This article first appeared in The Edge Financial Daily on June 6, 2017 - June 12, 2017

Oil and gas sector
Retain neutral call: Petroliam Nasional Bhd’s (Petronas) core earnings in the first quarter ended March 31, 2017 (1QFY17) improved by 25% year-on-year (y-o-y) to RM10.5 billion from RM8.4 billion in 1QFY16, thanks to higher average realised prices recorded (Brent prices up 59% y-o-y, Japanese Crude Cocktail (JCC) prices up 32%), strengthening of the US dollar against the ringgit (+6% y-o-y) as well as higher gas sales volume (+2% y-o-y).

Note that downstream segmental earnings also jumped by 1.6 times, underpinned by higher average selling prices and better margins as a result of improved plant utilisation to 86% from 83% in 1QFY16. The profit after tax (PAT) margin is 10.6% versus 5.3% in 1QFY16.

Sequentially, Petronas’ core PAT was down 15% from RM12.3 billion in 4QFY16 despite revenue growing 5% as it was largely bogged down by higher amortisation of oil and gas properties and higher tax expense (+19% quarter-on-quarter [q-o-q]) and higher net foreign exchange (forex) loss.

Petronas recorded higher earnings before interest, taxes, depreciation and amortisation (Ebitda) (+12% q-o-q, +58% y-o-y) in line with better average realised prices.

Apart from a higher top line, based on our channel checks, Petronas requested for further rate cuts in services cost in the beginning of the year. Thus, we saw its controllable operating expenditure (opex) cost down by 3% y-o-y and operating cash flow (OCF) in 1QFY17 strengthened (+2% q-o-q,+86% y-o-y), in tandem with higher Ebitda.

Meanwhile, Petronas spent RM11.9 billion on capital expenditure (capex) in 1QFY17 (-18% q-o-q, +6% y-o-y), of which 92% were attributable to local investment. We reckon the bulk of it was attributable to committed investment in the Pengerang Integrated Complex project, which was at 63% completion as of March this year.

Moving forward, Petronas will continue to embark on cost optimisation measures to lower its cost base. Petronas had spent an average capex of RM36 billion per annum in the past five years with about 60% allocated to the upstream segment. Capex-wise, we believe a higher priority will be given to the downstream segment, particularly the Refinery and Petrochemical Integrated Development (Rapid) project in the near term.

No dividend was paid in 1QFY17 as expected. In FY17, we believe Petronas’ OCF, at the most, is sufficient to cover its committed capex of RM60 billion but might not be sufficient to fully fund its dividend commitment of RM13 billion (versus RM16 billion in FY16). However, this is not alarming, in our view, given that Petronas’ balance sheet remains healthy with a net cash position of RM59.2 billion as of 1QFY17, improving from RM53.9 billion in 4QFY16.

The decision of Opec and non-Opec members agreeing to extend production cuts for nine months was slightly disappointing as some parties were expecting deeper production cuts.

With this outcome, we expect oil prices to trade at a lower range of US$48 (RM202.56) to US$52 per bbl in the near term versus US$53 to US$57 per bbl during the initial cut last December. However, better oil prices could be seen in the second half of FY17 on stronger demand and potential further price propping actions led by Saudi Arabia ahead of valuations of Saudi Aramco’s initial public offering (IPO).

Recently, news reported that Opec could revisit the proposal for a further cut of up to 300,000 bbl per day from the existing 1.2 million bbl per day cut. However, such a proposal is very much dependent on the reaction of other Opec producers as well as non-Opec countries. All in, we retain our in-house Brent oil forecast of US$55 per bbl for 2017.

Within the local scene, as higher priority is given by Petronas to the downstream, where most of the activities are considered commitment investments, it is unlikely to see further adjustments at the expense of the upstream segment should Petronas decide to trim down its capex budget. Hence, any cut from the upstream space will be dependent on the degree of project maturity and certainty of requirements.

Petronas has earmarked 10 to 15 greenfield projects and 20 to 25 brownfield projects for 2017 to 2019. The long-awaited maintenance, construction and modification contract amounting to RM5 billion is likely to be out in 2QFY17.

All in, we reiterate our “neutral” call on the sector but remain bullish on floating production, storage and offloading (FPSO) players such as Bumi Armada Bhd (outperform [OP]; target price [TP]: 90 sen) and Yinson Holdings Bhd (OP; TP: RM3.73) and service players like Dayang Enterprise Holdings Bhd (OP; TP: RM1.30) and Uzma Bhd (OP; TP: RM2.05) which are potential beneficiaries of a new round of contract awards within the opex space. — Kenanga Research, June 5