly priced? As for valuations, the sector as a whole is currently trading near mean valuation levels, in terms of both PBV and PER basis – down from +1-2SD earlier in 2020. While this means that as a sector in its entirety, valuations are fairly priced at the moment (recovery theme being well priced-in), this may also mean the emergence of selective stock picks. Depending on risk adverseness, we have identified the followings:

For defensive picks, we highlight: DIALOG (OP, TP: RM 4.35), SERBADK (OP, TP: RM2.50) – as these names have proven resilient and are still able to deliver earnings growth despite the challenging environment.

For recovery picks, we highlight: UZMA (OP, TP: RM0.72) – being one of the few beneficiaries of increased brownfield activities, coupled with its steeply discounted valuations.

For oil price trading proxies, we highlight: PCHEM (MP, TP: RM6.45), HIBISCS (Not Rated), LCTITAN (Not Rated) – given their high earnings dependency on oil prices, with our studies also showing that their share prices are also highly correlated to oil price movements.

Maintain NEUTRAL. While the worst of the downturn is seemingly behind us, sector fundamentals still remain weak. Fundamentally speaking, Petronas-related counters (i.e. PCHEM, PETDAG) are still trading at lofty valuations given their deteriorating ROEs. UZMA (OP, TP: RM0.72) emerges as our top trading pick, while DIALOG (OP, TP: RM4.35) and SERBADK (OP, TP: RM2.50) remain as our fundamentally-driven favourites.

Source: Kenanga Research - 6 Jan 2021